Tax-efficient Will Preparation Leave More To Beneficiaries, Less To The Taxman – Tax

The Covid-19 pandemic has caused much turmoil and disruption for
most people, socially, financially, medically. And judging from how
busy my Wills and Estates Group has been for the past year,
it’s also started many thinking more seriously about estate
planning, primarily the preparation of a will. When we think about
planning our will, we think of priorities. For example, about who
will take of our kids and provide for them. Or whether there will
be enough of an estate left over for family members once the taxman
gets his piece of the pie. With that in mind, here are a few
tax-saving strategies to discuss with your legal advisor when
preparing your will.

The spousal gift

Canadian tax rules provide that when you pass away, you are
deemed to have sold all of your assets immediately prior to your
death. To the extent that the disposition of any of your assets
results in a gain, then your estate will be subject to capital
gains tax.

On the bright side, at least your beneficiaries get to inherit
your assets with a bumped-up cost base and there is no tax to them.
There is, however, one important exception to this deemed capital
gain. You can defer your death tax exposure by making your spouse
the beneficiary of your estate, or perhaps better still, you can
leave your assets in a qualifying spousal trust. There is no
election that your estate need make; it’s an automatic deferral
to the extent you leave assets to your spouse or a spousal
trust.

Specifically, the tax rules provide that bequests to a spousal
trust (or to your spouse outright) will not trigger capital gains
tax on your death so that assets transferred to the spousal trust
will occur on a tax-deferred basis.

The bonus of a spousal trust is that you can choose trustees to
protect the surviving spouse against poor financial decisions, or
any undue influences. As well, you can ensure that the surviving
spouse will not be able to transfer assets to undesired
beneficiaries (for example, if he or she were to get remarried and
decide to leave your assets to their new spouse).

But you must be certain that the spousal trust qualifies for the
tax-deferred treatment; otherwise, no tax-deferred rollover upon
your death will be available.

Specifically, the spousal trust must meet the following
requirements:

• The spouse is entitled to receive all of the income of the
  trust while he or she is alive (but this does not include capital
  gains).




• No other person (including children) may receive or otherwise
  obtain the use of any income or capital of the trust.

Note that just because no one else is allowed to receive the
capital of the trust does not mean that the spouse is automatically
entitled to the capital. This means that you can provide that there
is no power to encroach on capital so that the nest egg stays safe
for your children while your spouse gets the benefit of the income
during his or her lifetime.

In other words, as long as no other person received or obtains
the use of the capital, the spousal trust will not be
disqualified.

In order to make sure that you do not stray from these
requirements, care should be taken when drafting your will and the
clauses relating to the spousal trust.

For example, if the spousal trust allows for the trustees to
lend funds on an interest-bearing basis to a relative, this could
be interpreted as allowing someone other than the spouse to receive
or obtain the use of the capital (it may be okay, however, to lend
funds on commercial terms; however, you should check with your
advisor).

Another advantage of a spousal trust is that it can provide for
certain testamentary debts to be paid, i.e., funeral expenses and
income taxes payable for the year of death and prior years.

Testamentary trusts

Before 2014, “testamentary trusts were deemed separate
taxpayers, with access to the graduated rates, allowing for various
income-splitting opportunities with children. However, as of 2016,
testamentary trusts no longer benefit from graduated tax rates nor
are they exempt from making tax installments or having an
off-calendar year end. As a result, testamentary trusts are subject
to a flat, top tax rate. The only exception to this rule is that
the estate designate itself as a “graduated rate estate”
(GRE) and thereby take advantage of the graduated tax rates for the
first 36 months after death.

There are specific rules that relate to GREs, namely that there
can be only one GRE per deceased person. It must meet the following
criteria:

1. The estate must designate itself as a GRE on the first
   year’s tax return;




2. No other estate of the individual can be designated as a GRE;
   and




3. The estate must use the deceased’s Social Insurance Number
   on each tax return during the 36-month period following his or her
   death.

Another benefit is that GREs are also the only type of
testamentary trust that can utilize capital loss carrybacks, which
allows the GRE to carry capital losses back to the deceased’s
terminal year under certain postmortem tax strategies (this is
especially important if an estate owns shares in a private company,
as such a strategy can help avoid double taxation). Additionally,
GREs enjoy various administrative benefits, such as being entitled
to refunds beyond the normal assessment period and an extended
notice of objection deadline.

I would also note that if you are philanthropic, a GRE provides
for more flexibility in claiming donation tax credits.
Specifically, the tax credit can be claimed by the GRE in the year
the donation is made (or any of the following five years), it can
be carried back to previous year of the GRE, or even to the final
tax return of the deceased (or a year prior to death).

Previously published in The Fund Library on March 23,
2021.

The content of this article is intended to provide a
general guide to the subject matter. Specialist advice should be
sought about your specific circumstances.