The Best of The Blunt Bean Counter - Taking it to the Grave or Leaving it all to your Kids?

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting a July 2011 post (originally written as a guest post for The Canadian Capitalist) on estate planning and the four groups (at the risk of stereotyping) that people seem to fall into, when dealing with their estate.

Next week I will have a re-post of  a blog on accessing the capital dividend account for those of you that have private corporations and then a three-part series on a true summer topic - the tax issues surrounding the sale and/or transfer of your cottage.

Taking it to the Grave or Leaving it all to your Kids?

I am often engaged to provide estate planning. Many "older" Canadians have amassed great wealth (some just through the sale of their home and/or cottage). A 2006 Decima Research study estimated that over one trillion dollars in wealth could be transferred between 2006-2026. After twenty-five years of discussions regarding the distribution of wealth, where an estate will clearly have excess funds when the parents pass away (to be clear, this post is only discussing situations where you are very certain you have more funds than you need to live, not situations where you may have excess funds when you pass away, but are not secure enough to distribute while alive) it is my opinion that the parents should consider partial gifts during their lifetime.

It is my observation from the 25 years of meetings that people form four distinct groups when it comes to distributing their excess wealth:

1. Those that will take their wealth to their grave (or leave it to their pet Chihuahua)
2. Those that will distribute their wealth only upon their death
3. Those that may not be able to afford their grave (as they give and give to their children)
4. The most common, the middle ground of the extremes, those who are willing to distribute their wealth, but in many cases harbour concerns their wealth will be “blown” or lead to unmotivated children.

In this blog, understanding my opinions may be diametrically opposed to some readers, I will talk about these varied groups.

Taking it to the Grave and Leaving Nada to Your Family

For those who wish to take their wealth to the grave, there may be an altruistic or philosophical reason. However, there is more often than not, a deep rooted family issue, and the chill in the room makes it very clear that advisors should stay clear of delving into these family issues (when I initially wrote this post, I was criticized by a reader for saying the advisor should stay clear in these cases. I now think they were correct. I can think of a specific case since I wrote this post in 2011 where I challenged a client on this and they made a change to their will not because they really wanted to, but because the change could possibly help avoid litigation down the road, despite it being distasteful to them). 

Distributing your Wealth upon your Death

In the case of those who wish to distribute their wealth upon their death, the issue is typically philosophical. That is, one or both of the parents feel that their children need to make their own way in the world and that leaving them money during their lifetime will do their children a disservice or destroy their moral compass. This is a touchy area, but I often suggest that if the parents feel their children are well-adjusted, they should consider providing partial inheritances. A partial inheritance can facilitate a child’s dream, such as climbing Mt. Kilimanjaro while the child is physically able, or assist with the down payment on a cottage. The selling point on partial distributions is that the parents can share vicariously in the joy of the experience they facilitate.

Giving your Kids too Much while Alive

In the third situation, the parents spend every spare nickel on their children’s private school, dance lessons, hockey teams, etc., while younger and then assist in buying houses, cars, etc., when their children are older. In these cases I suggest the parents pare back the funds they spend on their children and/or make the children contribute to their own activities. It is imperative the parents impart upon their children that they are not an ATM and that there are family budgetary limits to be adhered to, often easier said than done.

The Balanced Approach

The majority of families fall into the last category. They are willing to distribute their “excess” wealth while alive, but in many cases harbour concerns their wealth will be “blown” or lead to unmotivated children. Dr. Lee Hausner, an advisor to some of the wealthiest families in the United States, suggests in various articles of hers that I have read, that parents do not transfer money during career-building years so the children learn to be productive members of society. Children should be taught they have choices to make (ie: distribute money for one thing they want but not three things they want) and they should learn to be philanthropic amongst other things. I think this advice stands on its own whether you are one of the wealthiest families in the United States or just a family that has been lucky enough to accumulate more assets then you will ever require.

How one distributes their wealth is an extremely private issue and each individual has their own thoughts and reasons for their actions. However, in my opinion, where you have the financial wherewithal, you should consider making at least partial gifts during your lifetime.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

The Best of The Blunt Bean Counter - Personal Use Property - Taxable even if the Picasso Walks Out the Door

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. In March, 2011 I wrote this blog post on personal use property and how many families tend to "ignore" these type of items for income tax and probate purposes.

Since 2011, this has become an even larger issue in Ontario, to name one province, as recent legislation has increased the liability of executors. So if you are an executor, tread carefully with respect to Personal Use Property such as art and collectibles.

Personal Use Property - Taxable even if the Picasso Walks Out the Door

I will start today’s blog with a question. What do stamps, duck decoys, hockey cards, dolls, coins, comics, art, books, toys and lamps have in common?

If you answered that the collection of these items are hobbies, you are partially correct. What you may not know is, that these hobbies also generate some of the most valuable collectibles in the world.

When a collector dies and leaves these types of collectibles to the next generation, the collectibles can cause rifts among family members. The rifts may occur in regard to which child is entitled to ownership of which collectible and whether the income tax liability related to these collectibles should be reported by the family members.

Let’s examine these issues one at a time. Many of these collectibles somehow "miss" being included in wills. I think the reason for this is two-fold. The first reason is that some parents truly do not recognize the value of some of these collectibles, and the second more likely reason is, that they do realize the value and they don't want these assets to come to the attention of the tax authorities by including them in their will (a third potential reason is that your parents frequented disco's in the 70's and they took Gloria Gaynor singing "Walk out the Door" literally- but I digress and I am showing my age).

Two issues arise when collectibles are ignored in wills:

1. The parents take a huge leap of faith that their children will sort out the ownership of these assets in a detached and non-emotional manner, which is very unlikely, especially if the collectibles have wide ranging values; and
2. The collectibles in many cases will trigger an income tax liability if the deceased was the last surviving spouse or the collectibles were not left to a surviving spouse. 

Collectibles are considered personal-use property. Personal-use property is divided into two sub-categories, one being listed personal property (“LPP”), the category most of the above collectibles fall into, and the other category being regular personal-use property (“PUP”).

PUP refers to items that are owned primarily for the personal use or enjoyment by your family and yourself. It includes all personal and household items, such as furniture, automobiles, boats, a cottage, and other similar properties. These type properties, other than the cottage or certain types of antiques and collectibles (e.g. classic automobiles), typically decline in value. You cannot claim a capital loss on PUP.

For PUP,  where the proceeds received when you sell the item are less than $1,000 (or if the market value of the item is less than $1,000 if your parent passes away) there is no capital gain or loss. Where the proceeds of disposition are greater than $1,000 (or the market value at the date a parent passes away is greater than $1,000) there maybe a capital gain. Where the proceeds are greater than $1,000 (or the market value greater than $1,000 when a parent passes away), the adjusted cost base (“ACB”) will be deemed to be the greater of $1,000 or the actual ACB (i.e. generally the amount originally paid) in determining any capital gain that must be reported. Thus, the Canada Revenue Agency essentially provides you with a minimum ACB of $1,000.

LPP typically increases in value over time. LPP includes all or any part of any interest in or any right to the following properties:

1. prints, etchings, drawings, paintings, sculptures, or other similar works of art; 
2. jewellery; 
3. rare folios, rare manuscripts, or rare books; 
4. stamps; and 
5. coins. 

Capital gains on LPP are calculated in the same manner as capital gains on PUP. Capital losses on LPP where the ACB exceeds the $1,000 minimum noted above, may be applied against future LPP capital gains, although as noted above, these type items tend to increase in value.

The taxation of collectibles becomes especially interesting upon the death of the last spouse to die. There is a deemed disposition of the asset at death. For example, if your parents were lucky or smart enough to have purchased art from a member of the Group of Seven many years ago for say $2,000 and the art is now worth $50,000, there would be a capital gain of $48,000 upon the death of the last spouse (assuming the art had been transferred to that spouse upon the death of the first spouse). That deemed capital gain has to be reported on the terminal income tax return of the last surviving spouse. The income tax on that gain could be as high as $12,000.

The above noted tax liability is why some families decide to let the collectibles “Walk out the Door.” However, by allowing the collectibles to walk, family members who are executors can potentially be held liable for any income tax not reported by the estate and thus, should tread carefully in distributing assets such as collectibles.

If you are an avid collector, it may make sense in some circumstances to have the collectibles initially purchased in a child’s name. You should speak to a tax professional before considering such, as you need to be careful in navigating the income attribution tax rules.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

Believe it or Not - We Are Not Immortal

Last week, Adam Mayers of The Toronto Star reviewed my book, Let’s Get Blunt About Your Financial Affairs. Thank you Adam for your review and in particular, your discussion about my views on inheritances.

Adam interviewed me for this article and one of the questions he asked me was "if there was anything I had learned or anything that I wanted to say about my book". I told him that while the book had an income tax bent, I had come to understand that an underlying theme of the book was to ensure that you put your financial house in order.

I also told Adam that while writing my speech for my book launch, I realized how much of my talk revolved around our denial of our mortality and the massive impact that it had financially and emotionally upon our families.

Think about it. Many of us do not want to accept our eventual death. The net result is either we avoid preparing a will (a 2012 survey by Lawpro says 56% of Canadians do not have a will) or we procrastinate updating our will, even when we have significant life events. I’ve seen this pattern repeated first-hand over the last 25 years.

When people finally prepare a will, many do not even inform their executor of their appointment. Even fewer provide the executor with a list of assets and where they are located. Why make the executor’s job easier if we are never going to die?

Finally, since we don’t want to consider our death, we often leave our spouse's in the financial dark, at a time of immense distress, because they have no idea what assets the family has and where they are located. Over the years, I have written several times on this subject and how you should stress-test your finances.

Ensure your spouse and loved ones are prepared and avoid hardship by providing them with the following financial roadmap:

• Location of your will and the name of the lawyer who drafted the will

• Name of your Executor(s)

• List of assets

• List of insurance policies

• List of digital assets including passwords

• Contact list for accountant, insurance agent, investment advisor, banker etc.

• Existence of accounts, safety deposits, safes

Ask yourself, could your spouse move forward seamlessly from a financial perspective if you passed away today? If your answer is no, get to work on preparing an Information Checklist/Estate Organizer.

As John F Kennedy said in a 1963 address to American University, “in the final analysis, our most basic common link is that we all inhabit this small planet. We all breathe the same air. We all cherish our children's future. And we are all mortal”.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Recent Changes in Legislation Make Reviewing Your Will A Must

Tax changes that will become effective January 1, 2016, may have a harsh and surprising effect on your will and estate planning. To explain these new changes, I have a guest poster, Howard Kazdan, a tax expert with BDO Canada LLP.

Below, Howard highlights some of the more significant changes in the legislation.

Recent Changes in Legislation Make Reviewing Your Will A Must

By Howard Kazdan

 

The interaction of life’s two certainties – death and taxes – is about to get more complicated effective January 1, 2016, due to legislative changes to the taxation of trusts and estates that have been enacted. You may wish to review your will after considering the information discussed in today's post.

Change in tax rates for estates and testamentary trusts, except for Graduated Rate Estates ("GRE")

 

Currently, estates and testamentary trusts (i.e. trusts that are created by will upon death) are subject to tax at graduated tax rates. Under these old rules, you could set-up multiple trusts (generally for each child to control their inheritances) to be taxed at the lower graduated income tax rates.

Effective January 1, 2016 only a GRE will be eligible for graduated tax rates. The lower tax rates may only be available during the first thirty-six months of the estate if that period is required to settle the estate. All of the income in other estates and testamentary trusts will be taxed at the highest personal tax rate. Under the new rules, if you had set-up say 3 separate trusts for each of your children, all of them will be subject to the highest tax rate, as they will not be considered GRE’s (however, there may be non-tax reason for still creating multiple trusts, such as to protect against spendthrift children, protect assets for family law purposes and asset protection).

The administration of these new rules may also become challenging where you have multiple wills (some provinces allow for two wills, one for personal assets and one for assets that are not required to be probated) and have different executors, since all of the wills may make up one estate. If one component of the estate no longer qualifies as a GRE, the entire estate may no longer qualify, and therefore all income will be taxed at the highest marginal tax rate.

Finally, the availability of tax elections for income to be taxed in a trust at graduated rates, even if such income was paid or payable to a beneficiary will now be extremely limited.

To qualify as a GRE certain conditions must be met, which include: 

 

• The estate must arise as a consequence of death

• The determination time is within the first thirty-six months of the estate

• The executor must designate the estate as a GRE

• No other estate can be designated as a GRE

Other benefits that will only be available to a GRE also include:

• ability to maintain an off-calendar year end

• ability to avoid capital gains on taxation of donated securities

• no requirement to make tax installments

• ability to carry losses back to terminal return

• more flexibility for claiming tax credits in respect of donations made by will/bequests

Due to the significant benefits of qualifying as a GRE, it will be necessary to plan accordingly.

Change in taxation of Life Interest Trusts

 

These trusts are often used to provide an income stream to a surviving spouse during their lifetime with the residual assets being distributed to other beneficiaries after that individual dies.

For example, spousal trusts are common in a blended family where husband and wife were previously married and each has children from a previous marriage. The husband may have established a spousal trust in his will whereby his wife was to receive income during her lifetime, but his children from previous marriage will receive the capital of the trust after she dies, and her children from a previous marriage are the beneficiaries of her estate after she dies.

Currently, when the wife dies, there will be a deemed disposition of the assets of the trust at fair market value and any income arising from the deemed disposition will be taxed in the trust.

The new rules will shift the reporting of income arising in the final year before death of the wife, including income on the deemed disposition of the assets, to her final income tax return. Since the beneficiaries of her estate and the spousal trust are different, this will lead to inequitable results (estate beneficiaries will owe tax, but the trust beneficiaries will own the assets). If the Canada Revenue Agency is unable to collect this tax from the estate, then it will have the ability to demand payment of the tax from the trust beneficiaries.

Planning for Disabled Persons

 

The new rules provide for a Qualified Disability Trust (“QDT”) which can be established for a beneficiary that qualifies for the disability tax credit. A QDT will allow for the taxation of income at marginal tax rates during that beneficiary’s lifetime, provided all of the required conditions are met.

As the conditions are very complicated and potentially require elections, it is imperative to review any wills that have provisions for a disabled person in context of the new rules with your lawyer and accountant.

Charitable Bequests On Death

Currently, on death, donations in the will are included in the final tax return of the individual or in the prior year, not in the estate return. Under the new rules, the donation will be deemed to be made from the estate which may result in additional flexibility in claiming the donation tax credit if the estate qualifies as a GRE.

The new rules are very complex and it would be prudent for your accountant and/or lawyer to review your will and any current estates, testamentary trusts or other life interest trusts that you may be connected with as a trustee, executor or beneficiary because planning strategies previously anticipated may no longer be effective. Where it is possible to amend such documents, it may be advisable to do so. Where it is no longer possible to amend such documents then additional planning may be required to determine next steps.

Here is a link to an excellent BDO tax memo which you may also wish to read if you want more detail.

Howard Kazdan is a Senior Tax Manager with BDO Canada LLP. He can be reached at 905-946-5459 or by email at hkazdan@bdo.ca

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

The Best of The Blunt Bean Counter - Stress Testing your Spouse's Financial Readiness if you were to Die Suddenly

This summer I am posting the "best of" The Blunt Bean Counter blog while I work on my golf game. Today, I am re-posting an October, 2012 blog on stress testing your spouse's financial readiness if you were to die suddenly. This post has proven to be my most impactful blog post ever. It spawned a couple of newspaper articles, led to a BNN appearance, various interviews and has been the topic of several speeches.

Stress Testing your Spouse's Financial Readiness if you were to Die Suddenly

I have written about several morbid estate planning topics on my blog. However, I think today’s post easily ranks as #1 on the morbidity scale.

I will have the impertinence to suggest that you should stress test how financially and organizationally ready your spouse would be should you die suddenly, or vice versa.

Essentially I am telling you to take a financial and organizational walk through your death.

As I don’t want to be known as Morbid Mark, I am going to provide a side benefit of undertaking this morbid task. Girls, instead of the usual headache excuse, tell your guy sure, but first lets stress test your death. I guarantee you will have the night off. Guys, if your wife is taking you to the ballet, just before you are about to leave, tell her you just want to financially stress test her death and I don’t think you will have to attend the Nutcracker.

Seriously though, even with today’s modern families, where both spouses often have some level of financial acumen, most families really give little thought to what would happen if god-forbid one of them passed away unexpectedly.

It is important to understand that this post is not intended for older readers, but to anyone married or in a common law relationship, no matter their age. A 40 year old can get hit by a car anytime, just as much as an elderly person can pass away due to old age. The idea for this blog came about because I realized if I passed away suddenly, I had only partially provided my wife a financial road map or our assets, insurance polices etc. Why I am even cognizant of such a morbid concern is that my father passed away suddenly 25 years ago and if I was not an accountant, my mother would have been overwhelmed trying to find insurance polices, bank accounts and various other investments at a time of intense grief and shock.

Many of the comments I make below were discussed in Roma Luciw's Globe and Mail article Why you should stress-test your finances for a sudden death, so I apologize for any duplication if you read that article, but there are additional links below.

Some of the issues that need to be stress-tested:

1. If you have pre-paid your funeral or have certain wishes, ensure your spouse is aware of where this information is located.
2. Does your spouse know where to find a copy of and/or the lawyer who drafted your will? More importantly, is your will up-to-date? If you own your own company, do you have two wills?
3. Do you have a folder for all your insurance policies? Does your spouse know where it’s located? While in good health, you should prepare a summary of all insurance policies you have on an excel spreadsheet; list the policy number, the insurance company, the type of insurance as well as the value of the insurance and staple it to the front of your insurance folder. You may also want to create a special password protected file (let’s call it the “Information Folder” for lack of a better name) on your spouse’s computer that contains this summary information.
4. Do you have a list of the assets you own and where they are located? As I discussed in my blog Where are the Assets, you should complete and update yearly a basic information checklist. Again, I suggest a PDF placed in your Information Folder.
5. As I discussed in this blog on Memory Overload, the use of multiple passwords is so prevalent that you should consider making a list of your key passwords for your spouse, that again is either put into the Information Folder or another more secure location. The objective of this exercise is to ensure your spouse will not be locked out of your various financial accounts because he/she does not know the passwords.
6. Do you have a contact list for your spouse with the phone numbers and contact information of your accountant, lawyer and financial advisor? Have you introduced your spouse to these people? Again, consider creating a PDF and putting it in the Information File.
7. Consider any accounts, safety deposit boxes, etc. your spouse may not be aware of. There are various reasons one spouse does not make another spouse aware of these items. However, the reason for their existence is not relevant here, what is important is that you somehow ensure that someone will become aware of the existence of these accounts or safety deposit boxes if you die. 

The above list is far from comprehensive. However, the intention of this blog was not completeness, but to get you to take a step back and consider the unthinkable and whether or not you have prepared the proper trail to allow your grieving spouse to move forward financially with the least amount of stress. I know this is morbid and people tend to procrastinate or ignore anything related to death, but look at this as selfless instead of morbid and maybe you will be moved to act.

 

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

The Two Certainties in Life: Death and Taxes - Impact on Your Personal Income Tax Return

Last week you read that upon your death, you are deemed to have disposed of your assets for income tax purposes (unless you leave them to your spouse). Today, you'll get a closer look at these rules.

For purposes of this post, I am assuming your spouse has predeceased you, or you leave your property to someone other than your spouse; so that there is not a tax-free transfer available upon your demise.

General Rule

Upon death, you are deemed to have disposed of your property for proceeds equal to its fair market value (“FMV”). This is known as a deemed disposition. The deemed disposition being equal to the excess of the FMV over the adjusted cost base of the property (“ACB”). For example, say you purchased 1000 shares in Blunt Bean Inc. for $150,000 and the shares are worth $275,000 upon your death. Your executors would have a $125,000 capital gain to report on your terminal tax return (final return from Jan 1st of the year you die to the date of your death).

For most people, there are two basic categories or property upon death, those being non-depreciable capital property and capital property.

Non-Depreciable Capital Property

Non-depreciable capital property would typically include shares, bonds, land (note: depending on the circumstances, land may not be capital property) and partnership interests. As noted above, upon death you are deemed to have disposed of your non-depreciable property for proceeds equal to its FMV. To be clear, that means the $125,000 capital gain in the example above is reported on your terminal return, notwithstanding you never sold the shares of Blunt Bean Inc. Thus, upon your death, for tax purposes you have in essence been “deemed” to have sold all your non-depreciable capital property even though there is no actual sale.

If you left the shares of Blunt Bean Inc. to your daughter, the ACB of the shares to her will become $275,000, which accounts for the fact your estate already paid tax on the increase in value from $150,000 to $275,000.

If the deemed disposition results in a capital loss, the losses offset any capital gains on the terminal return. If your capital losses exceed your capital gains in your final return, you can then deduct those excess losses against other income in the year of death, or in the previous year to the extent you have not previously claimed the capital gains exemption.

Principal Residence

Your principal residence is technically subject to the deemed disposition rules. However, if you only have one house (no cottage) and have lived in that house since it was purchased, your estate will typically be able to claim the principal residence exemption on your behalf and that property will be tax-free. It is important to note that your estate may have a capital gain or loss when it sells your principal residence, if the value of your principal residence has increased or decreased from the deemed value on the date of your death. This can occur where it takes a while to sort out the estate and the principal residence is not sold for months or even years.

Some Exceptions to the Deemed Disposition Rules

There are a couple significant exceptions to the deemed disposition rules:

(1) There is no deemed disposition on your cash holdings; however, if you hold foreign currency, you could have a foreign exchange gain.

(2) There is also no deemed disposition on your TFSA; however, there are various rules relating to what happens after your death to your TFSA. Taxtips.ca has a good summary here.

Depreciable Capital Property

Depreciable capital property would typically include buildings owned for rental purposes by the deceased taxpayer, and equipment used in an unincorporated business.

For depreciable property the same deemed disposition rules apply. However, there can also be recapture of prior depreciation (capital cost allowance claimed) where the FMV exceeds the undepreciated capital cost allowance (“UCC”) or instead of a capital loss, there may be a terminal loss where the deemed proceeds are less than UCC which can be used to offset other income in the year of death.

RRSP/RRIF

At the date of your death, the value of your RRSP or RRIF is included as income on your terminal return. For example, if your RRSP has a FMV of $560,000 on the day you die; your terminal return would reflect income of $560,000. The estate is supposed to receive a tax slip for the $560,000 RRSP/RRIF value upon death, but it has been my experience, that these slips are often not issued or are issued incorrectly, so you need to be diligent that the correct value is included on the terminal return. (As noted at the outset, I have assumed your spouse has already passed away, so the RRSP cannot be transferred tax-free to your spouse. However, the tax may be deferred if the beneficiary is a financially dependent child or grandchild under 18 years of age, or a financially dependent mentally or physically infirm child or grandchild of any age).

Note: See the comment section below for an interesting point made by Jean-Pierre Laporte about using a personal  pension plan to avoid the deemed disposition in relation to RRSPs.

Asset Rich but Cash Poor

Under the deemed disposition rules, it is possible to have a large deemed capital gain and a large associated income tax liability, yet not have the liquid assets to pay that liability. For example, you have significant real estate assets that appreciated considerably before your death, but little cash. In these cases, the estate may qualify to file form T2075 which allows for taxes to be paid in ten or less annual installments, with interest. In order to utilize this provision, security would have to be provided to the CRA.

The above is just a general overview of the income tax rules upon death. There are various other detailed rules I have not discussed that may relate to the death of an individual. Next week, I finish this discussion when I review the rules relating to the ownership of shares of a private corporation.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

The Two Certainties in Life: Death and Taxes

We have all heard the famous quote “In this world nothing can be said to be certain, except death and taxes”. Did you know the person who uttered this profound statement was none other than Benjamin Franklin?

This blog post and the two follow-up posts, will share with you the income tax consequences of Benjamin's second certainty, the always popular subject of dying.

Deemed Disposition

Ignoring the fact that the U.S. Income Tax Code in the 1700's may have been slightly different than today, Franklin's view on death and taxes was that of an American. This distinction is very important. The U.S. tax system taxes you on the value of your estate upon death, while Canada deems you to have disposed of your property at death, at its fair market value, which triggers income tax on any unrealized capital gains (paper gains).

I will explain this “deemed disposition” in greater detail later on, but simply put, if you own shares in say Bell Canada that are worth $40 upon your death, that you purchased for $15, you/your estate are deemed to have a $25 ($40-$15) capital gain per share, if your assets are not left to your spouse.

Probate Fees

Depending upon the province in which you live, you may also be subject to probate fees (Estate Administration tax in Ontario) on the value of your estate at death. However, notwithstanding people plan around probate fees, often to their detriment; these fees/taxes are typically fairly immaterial to an estate in Canada (1.5% versus 40% Estate tax in the U.S. or higher, depending upon the state and size of your estate). Here is a summary of the probate fees for each province. For purposes of this blog, and the two follow-up blog posts I have written, I am just going to focus on the “deemed disposition” upon death and ignore probate fees.

Personal vs Corporate

 

It has been my experience that most people are not clear about how the income tax system works upon their death. In particular, shareholders of private corporations are often surprised when I inform them that any increase in value of the shares of their private corporate shareholdings are subject to income tax upon their death (they often think the yearly corporate tax they pay has covered this liability). This does not even account for the fact that without proper tax planning, there could be double taxation in respect of their corporate shareholdings.

In order to deal with the distinction between the personal and corporate income tax consequences, I have made this topic a three-part blog series. Next week, I will deal with the personal income tax consequences of you dying, and the following week, I will discuss the income tax consequences of dying when you own shares in a private corporation.

Just Die First

 

You can avoid all these messy income tax complexities upon death by just dying first☺ if you are married or in a common-law relationship. This is because if you leave your property to your spouse or common-law spouse, the property passes to them at the adjusted cost base of the property and the capital gain is deferred until the surviving spouse or common-law partner dies, or they sell the property during their lifetime.

Consequently, the deemed disposition rules typically only apply in the following three situations:

(1) Your estate elects out of the automatic transfer to your spouse (this can be done on a property by property basis).

(2) You are the last to die spouse.

(3) You leave your property to your children or other beneficiary, instead of your spouse.

Next week, I will discuss in greater detail, the personal income tax consequences of passing away. 

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Just Do It – Write Your Financial Story! What the Heck are You Waiting For?

I am back from my summer blogging sabbatical and I am cranky. Not because I worked on my golf game and it is only marginally better. Nope, I am cranky because you, my readers, are listening to my suggestions but you’re not following up on them.

So what am I ranting about? Let me tell you. I have written a number of times about ensuring you update or prepare a will, ensuring you have powers of attorney ("POA") for both your financial affairs and health, and have also posted a couple detailed blogs on stress testing your finances should you die suddenly.

I have been pleased that many readers, friends, and acquaintances have told me that these posts have been very helpful. I have been delighted when they inform me they intend to take action in getting their financial house in order, to ensure their spouse/partner can carry on somewhat seamlessly should they pass away.

The problem is when I see them and ask if they have followed through; the answers I get are either: (a) I have started or (b) it is on my list of things to do.

Even financial experts like Ellen Roseman procrastinate. As Ellen wrote in this article, it was her 2013 New Year’s resolution to put her financial house in order. However, six months later Ellen wrote she had made little progress in “writing her financial story”. When I saw Ellen several months later at the Canadian Bloggers Conference, she informed me she still had not completed her New Year’s resolution. I have not spoken to Ellen lately, so she may have completed her task, but it is more fun to use a financial expert as Exhibit A :).

Ellen is not alone. A friend of a friend who is a very sophisticated financial person has told me on three different occasions how useful my blogs on this topic were, but yet, each time I ask him about his progress, I get silence.

So how do we break this log jam? If you are the financially savvy spouse/partner (in most marriages/relationships, one spouse/partner tends to handle the finances and the other spouse/partner often pays little or no attention to the finances) how about asking your spouse/partner tonight at dinner if you were to die suddenly, would he/she know where your will is, what assets you have, where to find the insurance, any of the passwords to your financial accounts, etc.? I would suspect the answer is no (after they blame you for ruining their dinner). Now sit back and think for a minute… not only will your family be in mourning (unless they are hoverers), but consider the financial and emotional stress you will be putting your spouse/partner under as they attempt to untangle your financial web.

Getting Your Financial House in Order

There a four key components to getting your house in order.

1. Discuss – Sit down with your spouse/partner and discuss whether your will(s) reflect your current financial situation and life realities. Determine what awareness they have of your financial situation and how easily they/you could carry on if you/they passed away.

2. Dig – Go through all your financial documents and pull together information in respect of your bank accounts, insurance policies, investment accounts, assets, passwords, loans and LOCs etc.

3. Document – Document the above in one location, be it your safety deposit box, a safe or via one of the Internet vaults.

4. Update – Some of you may be sitting back smugly saying “I have done this already Mark”. However, this is an ongoing process. You need to update your financial story annually. I know this because I updated my list six months ago and recently noticed that five passwords had to be changed because sites were compromised, or I was required to change passwords. I also moved some assets around to new locations.

If I have not guilted you into action, I am not sure what else I can do. All other alternatives I can offer you allow you to procrastinate, so I am not sure they will help. Writing your financial story, as penned by Ellen, is vital. I truly urge you at minimum to update your will(s), ensure you have POAs and create a list of your financial assets, life insurance, passwords, etc. If you do not do this, your family may not only face a devastating loss if you were to pass away, but a financial nightmare.

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. 

Plutus Award Nomination

I want to thank everyone who nominated me for a Plutus Award in the category of “Best Tax Blog”. This is the third year in a row I have been nominated as a finalist in this category and it’s about time a Canadian Tax Blog took the coveted Plutus Award away from my American counterparts. It would just continue the Tim Horton's/Burger King trend of Canadian tax being King:)

The other nominees are:

Tax Girl - Written by Kelly Phillips Erb of Forbes Magazine.
Joe Taxpayer - Written by an everyday Joe, who likes numbers.
TaxProfBlog - Edited/written by Paul L. Caron of Pepperdine University School of Law.
The Wandering Tax Pro -Written by 40 year tax preparer Robert Flack. Got to love this guy. On his site it says " Before contacting me with questions about how a blog post relates to your specific situation, please be aware that I do not give free tax advice to non-clients by e-mail, comment response, or phone. So don't waste your time". Now this guy should be called The Blunt Bean Counter!

New Will Provisions for the 21st Century – Reproductive Assets

In my wildest dreams, I would never have imagined ten years ago I would be posting a blog on how you address reproductive assets in your will. Yet today, I have a guest post by Katy Basi on this topic. This is Katy’s third post in this series on New Will Provisions for the 21st Century.

Her first post in the series dealt with how you handle RESPs in your will and her second post discussed will provisions related to Digital Assets.

I thank Katy for this very informative and enlightening series. I have received excellent feedback on all of Katy’s posts.

Does your Will address your Reproductive Assets?

By Katy Basi

“My what?” you may ask. Do you have sperm/ova/embryos in a clinic somewhere? Have you banked cord blood for your child? (Okay, cord blood isn’t really a “reproductive asset” but I’m throwing it in as a two for one promotion). If so, what are your intentions with respect to these “assets” in the event of your death, and does your will tell your executor what these intentions are? If reproductive technologies were involved in creating your children or grandchildren, does your will adequately define “child” and “issue”?

Medical technology is able to leap tall buildings in a single bound these days, and estates law is hard pressed to keep up. For example, the drafting of most wills implicitly assumes that your ability to have children dies when you do, but medical reality tells a different story. If your DNA is banked in any form, your ability to reproduce may long outlive you, potentially creating “after-born children”. (In one of the few instances of the Canadian legal system addressing these issues, your written consent is required in certain cases for the use of your reproductive assets (see the Assisted Human Reproduction Act)). 

You may be able to have your estates lawyer deal with the possibility of after-born children in drafting your will, or you may have no reproductive assets banked and therefore not be very worried about this issue. If you fall in the latter camp, consider whether part or all of your estate may be inherited by your grandchildren. For example, if your son Clark predeceases you having his own children, should a grandchild conceived by your daughter-in-law after your death, using Clark’s banked sperm, be included or excluded from your estate?

Regardless of the after-born children consideration, what should happen to any sperm/ova/embryos banked in a clinic upon the death of the donor? The contract signed with the clinic in question may provide an answer, e.g. the donor may have given the clinic permission to donate or destruct these materials upon his or her death. Otherwise, does the residuary beneficiary inherit these materials? Is an embryo even capable of being inherited, i.e. is it property? Ideally these issues should be dealt with before the death of the donor, while his or her intentions can still be ascertained.

Clearly we are just starting to address this somewhat murky area of estates law. In my practice, reproductive assets currently come into play in three additional areas:

1) Parents have banked cord blood for their child. I often include a provision in the parents’ wills (i) directing the trustee of their child’s trust to continue paying storage fees for the cord blood until the child reaches a certain age, and (ii) instructing the trustee to transfer ownership of the cord blood to the child once he or she attains that age. We do not yet know the limitations of cord blood, and it may end up being the most valuable asset in your estate if a member of your family has certain medical issues (yes, potentially more powerful than a locomotive….)

2) A couple with fertility issues has found a surrogate or gestational carrier. There is usually a surrogacy contract in this scenario, and the contract often requires the couple to have properly executed wills providing for the child that may result from the surrogacy. This requirement can lead to last minute, faster than a speeding bullet wills, which may not be as carefully drafted as they need to be under these circumstances (see #3 below). Expert advice is strongly recommended!

3) A client has a child (or is planning to) where the child is not biologically related to the client, and the child has not yet been adopted by the client. Careful drafting of the client’s will is required to ensure that the child will inherit regardless of the status of any planned adoption. Often a will refers to “my child” generically, without naming the child, either because the child is not yet born, or the client intends to have additional children and does not want to revise his/her will immediately upon the birth of the next child. If not specifically defined in the will, “my child” refers to a person’s child by blood or adoption. If a client has not yet adopted a child, and is not related by blood to the child (e.g. a donor was used), a broader definition of “child” needs to be included in the client’s will. Conversely, if a client has donated reproductive material (e.g. sperm or eggs), his or her will should be carefully drafted to exclude any children related to the client only by virtue of this donation. (While other provinces have legislation clarifying that sperm and egg donors are not parents, Ontario currently does not.)

Clients who have been involved with reproductive technologies have often been through significant stress and, in some cases, heartbreak. Reproductive technologies are incredibly costly, so credit cards are maxed out and wills and estate planning are very low down the priority list. Once the time comes to address your estate plan, alert your lawyer to these issues if they pertain to you – protect that child you worked so hard for!

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.

The above blog post is for general information purposes only and does not constitute legal or other professional advice or an opinion of any kind. Readers are advised to seek specific legal advice regarding any specific legal issues.

When Spouses Don’t Leave All Their Assets to Each Other - The Income Tax Implications - Part 2

On Monday, I addressed deemed dispositions, automatic spousal rollovers and the reasons behind spouses deciding not to have mirror wills. Today, I look at the income tax liability and liquidation issues that arise when spouses do not leave all their assets to each other.

Tax Liability

The debts of an estate are paid from the residue the estate. This can be problematic where the intention is to leave a certain amount of money to a spouse and the rest to say the children of a first marriage. For example, an RRSP will transfer to your surviving spouse tax free, but the assets left to the estate for the benefit of the children will be subject to tax and the children will only get the net proceeds. This result is often not the intention of a parent who ignores the tax aspect of their legacy.

Often wills leave specific assets to certain beneficiaries and the residual of the estate to others. For example, if a son is the beneficiary of a specific asset, let's use a cottage, the son gets the cottage and the estate has the tax liability for the deemed disposition of the cottage. Again, that is not the intention of the deceased who assumes his son will be responsible for the tax liability on the cottage.

Lynne Butler of the blog Estate Law Canada says “It's possible to draft a will to state that the person receiving an asset should also pay the tax bill associated with the asset, but almost nobody ever does that. I think more people would do that if they were only aware that it was possible.”

In order to ensure you don’t “stick” your estate with a large tax liability, you may wish to consider Lynne’s advice when drafting any will, but especially where spouses have different wishes.

Liquid vs Illiquid Assets

As discussed on Monday, the deemed disposition rule can result in the estate being left with a large income tax liability; the ability to pay that liability is a function of the liquidity of the remaining assets. Where spouses have different wishes on death, your estate planning needs to consider if you are leaving the estate and/or your spouse with enough liquid assets to pay the deemed income tax liability.

For example, say Sue and her spouse Edward have equal ownership in a rental property. But Sue wants to leave her estate to her children from her first marriage while Edward wants to do likewise to his children from his first marriage. If Sue were to pass away first, there would be a deemed disposition of her 50% ownership in the rental property. Because much of Sue’s wealth is tied up in the rental property, it may be problematic for the estate to pay the income tax liability on her deemed disposition without liquidating the real estate to pay the income tax liability and Edward may not be amenable to doing such.

In situations such as these, where spouses have different wishes, they need to consider ways their estate can pay their final tax liability without a forced liquidation of assets. One possible solution is the use of insurance. Many people purchase insurance to cover their anticipated income tax liability on their death. Another alternative where there are significant liquid assets is to ensure the estate always maintains enough cash to cover any potential income tax liability on death.

Plan

Where spouses have different wishes upon death, the income tax consequences can get ugly. While in good health, spouses either independently or jointly, need to review these consequences with their accountant(s) or lawyer(s) to ensure they have considered the possible consequences and have a plan.

Next week, I will continue with this somewhat morbid theme and post a two-part guest blog by Katy Basi on "qualifying spousal trusts". Katy will discuss how they work and why you would consider using them. Katy is back by popular demand after guest posting on New Will Provisions for the 21st Century in respect of RESPs and Digital 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. Please note the blog post is time sensitive and subject to changes in legislation or law.

When Spouses Don’t Leave All Their Assets to Each Other - The Income Tax Implications

You must admit, nobody has as many uplifting titles for their blog posts as I do. I have previously had such cheery titles as “Stress Testing Your Death” and “Is it Morbid to Plan for an Inheritance”. So today, in keeping with my "Morbid Mark" theme, I will discuss the tax implications that can occur when one spouse passes away, and does not will all of their assets to their surviving spouse.

Deemed Disposition Upon Death

Upon death, you are deemed to have disposed of your capital and non-depreciable property (typically your principal residence is tax-free) for proceeds equal to the fair market value (“FMV”) of the assets immediately before death. If the FMV of any property is greater than the original cost of that property, your executor must report a capital gain on your income tax return for the year of death (known as a terminal return).

For example, if John passed away on September 1, 2013 and he owned shares of Bell Canada worth $40 on September 1st, that he had purchased for $28 several years ago, his estate must report a deemed capital gain of $12 per share on his terminal return. The same would hold true for a rental property, which may also have additional potential issues, such as the recapture of capital cost allowance (depreciation).

Automatic Spousal Rollover

There is an exception to the deemed disposition rule, where the property passes to the deceased spouse, common-law partner or a "qualifying spousal trust". In this situation, the transfer takes place at the adjusted cost base (ACB) of the property, not the FMV of the property and the deemed capital gain is deferred until the spouse or common-law partner dies; or the property is disposed of by the spouse or common-law partner. So if John was married to Mary and left everything to her in his will, the Bell Canada shares would transfer to Mary tax-free at a cost base of $28.

In the good old days of Ozzie and Harriet, the automatic provision was fairly standard. People stayed married and both spouses would usually have mirror wills, leaving all or most of their property to each other.

Today, with the high rate of divorce, second families and spouses who have independent thoughts, it is not that unusual for spouses to have different wills or wills in which they only leave some assets to their current spouse.

Where spouses have different wishes in their wills and don’t leave all their property to their surviving spouse, the deemed disposition rules noted above come into effect. The resultant income tax liability can in some cases be large and where assets are not liquid, the payment of those taxes can sometimes be problematic.

Why Would Spouses Have Different Wishes

There are a myriad of reasons why spouses may not have mirror wills or leave all their assets to each other. Here are some common reasons:

1. Second families- A testator may structure their will to only leave a certain amount to the surviving spouse, or to a spousal trust for their surviving spouse so they can leave other property and monies directly to their children from the first marriage; this triggers the deemed disposition rules on the property left to their children.

2. Black Sheep Children -One spouse may have an issue with one of their children and be concerned their surviving spouse will turn around and leave money to the black sheep child when they pass away.

3. DINKS – The “double income no kids” cohort often have other family members they wish to benefit from their estate, such as parents, siblings, nieces and nephews. They are confident that their surviving spouse has enough assets of their own and will not need a large inheritance in order to have a prosperous retirement. According to estates lawyer Katy Basi “The wills that we draft for childless testators are often long and sometimes quite complicated. The tax implications of the estate plan need to be carefully considered.”

4. Charitable Wishes – Spouses often have different charitable views. One spouse may want to leave a significant portion of their wealth to charity while the other does not. In this case, the concern is not an income tax issue, as the donation(s) eliminate most of the tax liability, but the issue becomes a question of whether assets must be liquidated to enable the executor to make the donations in the will.

As I have been told my blog posts are too long, I will stop here today. On Wednesday, I will discuss the income tax implications, liquidity concerns and planning issues when spouses don't leave all their assets to each other.

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. Please note the blog post is time sensitive and subject to changes in legislation or law.