As Benjamin Franklin once said, "there is nothing in this world that can be certain, except for death and taxes."
This oft-quoted passage has only become more accurate over time, but perhaps missed drawing the reader's attention to the final certainty: that in the end, both death and taxes come for us at the same time.
For most, an estate plan is basically a will, describing where your assets will go after you die, as well as Powers of Attorney that dictate who will make decisions for you if you are incapable. However, upon your death, large tax liabilities often arise, but are overlooked and unaccounted for in the simple estate plan.
As your assets grow and family gets bigger, it is important to ensure that you are aware of the tax implications of death so that you are able to pre-plan your estate and leave as much money as possible to your intended beneficiaries. Therefore, when you make your estate plan with a professional, it is important to keep the following tax strategies in mind:
1) Estate Administration Tax
The person appointed to carry out the terms of the will must first submit an application for a Certificate of Appointment of Estate Trustee, issued by the Ontario Superior Court of Justice, before distributing the deceased's estate. Before issuing that certificate, the court will levy an Estate Administration Tax ("EAT"), set in section 2(6) of the Estate Administration Tax Act, 1998.
Contrary to popular belief, the EAT, or Probate Tax, is not egregiously high. It is only 0.5 per cent of the Estate's first $50,000, amounting to $250 total, and 1.5 per cent thereafter, totaling $15 to each additional $1,000 of value in the Estate.
While it is not as intimidating as some people think, it still must be accounted for, as EAT is $7,000 on an estate worth $500,000, $14,500 on an estate worth $1,000,000 or $74,500 on an estate worth $5,000,000. Including all the property and assets in your possession, many people do not realize how high their estate is valued, which can leave a large EAT bill for your estate.
2) Income Tax
Upon death, a new taxpayer is created, the estate of the deceased, who owes taxes just like any other individual. According to section 70 of the federal Income Tax Act ("ITA"), income tax becomes immediately payable upon death. Any monetary interest of a taxpayer, including employment and business income as well as investment income, where tax was not paid before death is deemed to have accrued in daily amounts up to and including the day of death.
As well, the taxpayer is deemed to have disposed of all property immediately before death at its fair market value. The property is treated as if the deceased had sold their real estate, jewellery, assets and all other capital property immediately before death and received its fair market value in return. This may trigger a capital gains tax, where the deceased is liable to pay taxes on the amount the asset has increased in value since the day it was acquired.
In addition, the law treats it as though the deceased has withdrawn all funds from their registered retirement plans such as RRSPs, RRIFs, etc. the moment before death. Since that money is tax-deferred, taxes on such retirement funds are due upon death.
3) Taxes on Beneficiaries
Any person who acquires any property as a result of the taxpayer's death is deemed to have acquired it from the deceased at its fair market value immediately before death, and so becomes a "beneficiary" under the estate. Importantly, this income of the estate, which is paid or becomes payable to a beneficiary, is included in the beneficiary's income. The income of the estate may thereby have tax implications for not only the deceased's estate, but for any person who receives benefits from the estate.
Tax Planning & Strategies
The taxes due on the death of a taxpayer can accumulate quickly and unexpectedly, resulting in high tax bills and a reduction of the value of the estate. The taxman can also distort the intention of the deceased, as less money may be left to be distributed to his or her chosen beneficiaries. However, effective estate and tax planning can reduce the amount of taxes owed by your estate after death, leaving more money remaining to take care of your loved ones or selected charities.
It is recommended that you speak to an estate planning professional prior to considering any tax planning strategies, but there are a number of commonly used methods to reduce specific taxes:
■ To reduce the Estate Administration Tax, the goal is to keep money out of your estate. One common method is to designate the proceeds of any Insurance funds to go directly to an individual. For example, if you designate your spouse as a beneficiary of your life insurance proceeds, the money will flow directly to your spouse instead of into your estate, thereby reducing the value of your estate and EAT owed.
■ To decrease income tax due upon death, a common strategy is to reduce the amount of assets owned in your name since there is a deemed disposition upon death. You can't dispose of something you don't own. Therefore, it is a common strategy to gift assets to their intended beneficiaries prior to death. That way they are not owned by you at death and do not trigger any additional tax liabilities.
■ To reduce taxes owed by beneficiaries on benefits received from the estate, the assets can be given to beneficiaries in trust. Trusts are treated separately and attract their own tax rules. As well, the estate may make an election for the distribution of income to be taxable to the estate rather than the beneficiary. This election is normally made only if the estate has sufficient losses and loss carryforwards to shelter the income, or where the estate's marginal tax rate is lower than that of the recipient beneficiary.
These are just some strategies that can be used while creating your estate plan. There are many other strategies that are available to help reduce the amount of taxes owed upon death, but their use will depend on each person's unique situation. It is important to be aware of all tax implications and to work with a professional when setting up your estate plan, but hopefully this has been able to explain some of the tax consequences of death and that there are strategies that can help alleviate those liabilities.