The Best of The Blunt Bean Counter - The Duties of an Executor

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 blog post from April 2011, on the duties of an executor. As the 86 comments on the initial post reflect, many people are oblivious to these duties, until they are suddenly thrust upon them. This is the last "Best of" for this year, I return next week with my regular newly minted blog posts.

The Duties of an Executor

 As I noted in the first installment of this series, I have been an executor for three estates. I have also advised numerous executors in my capacity as the tax advisor/accountant for the estates of deceased taxpayers. The responsibility of being named an executor is overwhelming for many; notwithstanding the inexcusable fact many individuals appointed as executors had no idea they were going to be named an executor of an estate. In my opinion, not discussing this appointment beforehand is a huge mistake. I would suggest at a minimum, you should always ask a potential executor if they are willing to assume the job (before your will is drafted), but that is a topic for another day.

So, John Stiff dies and you are named as an executor. What duties and responsibilities will you have? Immediately you may be charged with organizing the funeral, but in many cases, the immediate family will handle those arrangements, assuming there is an immediate family in town. What’s next? Well, a lot of work and frustration dealing with financial institutions, the family members and the beneficiaries.

Below is a laundry list of many of the duties and responsibilities you will have as an executor:

• Your first duty is to participate in a game of hide and seek to find the will and safety deposit box key(s).  If you are lucky, someone can tell you who Mr. Stiff's lawyer was and, if you can find him or her, you can get a copy of the will. Many people leave their will in their safety deposit box; so you may need to find the safety deposit key first, so you can open the safety deposit box to access the will.
• You will then need to meet with the lawyer to co-coordinate responsibilities and understand your fiduciary duties from a legal perspective. The lawyer will also provide guidance in respect of obtaining a certificate of appointment of estate trustee with a will ("Letters Probate"), a very important step in Ontario and most other provinces. 
• You will then want to arrange a meeting with Mr. Stiff's accountant (if he had one) to determine whether you will need his/her help in the administration of the estate or, at a minimum, for filing the required income tax returns. If the deceased does not have an accountant, you will probably want to engage one. 
• Next up may be attending the lawyer’s office for the reading of the will; however, this is not always necessary and is probably more a "Hollywood creation" than a reality. 
• You will then want to notify all beneficiaries of the will of their entitlement and collect their personal information (address, social insurance number etc).
• You will then start the laborious process of trying to piece together the deceased’s assets and liabilities (see my blog Where are the Assets for a suggestion on how to make this task easy for your executor). 
• The next task can sometimes prove to be extremely interesting. It is time to open the safety deposit box at the bank. I say extremely interesting because what if you find significant cash? If you do, you then have your first dilemma; is this cash unreported, and what is your duty in that case? 
• It is strongly suggested that you attend the review of the contents of the safety deposit box with another executor. A bank representative will open the box for you and you need to make a list on the spot of the boxes contents, which must then be signed by all present.
• While you are at the bank opening the safety deposit box, you will want to meet with a bank representative to open an estate bank account and find out what expenses the bank will let you pay from that account (assuming there are sufficient funds) until you obtain probate. Most banks will allow funds to be withdrawn from the deceased’s bank account to pay for the funeral expenses and the actual probate fees. However, they can be very restrictive initially and each bank has its own set of rules. 
• As soon as possible you will want to change Mr. Stiff's mailing address to your address and cancel credit cards, utilities, newspapers, fitness clubs, etc. 
• As soon as you have a handle on the assets and liabilities of the estate, you will want to file for letters of probate, as moving forward without probate is next to impossible in most cases. 
• You will need to advise the various institutions of the passing of Mr. Stiff and find out what documents will be required to access the funds they have on hand. In one estate I had about 10 different institutions to deal with and I swear not one seemed to have the exact same informational requirement. 
• If there is insurance, you will need to file claims and make claims for things such as the CPP benefit. 
• You will need to advertise in certain legal publications or newspapers to ensure there are no unknown creditors; your lawyer will advise what is necessary.
• It is important that you either have the accountant track all monies flowing in and out of the estate or you do it yourself in an accounting program or excel. You may need to engage someone to summarize this information in a format acceptable to the courts if a “passing of accounts” is required in your province to finalize the estate. 
• You will also need to arrange for the re-investment of funds with the various investment advisor(s) until the funds can be paid out. For real estate you will need to ensure supervision and/or management of any properties and ensure insurance is renewed until the properties are sold. 
• A sometimes troublesome issue is family members taking items, whether for sentimental value or for other reasons. They must be made to understand that all items must be allocated and nothing can be taken.  
• You will need to arrange with the accountant to file the terminal return covering the period from January 1st to the date of death. Consider whether a special return for “rights and things” should be filed. You may also be required to file an “executor’s year” tax return for the period from the date of death to the one year anniversary of Mr. Stiff's death. Once all the assets have been collected and the tax returns filed, you will need to obtain a clearance certificate to absolve yourself of any responsibility for the estate and create a plan of distribution for the remaining assets (you may have paid out interim distributions during the year).

The above is just a brief list of some of the more important duties of an executor. For the sake of brevity I have ignored many others (see Jim Yih's blog for an executor's checklist).

The job of an executor is demanding and draining. Should you wish to take executor fees for your efforts, there is a standard schedule for fees in most provinces. For example in Ontario, the fee is 2.5% of the receipts of estate and 2.5% of the disbursements of the estate.

Finally, it is important to note that executor fees are taxable as the taxman gets you coming, going and even administering the going.

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.

Estate Planning and the Black Sheep Child

In November, Adam Mayers of The Toronto Star reviewed my book, Let’s Get Blunt About Your Financial Affairs. In his article, he discussed some of the comments I made in my book on inheritances.

123 REF-Tomas Marek

My observations elicited some very interesting emails to my inbox. Some of the emails provided tragic and sad details of children being left out of their parents' lives and consequently their wills for various reasons. One reader, who is gay, asked me if he could be left out of a will solely for that reason.

This question is far outside my area of expertise. I thus enlisted my wills, trusts and estates expert Katy Basi, to answer his question and discuss in general, the consequences from both the parents and child's perspective, of leaving a black sheep child out of the will.

Please note: Katy and I use the term "black sheep" colloquially and the term is not meant to be demeaning in any manner.

Estate Planning and the Black Sheep Child

By Katy Basi

Many families have one (or more) black sheep children, and estates lawyers commonly deal with two categories of questions regarding these shunned family members. In this blog post I will refer to our sample unfortunate as Cain (though most black sheep are not guilty of fratricide!). The two situations are as follows:

1. If the client is not Cain - can I cut Cain out of my will? If I do, will he be able to challenge my will? 
2. If the client is Cain – can my family members cut me out of their wills?

The Parent is the Client

If you plan to cut Cain out of your estate plan, I typically have three pieces of advice for my clients:

(1) Explain in the will why Cain is being treated differently than other family members of the same degree of family connection. For example, if a child is being cut out of a will because they have chosen not to have contact with their parents for two decades, the will should state that very relevant fact. Otherwise, Cain could argue that the lawyer made a drafting error by leaving him out, or this omission could be used as evidence of the parents’ lack of capacity to make the will(s) in question (i.e. the argument then goes “Clearly the fact that they “forgot about me” indicates that they had lost their marbles!”).

(2) Consider leaving a set dollar value legacy to Cain, and then having a clause that takes the legacy away if Cain challenges the will for a reason other than a valid interpretation issue. This is known as an “in terrorem” clause and needs to be very carefully drafted by an estates lawyer in order to be legally effective.

(3) Arrange for a capacity assessor to interview the testator before the will is signed (though not too far in advance of signing). The capacity assessor should then write a letter or report of some kind confirming that the testator has the capacity to make the will in question (presuming that this is the case, of course). This is particularly helpful if the testator is elderly or ill, or if there are any other factors which could lend strength to a “lack of capacity” argument by a disappointed beneficiary. I have seen a capacity assessment stop estate litigation in its tracks.

Cain is the Client

When I am advising Cain, my first piece of advice is to consult an estates litigator (I am an estates solicitor, and therefore a major part of my job, in my view, is to help clients plan their estates in such a way as to discourage litigation). After that disclaimer, my counsel generally flows along these lines:

(a) We are lucky (in my view) to have testamentary freedom in Ontario, subject to certain limitations (other provinces such as British Columbia have enacted laws limiting testamentary freedom to some extent).

(b) One exception to testamentary freedom is the ability of certain family members (e.g. minor and adult children, parents and siblings) to make a support claim against the estate. For example, if Cain is an adult child who was financially supported by his parents, and was not left a sufficient inheritance by them (as determined by a court) Cain may make a support claim against the estate. Support can include providing accommodation at lower than fair market value rent.

(c) Where no financial support has been provided, Cain’s usual recourse is to try to have the will that cuts him/her out declared invalid, usually on the basis of a lack of testamentary capacity (as alluded to above) or undue influence (e.g. “my sister pressured my mom into cutting me out of her will”).

(d) Either of these claims will require solid evidence to be successful in court.

(e) A successful will challenge is not helpful if the prior will also cuts out the challenger, presuming that the prior will is valid.

(f) While in the old days most of the costs associated with estate litigation were borne by the estate in question, the courts have shifted their approach in recent years. These days, courts do not hesitate to order an unsuccessful will challenger to pay, not only their own costs, but also the costs of the estate relating to the challenge. Litigation is very, very expensive and time-consuming, so launching a will challenge due to feeling left out, without a good evidentiary case, is just not a good idea.

(g) However, if the will challenger has been cut out of the will for a reason that is against public policy, then litigation may be successful even if the testator had capacity and was not unduly influenced. If Cain can prove in court that he/she was cut out of an estate plan due to discrimination on a basis not permitted under the Charter of Rights and Freedoms, for example due to their sexuality, or because they married outside of his/her race/religion etc., then Cain may have a valid claim. The evidentiary mountain here can be steep to climb, but in a recent case the claimant was successful in overturning her father’s will on the basis that her father had cut her out as she had a mixed-race child. She was successful despite the fact that there was no reference to this discrimination under the terms of the will. There was, however, substantial external evidence as to the discriminatory reason behind her father’s estate plan.[Note: Just prior to the publication of this blog post, the decision of the lower court was overturned by the Ontario Court of Appeal, reinstating the father's original estate plan. It would be very helpful to have guidance from the Supreme Court of Canada regarding this issue if the daughter decides to ask for leave to appeal].

My discussions with clients about cutting out, or being, the black sheep tend to be fraught with sadness, anger and frustration. My experience is that clients do not cut out a black sheep lightly, and in many cases would usually be overjoyed to reconcile, knowing that there will need to be apologies and compromise on both sides. By the time I am counselling a black sheep about being cut out, it’s clear that no amount of litigation will heal the hurt feelings.

Bloggers Note: Katy has written numerous guest posts for this blog. Many of her articles have proven to be very popular with readers. If you want to read more from Katy, the best way to review her previous blog posts is: go to the search function on the top right hand side of the blog and type in her name.

Katy Basi is a barrister and solicitor with her own practice, focusing on wills, trusts, estates, and income tax law (including incorporation's and corporate restructurings). 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@basilaw.com. More articles by Katy can be found at her website, basilaw.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.

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.

The Best of The Blunt Bean Counter - Estate Freeze - A Tax Solution for the Succession of a Small Business

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 June, 2014 blog post on Estate Freezes. If this topic interests you, there were two follow-up posts based on noted author Tom Deans, that suggest an Estate Freeze could be the wrong solution for family succession and a discussion of some vital issues when transferring a family business.

Estate Freeze – A Tax Solution for the Succession of a Small Business

Winston Churchill once said, “Let our advance worrying, become advance thinking and planning.” Small business owners often worry about their exit strategy and/or succession plan. They may also be concerned about what would happen to their business if they have a health scare or receive an ultimatum from a child working in their business. Often a small business owner’s worry becomes their anxiety, instead of their advanced planning.

As a small business owner, at the end of the day, there are essentially only two exit strategy/succession options you need to plan and/or consider:

(1) A sale of your business, typically to a competitor, sometimes to current management or very infrequently, an actual sale to a child or other family member; or

(2) A transfer of the business to your children without a sale (for purposes of this article I will refer to this option as an “estate freeze”).

My blog post today discusses estate freezes. How you can transfer your business tax-free to a successor (typically your children, sometimes to existing management) while continuing to control and receive remuneration from your business.

As noted in the links in the first paragraph, Tom Deans the author of Every Family's Business (the bestselling family business book of all-time) believes a business should in most cases be sold and never handed over to the next generation (such as done with an estate freeze) without the parent(s) adequately being compensated for the business, including their children.

What is an Estate Freeze?

The most tax efficient manner to transfer your business to your children is to undertake an estate freeze. An estate freeze allows your child(ren) to carry on your business, while at the same time you receive shares worth the current value of your business. In addition, once your share value is locked-in, your future income tax liability in respect of your company’s shares is fixed and can only decrease. Keep in mind that when you freeze the value of your company you are not receiving any monies for your shares at that time. There may be ways to monetize that value in the future, but on an estate freeze, you typically only receive shares of value, not cash.

The key risk in any estate freeze is that your children may partially or fully devalue these shares and your company. So while an estate freeze may be the most tax efficient way to transfer your business, it may not be the best decision from an economic or monetization perspective. 

In a typical estate freeze, you exchange your common shares of your corporation on a tax-free basis for preferred shares that have a permanent value (“frozen value”) equal to the common shares’ fair market value (“FMV”) at the time of the freeze. Subsequently, a successor or successors, say your children or family trust can subscribe for new common shares of the corporation for a nominal amount.

This concept is best explained with an example. Assume Mr. A has an incorporated business worth $3,000,000 and wants to undertake an estate freeze. In the course of the freeze, Mr. A is issued new preferred shares worth $3,000,000 and his children or a family trust subscribes for new common shares for nominal consideration. Mr. A’s tax liability in relation to these shares on death, is now fixed at approximately $750,000 in Ontario at the high rate. Often, a key aspect of an estate freeze is a plan to reduce the tax liability by redeeming the preferred shares on a year by year basis as discussed below.

If you have access to your lifetime capital gains exemption (currently at $813,600 but indexed for inflation), your income tax liability may be reduced when the shares are eventually sold or upon your death if you still own them at that time. Finally, you may choose to crystallize your exemption when you freeze the shares.

The preferred shares received on the freeze can be created such that they allow you to maintain voting control of your corporation until you are satisfied your child(ren), is(are) running the company in the manner you desire. This maybe a double-edged sword, as you may tend to hold onto control long after your successors have proven themselves. This may become a contentious issue.

Preferred shares can also serve as a source of retirement income. Typically what is done is that your preferred shares are redeemed gradually. So, for example, if you need $100,000 before tax a year to live, you can redeem $100,000 of your preferred shares each year. Let’s say you live 20 years and redeem a $100,000 a year. By the time of your death, you will have redeemed $2,000,000 ($100,000 x 20 years) of your preferred shares and they will now only be worth $1,000,000 ($3,000,000 original value less $2,000,000) at your death. Your income tax liability on these shares at the time of your death will now only be approximately $250,000.

The Benefits of an Estate Freeze

1. On death (something we should all be planning for), an individual is subject to a deemed disposition (i.e. a sale) on all of his/her assets at FMV, which would include his/her shares of the business. An estate freeze sets your maximum income tax liability upon this deemed sale and as discussed above, this liability can be lowered over the years by redeeming the shares.

2. Family members will be able to become shareholders of the business at a minimal cost and be motivated to build the business (although Tom Deans would dispute this assertion).

3. Instead of having children directly subscribe for new common shares, you can create a discretionary family trust to hold the common shares. Every year, the corporation can pay dividends to the family trust which can then allocate the dividends to family members with lower marginal tax rates. This mechanism allows for great income splitting opportunities.

4. On the eventual sale of the business, the children or family trust may realize a significant capital gain. Assuming that the business qualifies for the capital gains exemption, the family trust can allocate this capital gain to each beneficiary who may be able to use his/her own lifetime capital gains exemption limit to shield $813,600 or more of capital gains from income tax.

One of the more critical aspects of an estate freeze is the determination of the fair market value ("FMV") of your business. In order to ensure that an estate freeze proceeds as smoothly as possible, the FMV of the company must be calculated. In the event that the FMV determined is challenged by the Canada Revenue Agency (the “CRA”) the attributes of the preferred shares will have a purchase price adjustment clause that will let the freezer reset the FMV. The CRA has stated in the past that they will generally accept the use of a purchase price adjustment clause if a “reasonable attempt” has been made in valuing the company. Engaging a third party independent Chartered Business Valuator to prepare a valuation report is generally accepted as a “reasonable attempt” in estimating the FMV.

Issues to Consider Before Implementing an Estate Freeze

An estate freeze does not make sense for all business owners. While the above benefits do sound very enticing, it depends on each owner’s personal circumstances. Issues to be considered include:

1. Are you relying on the value of the company to fund your retirement? If so, it may be best to sell and ensure you have a secure retirement.

2. Do you have an identified successor, i.e. child, able and willing to work in your business?

3. Can you bring one child into the business without creating a dispute amongst your children?

4. Are your children married and how may a divorce or separation impact the business?

Long-time readers of my blog will know that I am a proponent of family discussions and getting over the money taboo. I cannot overstate the importance of having a detailed discussion with your family if you plan to hand your business over to one or more of your children. If you pass that hurdle, you must speak with your accountant and lawyer to ensure you understand the implications of the freeze and how to properly implement the corporate restructuring. Finally, your tax advisor will want to structure the freeze such that it can be “thawed” if the business suffers a setback due to the economy, or your child(ren) prove incapable of running the company.

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.

The Best of The Blunt Bean Counter - Is it Morbid or Realistic to Plan for an Inheritance?

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today is my last re-post (where did the summer go?) and I selected a post on whether it is morbid or realistic to plan for an inheritance. I selected this post because it seems to polarize people. They either think it abhorrent to consider planning for an inheritance or don't understand why it is not practical financial planning.

I recently followed this post up with Inheriting Money - Are you a Loving Child, a Waiter or Hoverer, a post that discusses four types of behaviour by those who will inherit money.

Is it Morbid or Realistic to Plan for an Inheritance?

I have written several blog posts on estate planning and inheritances, including “Taking it to the Grave,” a blog I wrote for the Canadian Capitalist, in which I discuss whether parents should distribute future inheritances in part or in whole while they are alive and “How your Family Dynamic can affect your Estate Planning”  in which I discuss how parents have to navigate a minefield of family issues with respect to the determination of executors, the distribution of family heirlooms and the distribution of hard assets.

These blogs elicited a wide range of opinions and comments that I found fascinating. Some people believe they are better off because their parents made them work for everything and they don’t want any financial assistance from their parents either during their life or after they pass away. Others state that as long as parents are careful to ensure they don’t destroy their children’s motivation, partial inheritances make sense. Finally, others say they have been sickened as they observe children waiting at a parent’s deathbed salivating at the thought of their inheritance.

All this leads me to another very touchy subject; should a child (let’s assume the child is at least 40 years old) plan their own future based on a known or presumed inheritance? To add some perspective to this issue, it is interesting to note that a recent survey by the Investors Group states that 53% of Canadians are expecting an inheritance, with over 57% of those, expecting an inheritance greater than $100,000.

Inheritances can be categorized as either known or presumed inheritances. An inheritance would be categorized as known, when a parent(s) has/have discussed the contents of their will with their child(ren) or at least made known their intentions. In these cases, while the certainty of the inheritance in known, the quantum is subject to the vagaries of the parent(s) health, the parent(s) lifestyle, the income taxes due on the death of the last to survive parent and the economic conditions of the day. (Speaking of discussing the will with your children, it is very interesting to note that my blog post One Big Happy Family until we discuss the Will which had limited initial traction, is now by far and away the most read blog I have ever written).

An inheritance may be presumed where the financial circumstances of the family are obvious. A child cannot help but observe that the house their parents purchased 30 or 40 years ago for $25,000 is now worth $800,000 to $1,000,000, or that the cottage their family bought for $100,000 many years ago can be subdivided and is now worth $700,000.
Many average Canadian families have amassed significant net worth just by virtue of the gains on their real estate purchases. These families would not be considered wealthy based on lifestyle or income level, yet their legacy can have a significant impact upon their children. Inheritances are not only an issue for wealthy families.

I think most people will agree that where an inheritance will be so substantial that it will be life changing; parents need to downplay the inheritance issue and/or manage the inheritance by providing partial gifts during their lifetime. Rarely can a child become aware of a life-changing inheritance without losing motivation and experiencing a change in their philosophical outlook on life.

Although life changing inheritances are rare, life "affecting" inheritances are not. So, should children change how they live and how they plan for the future based on a known or presumed future inheritance? In my opinion, if the inheritance is known and will be substantial enough to alter a child’s current or future living standard, the answer is a lukewarm yes, subject to the various caveats I discuss below.

I think it is imprudent to ignore reality and where an inheritance has the attributes I note above, it should be considered as part of your future financial plan. However, I would discount the amount used for planning purposes significantly, to account for inherent risks. Those risks include the longevity of a parent, economic downturns that reduce your parent(s) yearly income stream,  potential medical costs and finally, the ultimate risk one takes in planning for an inheritance; the risk of somehow falling out of favour and being removed from your parent(s) will.

Where there is a presumed inheritance, I would suggest you need to be ultra conservative if you want to plan for the inheritance, since not only are you guessing at the inheritance amount, but you face an additional risk that your parent(s) may have offsetting liabilities such as a mortgage or line of credit of which you are unaware.

So what do the experts have to say on this matter? In the press release for the Investors Group survey, Christine Van Cauwenberghe, Director, Tax and Estate Planning, says that "Knowing the dollars and cents behind your inheritance can have an impact on your financial plans. It is smart to know what you can expect so you can plan accordingly and family dialogue is a good place to start."

Ted Rechtshaffen, a certified financial planner at Tri-Delta Financial, in a National Post article I discuss below, says "he may be in the minority but he encourages clients to count on their inheritances when planning to some degree." He however, goes on to say he tells clients to be super-conservative. Finally, he concludes with "I know it goes against the grain because you are counting on money you don't have", adding, "it depends where your parents are in their life cycle and how clearly they have signalled their intentions".

I think Christine and Ted's comments clearly point out the conundrum here, for which there is no black and white answer. It is probably unwise to ignore a known potential inheritance, but because the final inheritance is subject to so many variables, you must risk assess that inheritance and discount its quantum by a significant amount, such that your planning becomes a paradoxical situation.

But what if you see no risk in your parent(s) financial situation deteriorating and you feel you will never be removed from the will, how can your financial planning be affected? For argument’s sake, let’s say your inheritance will be large enough to affect your future planning, but not large enough to affect your motivation or change your lifestyle.

The most obvious change to your financial plan may be to underfund your RRSP. Most Canadians struggle to make yearly RRSP contributions. They live in mortal fear that they will not have enough money to live the retirement they envision. But, if you know your parent(s) have enough funds to live out their life/lives comfortably, and say your inheritance will be in the $300,000 to $500,000 range, do you need to make your maximum RRSP contributions?

Other planning issues include whether you should purchase a home out of your price range or underfund your children’s education fund, knowing that you will receive an inheritance to pay off the mortgage or to pay off any education related loans. Alternatively, you may over fund your child’s education by sending them to a private school you would never had considered without knowledge or presumption of a future inheritance.

How you deal with debt could also be affected. If you have debt, should you just limit it to a manageable level and not concern yourself with paying it down? Or alternatively, should you pay it off because you can reallocate funds once committed to your RRSP, TFSA or RESP, knowing your inheritance will cover your RRSP, TFSA or RESP?

We have all heard about about the huge debt level many Canadians are carrying. Based on comments made by Benjamin Tal, deputy chief economist for the CIBC, one wonders if at least subconsciously some of this debt level in being carried because people know they have an inheritance coming? Mr.Tal in an article in the Toronto Star on Baby boomers set to inherit $1 trillion says "people talk about how much debt there is without looking at the size of the potential assets to come. Debt is relative to your income today, but your wealth tomorrow will improve when an inheritance comes."

So, have I seen people bank on an inheritance? Yes. To date, where I have observed such behaviour, the inheritances have come as expected. However, these cases may not be predictive of future cases.

Is it morbid to plan for an inheritance? Clearly, it is. Would most people rather have their parents instead of the inheritance? Yes. This topic is a very touchy subject and an extremely slippery slope, but to ignore the existence of a significant future inheritance that would impact your personal financial situation may be nonsensical.  However, if your financial planning takes into account a future inheritance, you should ensure you have discounted that amount to cover the various risks and variable that could curtail your inheritance and be extremely conservative in your planning.

Post script:

As the expression goes "Those who hesitate are lost". I started writing this blog back in late November, but could not come to a conclusion (if one can call the lukewarm recommendation I suggest above a conclusion) until recently on whether one should or should not plan for an inheritance. Thus, this blog post just sat. In the interim there have been two excellent articles on this topic. The first by Garry Marr of the Financial Post, titled Windfall no sure thing from which I quote Mr.Rechtshaffen above and another article by Preet Banerjee of the Globe and Mail, titled An inheritance should be a windfall, not a financial plan.

In Preet's article he notes the potential flaws of incorporating an inheritance into your financial plan. He also concludes with some words of wisdom "There are enough variables affecting your own financial success. Ideally, you shouldn’t bank on an inheritance in your financial plan, but rather treat it as an unexpected windfall. Most people would rather give it up in exchange for having their parents back".

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.

You Have Been Named An Executor- Part 2- Now What?

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today, I am re-posting the second of a 3 part series I wrote on executors. This post is my 10th most read post and deals with the duties upon being named an executor; which is unfortunately, a surprise appointment in many cases.

The first post in this series recounts the fascinating betrayal of Paul Penna (founder of Agnico-Eagle Gold Mines Ltd.) by a close friend who was named the executor of his estate; while the third blog, a guest post by Heni Ashley discusses the issue of whether you should use a corporate executor.

You Have Been Named An Executor- Part 2- Now What?

As I noted in the first installment of this series, I have been an executor for three estates. I have also advised numerous executors in my capacity as the tax advisor/accountant for the estates of deceased taxpayers. The responsibility of being named an executor is overwhelming for many; notwithstanding the fact many individuals appointed as executors had no idea they were going to be named an executor of an estate. In my opinion, not discussing this appointment beforehand is a huge mistake. I would suggest at a minimum,you should always ask a potential executor if they are willing to assume the job (before your will is drafted), but that is a topic for another day.

So, John Stiff dies and you are named as an executor. What duties and responsibilities will you have? Immediately you may be charged with organizing the funeral, but in many cases, the immediate family will handle those arrangements, assuming there is an immediate family in town. What’s next? Well, a lot of work and frustration dealing with financial institutions, the family members and the beneficiaries.

Below is a laundry list of many of the duties and responsibilities you will have as an executor:

• Your first duty is to participate in a game of hide and seek to find the will and safety deposit box key(s).  If you are lucky, someone can tell you who Mr. Stiff's lawyer was and, if you can find him or her, you can get a copy of the will. Many people leave their will in their safety deposit box; so you may need to find the safety deposit key first, so you can open the safety deposit box to access the will.
• You will then need to meet with the lawyer to co-coordinate responsibilities and understand your fiduciary duties from a legal perspective. The lawyer will also provide guidance in respect of obtaining a certificate of appointment of estate trustee with a will ("Letters Probate"), a very important step in Ontario and most other provinces. 
• You will then want to arrange a meeting with Mr. Stiff's accountant (if he had one) to determine whether you will need his/her help in the administration of the estate or, at a minimum, for filing the required income tax returns. If the deceased does not have an accountant, you will probably want to engage one. 
• Next up may be attending the lawyer’s office for the reading of the will; however, this is not always necessary and is probably more a "Hollywood creation" than a reality. 
• You will then want to notify all beneficiaries of the will of their entitlement and collect their personal information (address, social insurance number etc).
• You will then start the laborious process of trying to piece together the deceased’s assets and liabilities (see my blog Where are the Assets for a suggestion on how to make this task easy for your executor). 
• The next task can sometimes prove to be extremely interesting. It is time to open the safety deposit box at the bank. I say extremely interesting because what if you find significant cash in the box? If you find cash, you then have your first dilemma; is this cash unreported, and what is your duty in that case?

• It is strongly suggested that you attend the review of the contents of the safety deposit box with another executor. A bank representative will open the box for you and you need to make a list on the spot of the boxes contents, which must then be signed by all present.
• While you are at the bank opening the safety deposit box, you will want to meet with a bank representative to open an estate bank account and find out what expenses the bank will let you pay from that account (assuming there are sufficient funds) until you obtain probate. Most banks will allow funds to be withdrawn from the deceased’s bank account to pay for the funeral expenses and the actual probate fees. However, they can be very restrictive initially and each bank has its own set of rules. 
• As soon as possible you will want to change Mr. Stiff's mailing address to your address and cancel credit cards, utilities, newspapers, fitness clubs, etc. 
• As soon as you have a handle on the assets and liabilities of the estate, you will want to file for letters of probate, as moving forward without probate is next to impossible in most cases. 
• You will need to advise the various institutions of the passing of Mr. Stiff and find out what documents will be required to access the funds they have on hand. In one estate I had about 10 different institutions to deal with and I swear not one seemed to have the exact same informational requirement. 
• If there is insurance, you will need to file claims and make claims for things such as the CPP benefit. 
• You will need to advertise in certain legal publications or newspapers to ensure there are no unknown creditors; your lawyer will advise what is necessary.
• It is important that you either have the accountant track all monies flowing in and out of the estate or you do it yourself in an accounting program or excel. You may need to engage someone to summarize this information in a format acceptable to the courts if a “passing of accounts” is required in your province to finalize the estate. 
• You will also need to arrange for the re-investment of funds with the various investment advisor(s) until the funds can be paid out. For real estate you will need to ensure supervision and/or management of any properties and ensure insurance is renewed until the properties are sold. 
• A sometimes troublesome issue is family members taking items, whether for sentimental value or for other reasons. They must be made to understand that all items must be allocated and nothing can be taken.  
• You will need to arrange with the accountant to file the terminal return covering the period from January 1st to the date of death. Consider whether a special return for “rights and things” should be filed. You may also be required to file an “executor’s year” tax return for the period from the date of death to the one year anniversary of Mr. Stiff's death. Once all the assets have been collected and the tax returns filed, you will need to obtain a clearance certificate to absolve yourself of any responsibility for the estate and create a plan of distribution for the remaining assets (you may have paid out interim distributions during the year).

The above is just a brief list of some of the more important duties of an executor. For the sake of brevity I have ignored many others (see Jim Yih's blog for an executor's checklist).

The job of an executor is demanding and draining. Should you wish to take executor fees for your efforts, there is a standard schedule for fees in most provinces. For example in Ontario, the fee is 2.5% of the receipts of estate and 2.5% of the disbursements of the estate.

Finally, it is important to note that executor fees are taxable as the taxman gets you coming, going and even administering the going.

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.

One Big Happy Family - Until We Discuss the Will

This summer I am posting the "best of" The Blunt Bean Counter while I work on my golf game. Today, I am re-posting my 17th blog which I wrote way back in December 2010. This post tackles the taboo subject of whether you should discuss your will with your family. While this is my fifth most read post of all-time, it only had 6 comments which I find puzzling. Maybe our aversion to discussing our will goes as far as commenting on articles about the topic?

I almost forgot that when I started this blog, I used to post a non-financial post with ever tax or financial post, as evidenced by my Dentist's Wallpaper discussion that follows the main post.

One Big Happy Family - Until We Discuss the Will

What I want to discuss in today’s blog is the issue of whether parents should discuss their will with their children.

When there is a “black sheep” child in the family, or a child who is not treated equally in the will, I expect that a family meeting would likely be a disaster. But what about a meeting in situations when the children are treated somewhat equally? There is no right or wrong answer, but I think a family meeting is wise. Any meeting of this type can turn ugly because of money issues, but more likely, any ugliness will be the result of historical family jealousies or resentment over some prior issue or treatment. Nevertheless, if you feel you can navigate the minefields noted above, the family meeting can be very effective and useful.

The family meeting could be used to deal or clarify several different types of issues. For example:

1. Possible perceived inequalities: The meeting could be used to explain why you have left your Picasso to your daughter instead of your son so that he doesn’t feel slighted when the will is read. This discussion could involve explaining that since your daughter studied Art History at university, you feel she would appreciate the Picasso; however, since it is worth $500,000, you have left your son $500,000 of stock to equalize (or if you have not tried to equalize, you can explain why face to face). Also, where you have left more money to one child (perhaps they make less money than the other children), you can use the meeting to clarify why and explain that it has nothing to do with loving that child more, you are just helping them since they have not been as fortunate as the other siblings.

2. Determine wants and needs of the beneficiaries: Many families have second properties such as cottages or ski chalets. Some children may have attachments to these properties while others might not, or maybe you are not sure whether any child would want to take over the property when you pass. A meeting provides the opportunity to raise the issue for your children to decide among themselves if they will want to sell the property, share the use, or have one child inherit the property. This issue may be best discussed prior to a will being finalized.

3.  Deciding on an executor: Most children have no idea of the responsibilities and the burden of being named an executor of the will. You can broach this topic at the meeting to explain the duties of the executor and determine if the children or child you wish to be an executor(s) are/is willing to undertake the position.

4.  Full disclosure: Finally, depending upon how open you wish the meeting to be, you can provide a current list of assets to your children so they know what assets you own and where they are held. In any event, you should also provide such a list to your accountant, lawyer or spouse. A copy of the list should also go into your safety deposit box. They key take-away is that you must ensure such a document exists and someone knows where it is.

The decision to have a family meeting to explain your estate planning while alive and in good mental and physical health is a complex decision based on past family history and relationships. However, if you feel the meeting can be held without creating a “civil war,” it gives you a great chance to explain your estate planning and to get everyone onside.

Update: I followed this blog post up with another in February 2012, which reviews an Investors Group survey of Canadians attitudes towards discussing their wills. If you have any interest, here is the link.

The Dentist’s Wallpaper

There is not much to do while you are in the dentist’s chair, especially if you are not lucky enough to have nitrous oxide administered. Personally, I look for anything to take my mind off that damn drill.

One day while having a cavity filled I started reading my dentist’s wallpaper. Before you say “I think you really did have nitrous oxide administered and maybe too much,” you must understand my dentist’s wallpaper actually has “life quotes” all over it. One of the quotes was “Life is Hard by the Yard, But by the Inch Life’s a Cinch.”

I don’t want to get all philosophical here, but I just found the quote so interesting; it actually took my mind of the drill. Such a simple adage that says so much.

We all can get overwhelmed when we look at all the tasks and requirements of our daily lives, but if you break those tasks down into bite-sized pieces, the totality of all the tasks is less overwhelming. Although this is easier said than done, I do try and remember this quote when I feel overwhelmed.

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.

Are Estate Freezes the Wrong Solution for Family Business Succession? - Part 2 and Giveaway

On Monday I discussed why an estate freeze may not be the right solution for a family’s business succession plan and why Tom Deans considers an estate freeze to generally be the absolute wrong way to go about transferring a family business.

Today, I discuss my interpretation of Tom’s thoughts based on a panel discussion I participated in with him, my reading of his book and a review of interviews he has given. To be absolutely clear, these are my interpretations and Tom has not reviewed or commented in any way. Finally, I have a 4 CD audio set giveaway of Tom's book Every Family's Business.

Buy the Business, Are You Kidding Me?

In the postscript to Tom’s book Every Family's Business: 12 Common Sense Questions to Protect Your Wealth, he says the one part of his presentation that always elicits an uneasy response is when he says ‘in this room there are children who believe their parents will gift their business to them and parents who believe their children will purchase their business”. He goes on to say “this lack of clarity over the future ownership of the business is the greatest source of conflict and wealth destruction in a business".

What Tom is poignantly noting is the lack of communication between parents and their children and the unspoken assumptions that are often far from the truth. A parent needs to be honest with their child(ren) if their expectation is that their child(ren) will have to purchase the family business. Children need to be honest with their parent(s) about whether or not they are willing to purchase shares in the business or if they even have an interest in carrying on the business. The best business families are able to talk openly, honestly and frankly about money, business and family succession.

Just Sell the Damn Thing

Tom says “The legacy is not the business. The legacy is the family”. Many business owners believe their greatest legacy is their company and their job as entrepreneurs is to transition that business into their children’s hands. Tom suggests that owners need to grant themselves permission to take care of themselves first by selling for cash and looking at their business as an instrument of wealth creation. Although the business will typically be sold to competitors, Tom has no problem offering the business to children, as long as they purchase it on commercial terms and take on the risk of ownership (children may get preferential payment terms).

Tom says that when children find out they will not be gifted the business (through an estate freeze) they are often perturbed, however, when it is explained to them that someone is paying mom or dad millions of dollars, some of which may be allocated to them immediately or will ensure a significant inheritance for them in the future, they suddenly change their tune. Essentially, Tom is saying that the equity in your business does not have to be passed down as shares in the business, but can be passed as liquid wealth to your children down the road. To deal with the liquid wealth created by a sale, Tom wrote a second book entitled Willing Wisdom: 7 Questions to Ask Before You Die.

Transitioning Your Business to Your 65 Year Old Child

If a parent decides against selling the business and undertakes an estate freeze, often the parent becomes their own worst enemy. Tom half-jokingly noted during our panel discussion that when your parent has a heart attack at 71, twenty years ago they died. Now doctors put in a coronary stent and your parent is good for another 20 years. So when parents tell a child it will all be yours one day, that one day could be when you turn 65 and up until you obtain control of the company, your parent(s) may keep their thumb(s) on you (since they often maintain voting control as per my estate freeze discussion last week). Parents; skipping a generation is not succession planning! 

Find the End Before it Finds You

Tom says that in many cases your succession plan as an owner is no plan and until you suffer a health event, there is no urgency to plan. He suggests that it is important to start planning from day one, while you are healthy and clear of mind. Determine if there is a buyer in the house (family member) and as noted above, do not assume your children will be the buyer. He feels that if your children will not put up their own money (or obtain their own bank financing) to buy some or all of your shares, you should look elsewhere. If a child is not willing to risk their own capital, Tom feels that means they are either not committed to the business or they truly feel the business is old and past its freshness date.

Whether you want your business to be enticing to your children or an arms-length buyer, you must ensure your business adapts to changes and risks in the market place and that you continuously strive to improve operations and efficiency. By doing such, you make your company more valuable to an outside party and more attractive for a child to risk their own capital and carry on the business.

If you own a business, I strongly suggest you buy Tom’s book. In the end, he boils family succession planning down to 12 commons sense questions that start the family succession conversation but also cleverly have the ability to end the conversation quickly. I hope the two posts this week and last week’s blog on estate freezes, has given you plenty of food for thought.

Every Family's Business 4 CD Set Giveaway

I have two copies of a 4 CD audio set of Every Family's Business narrated by Tom. If you would like a copy, email Lynda@cunninghamca.com and I will randomly select the two winners and announce them on June 16th.

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.

Are Estate Freezes the Wrong Solution for Family Business Succession?

Last week I discussed how an estate freeze provides an efficient income tax solution for the succession of your family business by allowing you to lock in the value of your business and pass the ownership tax-free to your children. However, a freeze does not provide you with immediate liquidity, nor does it require your children to risk their own capital. Some family succession experts believe an estate freeze is a misplaced income tax solution; when what is really required, is a business

solution.

A few months ago, I was one of the “experts” on a panel that discussed family succession. The guest speaker and main attraction for the night was Tom Deans (yes, believe it or not, I was not the draw). Tom is the author of Every Family's Business: 12 Common Sense Questions to Protect Your Wealth, the best-selling family business book of all-time with more than 300,000 copies in circulation. Tom is an outspoken advocate of parents taking care of themselves, which often means selling their business, whether to a competitor, their own child or management, rather than just handing it over to their children for free (via an estate freeze). 

Tom's suggestion to monetize your business, rather than hand it over to your children, runs counter to the commonly held belief that your business is your legacy and that the ultimate family business is multigenerational. For many business owners, I would suggest that Tom’s advice to sell and safeguard your retirement is often the prudent decision.

Tom says an “estate freeze usually sets the stage for what I like to describe as the beginning of the ‘perpetuity project.’ This is when a family shifts its thinking away from the business as a money-making asset and toward the business as a legacy, with the goal of ‘longevity’ trumping all other strategic options for creating value.”

With statistics suggesting that only 30% of family businesses transition successfully to the 2nd generation and a meager 10% to a third generation, Tom may be correct that many parents are compliant in destroying their business by trying to ensure its perpetuity.

Why Parents May Choose to Undertake an Estate Freeze

In my experience, parents often cite three reasons for preferring an estate freeze over an outright sale to an arms-length party or to one of their children.

1. They see the family business as an annuity, so why sell for $4,000,000 ($3,200,000 or so after-tax) when it will make $4,000,000 every 4 to 5 years indefinitely if the business continues as it is or grows.

2. They feel they can easily redeem enough of their frozen shares each year to cover their living expenses so why burden the children with additional debt.

3. What is the point in selling shares to their children, if their children need to borrow from the bank to purchase the shares; especially since if the business goes sour, the parents figure they may need to step-up and cover the default anyways?

What Is so Bad About an Estate Freeze?

As many accountants can attest to, often a well- intentioned estate freeze that has saved the family thousands or even hundreds of thousands of dollars in tax ends up being the catalyst to family conflict and/or the ruin of the families business. Here are some of the downsides to an estate freeze:

1. In undertaking a freeze, shares are issued for no consideration. The children have no risk capital invested in the company, which can alter their commitment to the business. (More on this on Wednesday.)

2. Whether a company’s share value increases due to market forces or because of the children’s efforts or non-efforts is irrelevant; your children may end up making far more than you ever did, despite you handing them a turnkey operation (that may be fine with you).

3. An estate freeze requires decisions regarding which child(ren) will work in the business, how they will be compensated and which of them get shares and what percentage of the shares. All these decisions can blow-up. For example, let’s say you undertake an estate freeze and give your daughter who will work in the business all the shares of the business (which are in theory worthless at the date of the freeze, since you have all the current value in your special shares, say your shares are worth $2,000,000 in this example). You leave your other two children say $100,000 each in your will to “compensate” them for not being involved in the freeze. Imagine the sibling conflict if the business grows to $3,000,000 in value. The child working the business has benefited to the tune of one million dollars ($3,000,000- $2,000,000 freeze value) plus a full-time job, compared to the $100k the other children will receive in the will.

4. Parents often like the concept of freezes because it locks in the maximum amount of income tax they will owe on death, however, the freeze is also often viewed as a way for them to slow down and move away from the business. If the child who takes over the business makes a mess of the family company, mom or dad or both are often forced to step back in to save the company – not exactly the stress-free retirement they imagined.

5. In a blog posting by Tom, he states that an estate freeze “magnifies family genius – and incompetence – precisely because the market rules of ownership were violated through gifting, all in the name of saving tax. Families pay the highest price when they lose their mutual trust and respect for one another when gifting goes bad. And when trust is lost, family members resorting to litigation is the saddest progression of a family business in decline”.

The Benefits of Estate Freezes

My personal experience with estate freezes has been good. While the overwhelming majority of my clients over the years have sold their businesses, there have been several that have frozen their companies and everything worked out. I would say that is because most of these clients were able to distinguish which child(ren) deserved to work in the business and were committed to the business (in most cases, the children have been uniformly intelligent and often academically brighter than their parents, though not necessarily as street smart). The parents also gave significant thought to how they would compensate the children both involved in the business and those excluded from involvement. Finally and probably most import, the parents tried to understand the sibling dynamic within their families and whether a freeze made sense within these family dynamics.

When I spoke to Tom about this before his speech, he asked me “If all these children were so committed to the business and so bright, why would they not have agreed to purchase shares from their parents?”

After reading this post, you may be thinking to yourself that an estate free may not be the succession planning panacea it is marketed as; at least from the non-tax perspective. On Wednesday in part two of this post, I will discuss the issues Tom considers vital in regards to selling or transitioning your family business. In addition, I will give away two copies of a 4 CD set of Every Family's Business narrated by Tom.

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.

Estate Freeze – A Tax Solution for the Succession of a Small Business

Winston Churchill once said, “Let our advance worrying, become advance thinking and planning.” Small business owners often worry about their exit strategy and/or succession plan. They may also be concerned about what would happen to their business if they have a health scare or receive an ultimatum from a child working in their business. Often a small business owner’s worry becomes their anxiety, instead of their advanced planning.

As a small business owner, at the end of the day, there are essentially only two exit strategy/succession options you need to plan and/or consider:

(1) A sale of your business, typically to a competitor, sometimes to current management or very infrequently, an actual sale to a child or other family member; or

(2) A transfer of the business to your children without a sale (for purposes of this article I will refer to this option as an “estate freeze”).

My blog today discusses estate freezes. How you can transfer your business tax-free to a successor (typically your children, sometimes to existing management) while continuing to control and receive remuneration from your business.

Next week I’ll discuss Tom Dean’s thoughts on this matter. Tom who is the author of Every Family's Business (the bestselling family business book of all-time) believes a business should in most cases be sold and never handed over to the next generation (such as done with an estate freeze) without the parent(s) adequately being compensated for the business.

What is an Estate Freeze?

The most tax efficient manner to transfer your business to your children is to undertake an estate freeze. An estate freeze allows your child(ren) to carry on your business, while at the same time you receive shares worth the current value of your business. In addition, once your share value is locked-in, your future income tax liability in respect of your company’s shares is fixed and can only decrease. Keep in mind that when you freeze the value of your company you are not receiving any monies for your shares at that time. There may be ways to monetize that value in the future, but on an estate freeze, you typically only receive shares of value, not cash.

The key risk in any estate freeze is that your children may partially or fully devalue these shares and your company. So while an estate freeze may be the most tax efficient way to transfer your business, it may not be the best decision from an economic or monetization perspective. 

In a typical estate freeze, you exchange your common shares of your corporation on a tax-free basis for preferred shares that have a permanent value (“frozen value”) equal to the common shares’ fair market value (“FMV”) at the time of the freeze. Subsequently, a successor or successors, say your children or family trust can subscribe for new common shares of the corporation for a nominal amount.

This concept is best explained with an example. Assume Mr. A has an incorporated business worth $3,000,000 and wants to undertake an estate freeze. In the course of the freeze, Mr. A is issued new preferred shares worth $3,000,000 and his children or a family trust subscribes for new common shares for nominal consideration. Mr. A’s tax liability in relation to these shares on death, is now fixed at approximately $750,000 in Ontario ($3,000,000 x capital gains rate). Often, a key aspect of an estate freeze is a plan to reduce the tax liability by redeeming the preferred shares on a year by year basis as discussed below.

If you have access to your lifetime capital gains exemption (currently at $800,000 but indexed beginning in 2015 for inflation), your income tax liability may be reduced when the shares are eventually sold or upon your death if you still own them at that time. Finally, you may choose to crystallize your exemption when you freeze the shares.

The preferred shares received on the freeze can be created such that they allow you to maintain voting control of your corporation until you are satisfied your child(ren), is(are) running the company in the manner you desire. This maybe a double-edged sword, as you may tend to hold onto control long after your successors have proven themselves. This may become a contentious issue.

Preferred shares can also serve as a source of retirement income. Typically what is done is that your preferred shares are redeemed gradually. So, for example, if you need $100,000 before tax a year to live, you can redeem $100,000 of your preferred shares each year. Let’s say you live 20 years and redeem a $100,000 a year. By the time of your death, you will have redeemed $2,000,000 ($100,000 x 20 years) of your preferred shares and they will now only be worth $1,000,000 ($3,000,000 original value less $2,000,000) at your death. Your income tax liability on these shares at the time of your death will now only be approximately $250,000.

The Benefits of an Estate Freeze

1. On death (something we should all be planning for), an individual is subject to a deemed disposition (i.e. a sale) on all of his/her assets at FMV, which would include his/her shares of the business. An estate freeze sets your maximum income tax liability upon this deemed sale and as discussed above, this liability can be lowered over the years by redeeming the shares.

2. Family members will be able to become shareholders of the business at a minimal cost and be motivated to build the business (although Tom Dean's would dispute this assertion).

3. Instead of having children directly subscribe for new common shares, you can create a discretionary family trust to hold the common shares. Every year, the corporation can pay dividends to the family trust which can then allocate the dividends to family members with lower marginal tax rates. This mechanism allows for great income splitting opportunities.

4. On the eventual sale of the business, the children or family trust may realize a significant capital gain. Assuming that the business qualifies for the capital gains exemption, the family trust can allocate this capital gain to each beneficiary who may be able to use his/her own lifetime capital gains exemption limit to shield $800,000 or more of capital gains from income tax.

One of the more critical aspects of an estate freeze is the determination of the fair market value ("FMV") of your business. In order to ensure that an estate freeze proceeds as smoothly as possible, the FMV of the company must be calculated. In the event that the FMV determined is challenged by the Canada Revenue Agency (the “CRA”) the attributes of the preferred shares will have a purchase price adjustment clause that will let the freezer reset the FMV. The CRA has stated in the past that they will generally accept the use of a purchase price adjustment clause if a “reasonable attempt” has been made in valuing the company. Engaging a third party independent Chartered Business Valuator to prepare a valuation report is generally accepted as a “reasonable attempt” in estimating the FMV.

Issues to Consider Before Implementing an Estate Freeze

An estate freeze does not make sense for all business owners. While the above benefits do sound very enticing, it depends on each owner’s personal circumstances. Issues to be considered include:

1. Are you relying on the value of the company to fund your retirement? If so, it may be best to sell and ensure you have a secure retirement.

2. Do you have an identified successor, i.e. child, able and willing to work in your business?

3. Can you bring one child into the business without creating a dispute amongst your children?

4. Are your children married and how may a divorce or separation impact the business?

Long-time readers of my blog will know that I am a proponent of family discussions and getting over the money taboo. I cannot overstate the importance of having a detailed discussion with your family if you plan to hand your business over to one or more of your children. If you pass that hurdle, you must speak with your accountant and lawyer to ensure you understand the implications of the freeze and how to properly implement the corporate restructuring. Finally, your tax advisor will want to structure the freeze such that it can be “thawed” if the business suffers a setback due to the economy, or your child(ren) prove incapable of running the company.

As noted above, next week I will discuss Tom Dean’s views. Tom feels an estate freeze is not a succession plan or the best way to liquidate or sell a business.

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.

Is it Morbid or Realistic to Plan for an Inheritance?

I have written several blog posts on estate planning and inheritances, including “Taking it to the Grave,” a blog I wrote for the Canadian Capitalist, in which I discuss whether parents should distribute future inheritances in part or in whole while they are alive and “How your Family Dynamic can affect your Estate Planning”  in which I discuss how parents have to navigate a minefield of family issues with respect to the determination of executors, the distribution of family heirlooms and the distribution of hard assets.

These blogs elicited a wide range of opinions and comments that I found fascinating. Some people believe they are better off because their parents made them work for everything and they don’t want any financial assistance from their parents either during their life or after they pass away. Others state that as long as parents are careful to ensure they don’t destroy their children’s motivation, partial inheritances make sense. Finally, others say they have been sickened as they observe children waiting at a parent’s deathbed salivating at the thought of their inheritance.

All this leads me to another very touchy subject; should a child (let’s assume the child is at least 40 years old) plan their own future based on a known or presumed inheritance? To add some perspective to this issue, it is interesting to note that a recent survey by the Investors Group states that 53% of Canadians are expecting an inheritance, with over 57% of those, expecting an inheritance greater than $100,000.

Inheritances can be categorized as either known or presumed inheritances. An inheritance would be categorized as known, when a parent(s) has/have discussed the contents of their will with their child(ren) or at least made known their intentions. In these cases, while the certainty of the inheritance in known, the quantum is subject to the vagaries of the parent(s) health, the parent(s) lifestyle, the income taxes due on the death of the last to survive parent and the economic conditions of the day. (Speaking of discussing the will with your children, it is very interesting to note that my blog post One Big Happy Family until we discuss the Will which had limited initial traction, is now by far and away the most read blog I have ever written).

An inheritance may be presumed where the financial circumstances of the family are obvious. A child cannot help but observe that the house their parents purchased 30 or 40 years ago for $25,000 is now worth $800,000 to $1,000,000, or that the cottage their family bought for $100,000 many years ago can be subdivided and is now worth $700,000.
Many average Canadian families have amassed significant net worth just by virtue of the gains on their real estate purchases. These families would not be considered wealthy based on lifestyle or income level, yet their legacy can have a significant impact upon their children. Inheritances are not only an issue for wealthy families.

I think most people will agree that where an inheritance will be so substantial that it will be life changing; parents need to downplay the inheritance issue and/or manage the inheritance by providing partial gifts during their lifetime. Rarely can a child become aware of a life-changing inheritance without losing motivation and experiencing a change in their philosophical outlook on life.

Although life changing inheritances are rare, life "affecting" inheritances are not. So, should children change how they live and how they plan for the future based on a known or presumed future inheritance? In my opinion, if the inheritance is known and will be substantial enough to alter a child’s current or future living standard, the answer is a lukewarm yes, subject to the various caveats I discuss below.

I think it is imprudent to ignore reality and where an inheritance has the attributes I note above, it should be considered as part of your future financial plan. However, I would discount the amount used for planning purposes significantly, to account for inherent risks. Those risks include the longevity of a parent, economic downturns that reduce your parent(s) yearly income stream,  potential medical costs and finally, the ultimate risk one takes in planning for an inheritance; the risk of somehow falling out of favour and being removed from your parent(s) will.

Where there is a presumed inheritance, I would suggest you need to be ultra conservative if you want to plan for the inheritance, since not only are you guessing at the inheritance amount, but you face an additional risk that your parent(s) may have offsetting liabilities such as a mortgage or line of credit of which you are unaware.

So what do the experts have to say on this matter? In the press release for the Investors Group survey, Christine Van Cauwenberghe, Director, Tax and Estate Planning, says that "Knowing the dollars and cents behind your inheritance can have an impact on your financial plans. It is smart to know what you can expect so you can plan accordingly and family dialogue is a good place to start."

Ted Rechtshaffen, a certified financial planner at Tri-Delta Financial, in a National Post article I discuss below, says "he may be in the minority but he encourages clients to count on their inheritances when planning to some degree." He however, goes on to say he tells clients to be super-conservative. Finally, he concludes with "I know it goes against the grain because you are counting on money you don't have", adding, "it depends where your parents are in their life cycle and how clearly they have signalled their intentions".

I think Christine and Ted's comments clearly point out the conundrum here, for which there is no black and white answer. It is probably unwise to ignore a known potential inheritance, but because the final inheritance is subject to so many variables, you must risk assess that inheritance and discount its quantum by a significant amount, such that your planning becomes a paradoxical situation.

But what if you see no risk in your parent(s) financial situation deteriorating and you feel you will never be removed from the will, how can your financial planning be affected? For argument’s sake, let’s say your inheritance will be large enough to affect your future planning, but not large enough to affect your motivation or change your lifestyle.

The most obvious change to your financial plan may be to underfund your RRSP. Most Canadians struggle to make yearly RRSP contributions. They live in mortal fear that they will not have enough money to live the retirement they envision. But, if you know your parent(s) have enough funds to live out their life/lives comfortably, and say your inheritance will be in the $300,000 to $500,000 range, do you need to make your maximum RRSP contributions?

Other planning issues include whether you should purchase a home out of your price range or underfund your children’s education fund, knowing that you will receive an inheritance to pay off the mortgage or to pay off any education related loans. Alternatively, you may over fund your child’s education by sending them to a private school you would never had considered without knowledge or presumption of a future inheritance.

How you deal with debt could also be affected. If you have debt, should you just limit it to a manageable level and not concern yourself with paying it down? Or alternatively, should you pay it off because you can reallocate funds once committed to your RRSP, TFSA or RESP, knowing your inheritance will cover your RRSP, TFSA or RESP?

We have all heard about about the huge debt level many Canadians are carrying. Based on comments made by Benjamin Tal, deputy chief economist for the CIBC, one wonders if at least subconsciously some of this debt level in being carried because people know they have an inheritance coming? Mr.Tal in an article in the Toronto Star on Baby boomers set to inherit $1 trillion says "people talk about how much debt there is without looking at the size of the potential assets to come. Debt is relative to your income today, but your wealth tomorrow will improve when an inheritance comes."

So, have I seen people bank on an inheritance? Yes. To date, where I have observed such behaviour, the inheritances have come as expected. However, these cases may not be predictive of future cases.

Is it morbid to plan for an inheritance? Clearly, it is. Would most people rather have their parents instead of the inheritance? Yes. This topic is a very touchy subject and an extremely slippery slope, but to ignore the existence of a significant future inheritance that would impact your personal financial situation may be nonsensical.  However, if your financial planning takes into account a future inheritance, you should ensure you have discounted that amount to cover the various risks and variable that could curtail your inheritance and be extremely conservative in your planning.

Post script:

As the expression goes "Those who hesitate are lost". I started writing this blog back in late November, but could not come to a conclusion (if one can call the lukewarm recommendation I suggest above a conclusion) until recently on whether one should or should not plan for an inheritance. Thus, this blog post just sat. In the interim there have been two excellent articles on this topic. The first by Garry Marr of the Financial Post, titled Windfall no sure thing from which I quote Mr.Rechtshaffen above and another article by Preet Banerjee of the Globe and Mail, titled An inheritance should be a windfall, not a financial plan.

In Preet's article he notes the potential flaws of incorporating an inheritance into your financial plan. He also concludes with some words of wisdom "There are enough variables affecting your own financial success. Ideally, you shouldn’t bank on an inheritance in your financial plan, but rather treat it as an unexpected windfall. Most people would rather give it up in exchange for having their parents back".

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.