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Tax Planning to Reduce Taxes Upon Death

The following list provides some ideas on structuring your estate plan to reduce income taxes. It is a general article, and has not been personalized for your particular situation. Always consider your personal wishes first, and then plan to reduce taxes appropriately without jeopardizing your objectives.

Do not act on these ideas without seeking professional advice first. Reducing taxes at death requires advance planning. You can transfer your assets now or through your Will, and both timing options need to be considered. There are various methods to transfer assets, by gift, sale, bequest, through trusts or a combination. Each of these should be examined.  Use of gifts and joint ownership can create major tax and financial liability problems, so get legal and tax advice before using these techniques.  Also, know that any change in title on real estate should be reported on your income tax return.  Your first step in planning is to determine how much wealth you want to leave to your beneficiaries, who should get what, how much tax will be payable, and how it will be paid.

We will discuss a number of issues, those implemented by using your Will, those to do before your death and those that could be considered for either time.  However, is all cases, if you are planning a gift (while alive or through your Will) to someone living outside of Canada, ensure they obtain tax advice on cross border transfer issues.  Gift and inheritance taxes, and other such issues may apply where they live, resulting in substantial unexpected tax costs (even double taxes).  Likewise, if you use an executor in your Will who lives outside of the country, international tax and legal advice is important, as it is if you own property outside of Canada.

By Will

  1. When planning how to divide your assets among family, remember to consider values after tax. For example, if you wish to divide assets equally, a principal residence worth $100,000 will bear no tax, but an RRSP worth $100,000 will be fully taxable. Giving one to each beneficiary would not be equal.
  2. When investments increase in value from the time of purchase, upon sale or death, capital gains are incurred, which can result in significant tax liabilities. By transferring taxable assets (for example, real estate and marketable securities) to your spouse or to a trust set up for your spouse, you can take advantage of tax-free spousal rollover provisions and defer this tax until his or her death.  Obtain professional advice if you use a trust.
  3. Where you have a choice of beneficiaries, transfer income-earning assets, such as investments and rental properties, to beneficiaries in the lowest income tax brackets. This way taxes will be paid on income at a low rate of about 25% instead of the higher rates ranging up to 51%.
  4. If you have children and grandchildren, consider transferring  investments that earn income to the grandchildren if the children are in a good financial position without the inheritance.  The grandchildren may be in a lower tax bracket, paying little or no tax.  The parents can hold the money in trust for them until they reach adulthood, using it for education and for special needs of the children.
  5. Transfer your principal residence to a beneficiary who currently does not own their own home already to allow your beneficiary to benefit from the principal residence exemption. The Canada Revenue Agency (CRA) allows individuals to sell their principal residence for more than they paid for it without capital gains taxes (subject to certain provisions).
  6. When bequeathing ownership of your business, consider the tax implications to the recipient. Certain “association” rules governing corporate taxes may increase the beneficiary’s tax costs significantly if that person already owns a business. Look at alternatives, such as transferring ownership to other members of that beneficiary’s family.

Before Death

  1. Name your spouse as beneficiary of your Registered Retirement Savings Plan (RRSP) and/or Registered Retirement Income Fund (RRIF) to provide a tax-free rollover upon death. Without a rollover in place, your RRSP or your RRIF will become fully taxable upon your death, and may result in taxes being paid in higher tax brackets.  Using a spousal rollover, your spouse will be able to withdraw this fund over time thereby taking advantage of lower tax brackets.
  2. Name your spouse as successor holder (not beneficiary) of  your Tax Free Savings Account (TFSA) to provide a tax-free rollover upon death.  As a successor holder, your spouse will be able to keep the money within their TFSA for continued tax-free growth.
  3. If you have no spouse, name your minor child (or a disabled child of any age) who is still financially dependant on you as beneficiary of your RRSP or your RRIF. When naming your minor child as beneficiary of your RRSP or your RRIF, there are rules in place which allow an annual payment (referred to as an annuity) to be paid to this child until the child becomes 18 years of age. This annuity can reduce and defer taxes over a number of years.
  4. You may wish to transfer your RRSP or RRIF to a Registered Disability Savings Plan (RDSP) if you have a financially dependent infirm child or grandchild.  There are specific rules to follow and you should review these in advance with your financial institution and consider the related tax benefits.
  5. For individuals who need cash flow on death to meet tax costs or want to enhance the value of their estate, consider the purchase of a life insurance policy. Proceeds are paid tax-free upon death. Before buying, obtain independent and objective professional advice to determine how much you really need (or want), review the premium and/or growth guarantees or expected increases over the rest of your life, whether any cash surrender value (CSV) is paid in addition to the death benefit or not, how taxes apply if you withdraw the CSV early, etc.
  6. If you have sufficient income to meet your personal needs in the future, give away income-earning assets now. However, know that the CRA has “attribution rules” which deal with gifting to minor children. A child is considered a minor until the commencement of the year in which the minor reaches 18 years of age. If an income-earning investment (yielding interest, dividends, etc.) is gifted to a minor child or grandchild, any income (but not capital gains) earned on that investment will be taxed in your hands (i.e. attributed to you). However, gifts to adult children are not subject to these rules, and your gift may allow them to reduce their debt or generate investment income at a lower tax rate than you.
  7. If you own a life insurance policy that insures the life of your children or grandchildren, transfer the ownership to them when they reach the age of majority, and it occurs on a tax-free basis.  Transfer of ownership after your death may be taxable.

Before Death or by Will

  1. If you are planning a major charitable bequest, plan ahead to ensure maximum tax benefits are received. If the gift is very large compared to your income at death, you may not receive the full tax benefit. Arrangements can be made to obtain tax benefits while you are alive.
  2. If you have an investment portfolio with accumulated capital gains, and plan to leave a bequest to a charity, donate a portion of the portfolio directly to charity rather than selling the investments and donating cash. If investments given to a charity give rise to a capital gain, the capital gain will not be taxed.  Similar rules apply to ecologically sensitive land.
  3. If you own a farming business, transfer these assets to your children to use tax-free rollovers. Transfer or sale of a farming/fishing business may also qualify for the enhanced capital gains exemption (fixed at $1,000,000 at time of writing)  in addition to these family rollover provisions. Obtain professional advice now to see if you will qualify.
  4. Use the enhanced capital gains exemption to reduce taxes on transfer of an active business corporation, as well as for farms and fishing businesses.  Make sure that the business qualifies throughout the necessary time frames, which can be as long as 24 months prior to death or sale. The rules are quite complex and should not be anticipated without professional advice. There are a number of criteria that must be met.  Advice should be obtained now so that steps can be taken to make the business qualify. Taxes could be saved on over $800,000 of capital gains (the limit increases by inflation each year and is $892,218 for 2021).

Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum