My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Monday, October 14, 2013

Qualifying Spousal Trusts – What are They and Why do we Care?

Last week I noted the concept of a qualifying spousal trust in my post on "When Spouses Don’t Leave All Their Assets to Each Other - The Income Tax Implications". The creation and use of spousal trusts can be very complicated, so I thought this week, I would have Katy Basi, an estate expert break down the topic. I just had no idea 88 Fingers Louie and brontosaurus burgers would be that integral to the explanation.

Qualifying Spousal Trusts- What are They and Why do we Care?

By Katy Basi


Whenever I am drafting wills for spouses, I’m usually on the receiving end of both a quizzical look, and a moment of silence, near the beginning of the first meeting.

My clients level a quizzical look at me when I tell them that their plan of leaving everything to each other, and then to their children, means that they are creating “just trust me” wills.

To illustrate this point, we run the scenario of Fred dying and leaving everything to Wilma. After a suitable period of grieving, Wilma marries Barney (I’ve assumed that Betty divorced Barney years ago and has been living it up in Cuba). In Ontario, marriage revokes a will, so Wilma is intestate. Understandably alarmed, she runs to her nearest estates lawyer and draws up a new will, leaving everything to Barney. Wilma is concerned about Barney, as he not skilled at saving for retirement and will need funds in his old age if Wilma predeceases him.

Hmmm. That’s when the moment of concerned silence arrives. Back when Fred and Wilma made their original wills, they were trusting each other to “do the right thing” in the future. Sometimes that works out! Sometimes, not so much.

How can we address this issue? There are three main options:

1) Call up a family lawyer. The family lawyer can draft a marriage contract requiring Fred and Wilma to keep their current estate plan regardless of future circumstances. This is a relatively expensive and time-consuming option, especially if the only goal is to manage estate issues.

2) Create “mutual wills”. Mutual wills are essentially wills where Fred and Wilma promise not to change their wills in the future. I do not recommend mutual wills – they are fraught with legal uncertainty, and litigation abounds when mutual wills are in play.

3) Create “qualifying spouse trusts” (“QSTs”) in Fred and Wilma’s wills.

Let’s say that the residue of Fred’s estate was left to Wilma in a QST. If Fred dies first, a trustee (usually but not always the executor) will hold the residue in trust for Wilma. If there are funds left in the QST at Wilma’s death, it is Fred’s will that determines the distribution of the funds (not Wilma’s!) Upon Wilma’s death, Fred’s will instructs the trustee to divide the remaining funds among their children. This is starting to sound like a good idea!

A QST is a special kind of trust, with beneficial tax effects. When Fred dies, he is considered, for tax purposes, to have disposed of all of his assets at fair market value, and he will be taxable on any capital gains triggered by this disposition. There is an exception to this rule if Fred leaves his assets to Wilma, or to a QST. Fred is then considered to have disposed of his assets at his cost for tax purposes (so that no gain is triggered upon Fred’s death), and the QST is considered to have acquired the assets at that same cost. When Wilma dies, the QST will be considered to have sold its assets at fair market value, finally triggering any accrued capital gains. More or less, these are the same tax effects as if Fred had left the residue of his estate directly to Wilma.

So….we can use a QST in Fred’s will to provide for Wilma’s needs and take care of their children, without being disadvantaged from an income tax point of view. But how do we ensure that the QST functions effectively to protect Fred’s estate? On Wednesday, in Part 2 of this blog post I will address this issue and other practical questions such as how to ensure that the QST applies to the right assets.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. 

Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts, estate planning, estate administration and income tax law. Katy practiced income tax law for many years with a large Toronto law firm, and therefore considers the income tax and probate tax implications of her clients' decisions. Please feel free to contact her directly at (905) 237-9299, or by email at katy@katybasi.com. More articles by Katy can be found at her website, katybasi.com.