Wealth Transfer Strategy 9
Nobody likes to think about their death, and who wants to pay more tax than they have to? With a little planning, you can minimize the taxes your estate might pay at death and make sure of a smoother transition of your assets to your loved ones. Here are eight top strategies to deal with that potential tax bill.
Leave assets to your spouse
If you leave your assets to your spouse¹ or to a spousal trust for that person’s benefit, you’ll manage to minimize taxes on your death. Assets left to a spouse or spousal trust are deemed to be disposed of at the deceased’s adjusted cost base (ACB), thereby deferring tax until that spouse (or trust) sells the asset or until the surviving spouse’s death.
A spousal trust is a special structure that allows you to leave assets to benefit your spouse and leaves the day-to-day control and management of the assets to the trustees (which can include your spouse). To benefit from the tax-free rollover at your ACB on death, the trust must have very specific terms (a visit to a tax professional is highly recommended). The trust document must state that the spouse is the only one entitled to the income of the trust while alive and no one other than the spouse is entitled to the assets (i.e., capital) of the trust during the spouse’s lifetime.
Although assets left to a spouse or spousal trust are automatically transferred at their ACB, this doesn’t mean that your estate will necessarily have to choose the ACB as the transfer price. There may be some situations where your estate may still want to have the fair market value rules apply. For example, if there are unutilized capital losses on the date of death and your estate wants to trigger some capital gains to offset the losses, an election can be made to transfer assets to a surviving spouse or spousal trust at fair market value rather than at the ACB. If assets are transferred to your spouse or spousal trust at fair market value, this will become the ACB for future capital gain or loss calculations.
Give assets away
Since you’re deemed to have disposed of assets you own at the time of your death, it stands to reason that if you actually dispose of assets before your death, your estate will avoid the potential tax bill. If you know to whom you want to leave certain assets and won’t have to use those assets to fund your day-to-day living, you might consider giving those assets away during your lifetime.
Although giving assets away is generally considered a disposition for tax purposes, and therefore, could give rise to a tax bill if the fair market value at the time the asset is gifted is greater than its ACB, there can still be tax savings by using this strategy. For this idea to work, you’ll want to be sure that the asset you’re giving away is likely to grow in value in the future or you’ll be in a lower tax bracket in the year the gift is made than the year of death.
Choose beneficiaries carefully
Some individuals want to leave some assets to their spouse but also want to leave assets to other heirs. In these situations, it’s very important to choose the beneficiaries of particular assets carefully. Since assets left to a spouse can avoid the fair market value disposition on death, you may want to leave assets that have appreciated in value to your spouse first, if you can. If you’re going to leave assets to others, it’s best to leave tax-friendly assets such as cash, guaranteed interest contracts (GICs), money market funds, or assets that haven’t greatly appreciated in value, since the deemed disposition of these assets at fair market value won’t lead to a large tax bill anyway.
For assets flowing through your estate, since you may not know today which assets should be left to which beneficiaries, you may simply want to provide your executor with the ability to make that decision after consulting a tax professional on your death.
Make the most of exemptions
There are certain tax exemptions available that could help to greatly minimize a tax bill on death. Speak to your executor and tax advisor today to make sure that these exemptions will be taken advantage of when filing your final tax return:
- Principal residence exemption: This exemption can be used to offset the capital gains on the disposition (or deemed disposition in the case of death) on one property you own. This could be your home but it could also be a cottage or other property that you ordinarily inhabit (rental properties don’t qualify).
- Lifetime capital gains exemption: This exemption can offset up to $892,218 (indexed for inflation) of capital gains resulting from the disposition or deemed disposition of your shares in certain private companies in Canada. For a qualifying farm or fishing property, the exemption is $1,000,000. You have to meet a lot of tests to claim this exemption, so speak to your tax advisor.
Track your ACB
At the time of your death, the difference between the fair market value of capital assets and your ACB is your capital gain, which is subject to taxation. If you can justify as high an ACB as possible, you’ll help minimize your estate’s tax bill. The problem is that many people don’t know how to properly calculate their ACB — they simply assume that it’s their original purchase price. Although the purchase price is generally a starting point, there are a number of events and transactions that can take place over the years that could alter the ACB.
Make sure you keep track of the events and transactions that will impact your ACB so your executor can properly report your capital gains on death (you may need the help of your tax advisor with some of these):
- purchases of the same security at different values over time
- 1994 capital gains elections to “bump up” the cost base of certain assets
- inherited or gifted assets
- reinvested distributions from mutual funds or reinvested dividends from stocks.
Give to charity
Giving to charity is a great way to help a good cause while receiving a tax break. If you give to charity on your death (usually through your will), your estate can claim a donation tax credit for the fair market value of the gift on your final tax return.² If you give assets other than cash, your estate may still have to report a capital gain (or loss) resulting from the deemed disposition rules, however, the donation tax credit your estate receives will offset that gain.
More recently, changes have been made that allow for the donation of marketable securities to charity with no capital gains inclusion on your tax return. See “Charitable giving: The facts” for more information on giving to charity.
File multiple tax returns
In the year of death, there are four tax returns that can potentially be filed and filing more than one could save your estate some tax. Here are the four potential tax returns:
- Final, or terminal return: This is your regular tax return that reports regular income plus income accrued from January 1 to your date of death.
- Return for rights or things: This is an optional tax return that includes income earned and receivable at death, but not yet received. Examples of income included on this return are accrued vacation pay, or dividends declared but not paid as of the date of death.
- Return for a graduated rate estate (GRE): This optional return can be filed if the deceased received income from a GRE. The GRE may have a tax year that doesn’t start or end on the same dates as the calendar year.
- Return for a partner or sole proprietor: This optional return can be filed to report business income of the deceased if the business has an off-calendar year end and more than 12 months’ worth of business income would otherwise have to be reported on the deceased’s final tax return.
Why would your estate want to file multiple tax returns? Well, for one, a claim can be made for some personal tax credits, such as the basic personal amount, on each of the returns filed on your behalf, effectively multiplying the number of credits claimed in the year. In addition, by spreading your income out over several tax returns, your estate benefits from the lower graduated tax rates more than once in your year of death. Usually the help of a tax advisor should be sought to file the terminal and optional returns since the rules can be complex.
Buy life insurance
Once you’ve done all you can to minimize your tax liability on death, you may want to consider life insurance to help fund your estate’s eventual tax liability. By purchasing life insurance, you can be assured that your heirs will be left with as much of your estate as possible and that your assets won’t have to be liquidated to pay your estate’s tax bill. This is especially true when you may have heirs who’ll depend on your inheritance to assist with their day-to-day living expenses. Life insurance proceeds is an alternative to liquidating assets, such as the family cottage, to meet dependents’ financial needs.
Individuals with assets that will attract taxes on death who want to:
- understand the income tax implications related to those assets on death
- minimize or reduce their estate’s income tax bill on death and leave more assets to their heirs.
If this applies to you:
- Review those assets that may present tax planning opportunities.
- Consider one or more of these strategies to reduce tax on death.
- Review your estate plan with a tax or legal advisor.
1 Includes a spouse or common-law partner as defined by the Income Tax Act (Canada) 2 The donation receipt in these situations can only eligible be used to offset income in the year of death (or the preceding year) if the gift is considered to have been made by the deceased’s graduated rate estate.
The commentary in this publication is for general information only and should not be considered investment or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation. Manulife, Manulife Investment Management, the Stylized M Design, and Manulife Investment Management & Stylized M Design are trademarks of The Manufacturers Life Insurance Company and are used by it, and by its affiliates under license.