Probate Planning - Estate Tax & Trust Options

Jared Pilon

In recent years, probate planning has become a more recognized topic in estate planning discussions. This is due to the increases in probate fees in jurisdictions such as Ontario. In many provinces however, probate fees are essentially NIL. Even when considering provinces with ‘high probate fees’, the costs associated with probate planning may outweigh the fees incurred.

Estate Tax

On death, the automatic transfer of an asset to an individual rather than to the estate can result in tax inequalities as the estate would be liability for tax on an asset it does not own.

This will not be an issue if the asset was owned by individuals who were married or living common-law, as defined in the Income Tax Act. The reason being that most assets can rollover to a spouse or common-law partner on a tax deferred basis.

Additionally, if an adult child is holding the asset in trust for the estate, the asset would then form a part of the estate and could be used, if necessary, to fulfill the applicable tax liability.

If the asset is held by someone other than a spouse or common-law partner and the joint owner is the true owner who receives the asset on the passing of the original owner, tax issues can arise as we will see in the following case study.

 

Case Study

Grace had a vacation property with a fair market value (FMV) of $1,000,000. Grace has a full-time residence as well which she will be applying the principal residence exemption to.

Grace added her son, George, as a joint owner on the vacation property and indicated in writing that she planned to make him a true owner. Grace’s original adjusted cost base (ACB) of the vacation property was $250,000. Upon adding George as joint owner, Grace realized a deemed disposition equal to 50% of her ACB and now has a remaining cost base of $125,000.

On death, the vacation property is worth $1,200,000 and is transferred directly to George as he is the joint owner, with a right of survivorship.

Grace also had a daughter, Courtney. Grace left the remainder of her assets to Courtney through her will. These assets consisted of her principal residence and other assets worth approximately $1,200,000. Grace thought that she was doing what was best for her two children by splitting the estate evenly and transferring the cottage directly, thus avoiding probate fees on this asset.

In reality, Grace still owned 50% of the vacation property on passing. The capital gain can be calculated as FMV of $600,000 ($1.2M x 50%) less ACB of $125,000 = $475,000, half of which ($237,500) must be included in Grace’s income on her final tax return. Depending on which jurisdiction that Grace lived in and her other sources of income upon passing the estate could be liable for as significant amount of tax. The estate will be liable for the tax even though it did not receive the asset.

Courtney (via the estate) will be required to pay the tax liability on the vacation property as she is the sole beneficiary of the estate. George would be able to keep the vacation property and Courtney will ultimately receive an unequal portion of Grace’s overall assets as a result. Depending on the nature of the assets that Courtney receives, she may be required to sell some assets in order pay the tax liability generated by the vacation property transfer.

As we can see, Grace did not achieve her goal in splitting the estate evenly.

 

Missed Trust Planning Opportunities

Another potential lost opportunity that can arise through the addition of a joint owner is the inability to transfer assets into a testamentary trust.

  • Trusts can be used to hold assets for minors, deferring the time at which these individuals can take ownership of the funds/property. Additionally, this allows for the appointment of a trustee and avoids the interjection of a provincial trustee into the estate matters.
  • One potential strategy for transferring assets within a blended family situation is through the use of a trust whereby the assets are transferred in trust to the new spouse. This will allow the new spouse to use the assets within his/her lifetime but will not allow this individual to pass the assets to whomever they want upon their eventual passing. Instead, upon passing of the new spouse, the assets held in trust would revert to the children of the first spouse, which reduces the likelihood of a child being disinherited.
  • If an individual has low-income beneficiaries, a trust can be established in order to pay income to these beneficiaries through the discretion of the trustee. This should only be done where the overall tax liability of the family is reduced and legislation such as Tax on Split Income (TOSI) has been considered through discussions with a qualified accountant.
  • If there is a beneficiary with a disability, an individual may wish to set up a Henson Trust in order to hold estate assets and preserve the provincial social assistance benefits of the disabled individual. Henson Trusts are not available in all provinces, so it is important to speak with qualified professionals to ensure this planning is done correctly. If a trust meets the criteria of a ‘qualified disability trust’, income taxed within the trust will have access to graduated rates, similar to that of an individual.

If a testamentary trust is created through a will, it is important that the assets that were intended to be transferred to the trust are in fact transferred. If assets pass via joint ownership, the conditions within the will are void.
 

Conclusion

As we can see from these case studies, efforts to avoid probate fees can have drastically negative tax, distribution and equalization consequences. Instead of completing probate planning in a silo, it is important to consider your entire estate when making decisions. This will allow you to plan according to protect your assets, minimize tax and preserve your legacy.

 

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Posted: 12/12/22