When it comes to estate planning, Canadians don’t have to deal with estate taxes like US citizens. However, what many people don’t realize is that a “deemed disposition tax” applies when you die. In this article, we’ll give you tips for minimizing your estate’s exposure to this tax and structuring your estate plan to ensure your beneficiaries get the assets you intend for them.
Key points to remember
- Canadian deemed disposition tax, which is similar to US estate tax, is deferred when assets are transferred or held in a trust for the benefit of the surviving spouse.
- Creating a trust allows you to transfer assets while you are alive, which avoids probate fees when you die.
- If you die without a will, the Canadian province in which you lived decides how your assets are distributed.
Tax and estate planning
Deemed disposition tax is so named because your investments are deemed to be sold on death. Any capital gains triggered by their sale are included in a final tax return filed in the year of your death. A final tax return also includes the value of all retirement accounts and income from stocks, bonds, real estate investments, and even life insurance products in the year of death, from January 1 through on the date of death.
With Canadian federal tax rates of up to 33% in 2022, this final tax can be substantial. Provincial taxes and probate fees also apply. (Skipping probate fees is possible, however, with good advance planning.)
The good news is that the tax is deferred if the assets are transferred to a surviving spouse, rather than sold or otherwise left unclaimed. Taxes are deferred even if the assets are held in a spousal trust, which provides income to the surviving spouse. However, if the spouse sells the property, the tax applies. When the spouse dies and the assets pass to other heirs, 50% of capital gains from all stocks, bonds, real estate investments and other assets are taxable at the personal income tax rate.
The Government of Canada also has special rules that apply to depreciable property, based on its proceeds or the deemed proceeds of disposition at the time of the individual’s death, if not bequeathed to a spouse.
Why it is important to make a will
“Nothing is certain except death and taxes,” goes the old adage (attributed to American Benjamin Franklin). Although you cannot control either of these two inevitable events, you can write a will to ensure that your financial affairs will be managed according to your wishes once you are no longer able to do so due to incapacity or death. ‘a death.
Without a valid will, you are considered deceased intestate. When this happens in Canada, the province you lived in decides how your assets are distributed, regardless of your wishes. In accordance with intestate laws, the province generally distributes the first $50,000 of value to a surviving spouse, then divides the remainder between the spouse and the children. If you don’t have a surviving spouse or children, your parents are next in line to receive your assets, followed by your siblings.
Dying without a will also leads to additional delays and expenses. The court appoints a bonded administrator to serve as the executor of the estate. In addition, all property distributed to children under 19 must be transferred to a bonded guardian or public trustee. The process of appointing these directors is both costly and time-consuming.
Last will and testament
The purpose of the last will is to instruct someone you choose as your executor on how you want your assets to be distributed after your death. It usually does not give instructions about your funeral or burial, as it will usually not be opened until after the funeral, when the heirs meet for the reading of the will.
A power of attorney gives someone you choose the power to manage your financial affairs if you become incapable of managing them yourself. It gives this person, designated as your agent or attorney, the power to perform routine tasks such as:
- pay bills
- Filing of tax returns
- Opening mail
- Speak with accountants and lawyers
- pet sitter
- Vote on your behalf
Without a power of attorney, your spouse does not have the legal authority to perform various important tasks for you if you become disabled.
A living will gives power of attorney for health/mental matters to a person of your choice. It gives that person, acting as your proxy or proxy, the authority to initiate the medical treatment you wish to receive if you become unable to express your will. The document tells doctors, family members and the courts your wishes for survival and other medical procedures should you become brain dead, unconscious, terminally ill or otherwise unable to communicate.
A living will essentially gives your chosen agent the power to choose whether or not to “unplug” or decide your fate for you, but its value is questionable. Euthanasia is not legal under Section 215 of the Criminal Code of Canada, and a living will has no legal status. However, the Canadian Charter of Rights calls into question the constitutionality of this section of the Criminal Code by giving everyone the right to “security of the person and the right not to be deprived thereof”.
How a Trust Simplifies Estate Planning
A will ensures that your heirs get exactly what you want them to get, but a trust can simplify the process of transferring those assets to your heirs. The main difference between the two is that a trust will allow you to transfer assets to beneficiaries during your lifetime, while a will will transfer your assets upon your death.
A trust is a legal entity that owns some or all of your assets, such as bank accounts, real estate, stocks, bonds, mutual fund units, and private businesses. The terms of a trust are more legally binding than those of an ordinary will, which can be challenged in court to determine whether it fulfills the “moral obligation” of the deceased. A trust also allows you to avoid the probate process, where the contents of your will are made public.
Types of trusts
The primary type of trust in estate planning is a revocable living trust, so called because you can change or revoke the terms of the trust at any time during your lifetime. The trust tells the trustees how to distribute your assets to beneficiaries during your lifetime, after you die, or if you become unable to do so.
You and your spouse can be trustees and manage the assets of the trust. This feature of a living trust can be important, for example, if a family business is placed in a trust and you want to continue to exercise some control over its operations. When one of the spouses dies, the surviving spouse remains trustee, but the trust becomes irrevocable in the sense that only limited changes can be made to its terms.
As income from assets held in trust is taxable at the Canadian tax rate for trusts, inter vivos trusts are not as popular in Canada as in the United States, where income is taxed at the income tax rate. individual. An inter vivos trust established after June 17, 1971 is subject to tax on all income at the highest marginal tax rate of the province of residence. In contrast, a testamentary trust, which only operates after death, is taxed at the provincial personal tax rate.
In addition, assets that are transferred into or out of a Canadian trust are generally treated as if they had been sold, and they are taxed on any increase in value (appreciation) from the date of purchase. However, two relatively recent trust structures, the alter ego trust and the joint-spouse trust allow you to avoid capital gains taxation.
In sum, to ensure that your assets are distributed as you wish, you will need a last will, and you may also want to consider a living will, power of attorney and trust.