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Oliver Continuing Education

Series

Tax & Estate Planning Issues

Continuing Education Module

Copyright 2009 Oliver Publishing Inc.

All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted in any form or by any means without the prior

written permission of Oliver Publishing.

Revised October 2011

ISBN: 1-89-4749-37-5

Published by:

Oliver Publishing

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Toronto, Canada

M5S 1S4

Tel: (416) 922-9604 Fax: (416) 922-5126

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www.oliverslearning.com

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Tax & Estate Planning Contents

Chapter 1 Tax Planning ................................................................................................... 1 What Are The Basics of Tax? ..................................................................................................... 1 What Are the Principles of Tax Planning? .................................................................................. 2

What is Tax Planning? ............................................................................................................ 2 What Are Some Tax Planning Strategies? .............................................................................. 3 The Use of Business Losses .................................................................................................. 12

Tax Planning and Investment Income ....................................................................................... 13 The Taxation of Interest ........................................................................................................ 14 The Taxation of Dividends ................................................................................................... 14 The Taxation of Capital Gains .............................................................................................. 15 The Taxation of Mutual Funds ............................................................................................. 15

What are Other Means for Investing? ....................................................................................... 15 Oil and Gas Ventures ............................................................................................................ 15 Mining Exploration Investments .......................................................................................... 16 Limited Partnerships ............................................................................................................. 16 Whole and Universal Life Insurance .................................................................................... 16 Farming ................................................................................................................................. 16 Transfer of “Qualified Farm Property” by a Farmer to his or her child ............................... 17 Some Caveats Regarding Tax Shelters ................................................................................. 17 Stock Options ........................................................................................................................ 18 Incorporation ......................................................................................................................... 19

How is Life Insurance Taxed? .................................................................................................. 21 How Does Tax Impact Retirement Planning? ........................................................................... 22

Government Pensions ........................................................................................................... 22 Registered Retirement Plans ................................................................................................. 23 Registered Pension Plans ...................................................................................................... 24

What are Tax Issues for Small Business Owners? .................................................................... 25 How Expenses Affect Tax .................................................................................................... 25 Should a Business Incorporate? ............................................................................................ 25 Is it Better to Receive a Salary or Dividends or Both? ......................................................... 26 Tax Benefits Realized When a Business is Bought or Sold ................................................. 26 What is a Crystallization? ..................................................................................................... 26

Chapter 2 Estate Planning ............................................................................................. 27 What are the Basics of Estate Planning? ................................................................................... 27

Set Objectives ....................................................................................................................... 28 Gather and Analyze Information .......................................................................................... 28 Develop Strategies ................................................................................................................ 28 Monitor and Modify Plans .................................................................................................... 29 Implement plans .................................................................................................................... 29

What Documents are Needed? .................................................................................................. 29 What Assets Must be Considered in the Estate Plan? ............................................................... 30 What Should Appear on an Estate Planning Checklist? ........................................................... 30 Who Comprises the Estate Planning Team ............................................................................... 31 What is the Importance of a Will? ............................................................................................ 31

What Happens if There is no Will?....................................................................................... 31 What Types of Wills Exist? .................................................................................................. 32

Tax & Estate Planning

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How to Ensure the Will Meets the Client’s Needs ............................................................... 34 Special Classes in the Will .................................................................................................... 34 What is an Executor? ............................................................................................................ 34 Appointing Guardians for Minor Beneficiaries .................................................................... 36 What is a Common Disaster Clause? .................................................................................... 36 Per Capita and Per Stirpes .................................................................................................... 37 Restrictions of Testamentary Freedom ................................................................................. 37 How is a Will Changed or Replaced? ................................................................................... 37 Spousal Rights ...................................................................................................................... 37 What is a Power of Attorney? ............................................................................................... 38 Living Wills .......................................................................................................................... 38 How is an Estate Settled? ...................................................................................................... 38 How is a Will Probated? ....................................................................................................... 39 How Does the Executor Settle Debts and Other Claims? ..................................................... 41

What are the Techniques to Defer or Reduce Taxes? ............................................................... 42 Charitable Gifts ..................................................................................................................... 43

How are Personal Trusts Used in Estate Planning? .................................................................. 44 The Basics of Trusts ............................................................................................................. 44 The Trust Agreement ............................................................................................................ 45 What is the Role of the Trustee? ........................................................................................... 46 What is an Appropriate Use of a Trust? ................................................................................ 47 Types of Trusts ..................................................................................................................... 47

How Does An Estate Freeze Work? ......................................................................................... 50 The Basic Objectives of Estate Freezing .............................................................................. 50 The Use of Holding Companies and Inter-vivos (Living) Trusts ......................................... 50 How to Achieve an Estate Freeze ......................................................................................... 51 What are the Risks of Estate Freezing? ................................................................................ 51

How to Deal With a Cottage or Family Business ..................................................................... 51 Death Taxes .......................................................................................................................... 52 Tax Minimization or Tax Deferral at Death ......................................................................... 52 The Disposition of Capital Property At Death - Two General Rules ................................... 53 Four Types of Non-Deductible Reserves on a Deceased’s Final Tax Return ....................... 54 Circumstances When Two Tax Returns May Be Filed on Behalf

of a Deceased Proprietor or Partner ...................................................................................... 54 Income Beneficiary of a Testamentary Trust ........................................................................ 54 Allowances for Capital Losses ............................................................................................. 54

Conclusion ................................................................................................................................ 54

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Chapter 1 Tax Planning

The advisor must be aware of tax implications of decisions about investments and savings. To do so

requires an understanding of:

the basics of tax;

principles of tax planning;

tax minimization strategies;

tax planning and investment income;

other means for investing;

tax status of life insurance;

tax and retirement plans;

tax issues for small business owners.

What Are the Basics of Tax? The net amount of tax paid upon filing an income tax return is a result of:

how much total income has been earned;

what deductions and tax credits can be claimed;

the taxpayer’s tax rate.

There are many income sources that contribute to total income; the primary source for most

people is their salary or wages. Total income also includes income received from:

commissions and self-employment income;

pension income, including annuities, CPP, RRSPs, RRIFs, and LIFs;

certain disability benefits, including the CPP disability pension;

alimony;

investment income, including interest, dividends, and capital gains;

net rental income;

net business income (net business income is a result of total business income less

expenses and deductions);


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net research grants (net research grants is a result of total grant less expenses);

royalties.

A deduction reduces taxable income in proportion to the tax bracket of the taxpayer. Thus, a

$100 deduction to a person with $10,000 in total income and in the 26% federal tax bracket is

worth $26. The same $100 deduction is worth $36 to a person whose total income was

$50,000 because he or she is in the 36% federal tax bracket. Examples of deductions include

RRSP contributions and child-care expenses.

A tax credit is a direct reduction in tax. A $100 credit reduces tax by $100. A refundable

credit refunds the amount of the credit whether tax is paid or not. A non-refundable credit

refunds the amount of the credit only when tax is owed. The Goods and Services Tax credit is

one refundable credit; a charitable contribution is an example of a non-refundable credit.

Tax deductible charges from investment income include:

interest on funds borrowed to earn investment income;

investment counselling fees;

fees for administration or safe custody of investments;

safety-deposit-box charges;

accounting fees paid for recording investment income.

A taxpayer should keep all receipts for deductions and credits to benefit from their effect on

taxable income and federal tax.

There are two tax rates: the average (or effective) tax rate, and the marginal tax rate. It is the

marginal tax rate that is used to tell where, on the four-tiered federal tax-rate system, the

taxpayer falls. It expresses tax paid as a percentage of the person’s next (or last) dollar of

taxable income earned.

What Are the Principles of Tax Planning? The principal objective of tax planning is to pay less tax by taking advantage of all legal and

ethical means to avoid paying any more tax than necessary.

Clients must be educated about the tax consequences of investment and spending.

Tax is a somewhat controllable expense. Tax cannot be ignored, but it must not be the only

basis for investment decisions. Tax rules can change and can make earlier choices and

decisions of dubious benefit.

The advisor must know the tax implications of investment and insurance products so that

appropriate recommendations can be made.

What Is Tax Planning?

Taxation in Canada:

finances public projects (e.g., health care and defence);

redistributes income;

provides incentives for investing and planning for savings and retirement;

Chapter 1 — Tax Planning

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discourages unhealthy lifestyle choices (e.g., smoking).

The government provides different rates of tax for certain economic activities, assets, and

people. The advisor must take advantage of the lower rates to arrange the client’s affairs in

such a way that the least amount of tax is paid.

While the government provides tax incentives under the Income Tax Act, such as

contributions to RRSPs, it also imposes limits as to how much individuals can take advantage

of the incentives (e.g., RRSP contribution room).

Opportunities for reducing tax arise when:

income is deferred, because of the lower rates of taxation that will likely apply when an

individual is older;

income is split, and one person pays tax on the income at a lower rate;

family loans attribute income and gains to family members in a lower tax bracket;

the principal residence exemption is properly applied.

What Are Some Tax Planning Strategies?

Income Deferral

The purpose of deferring income is to delay paying tax until the client is in a lower marginal

tax rate. This means that the untaxed or lesser-taxed income can grow at a faster rate due to

compounding.

The major vehicles for the deferral of income for retirement are:

the Canada Pension Plan/Quebec Pension Plan;

employer pension plans;

registered retirement plans.

Registered Education Savings Plans (RESPs) are used to defer income to fund post-secondary

education.

The Registered Disability Saving Plan (RDSP), introduced in 2007, defers income to fund the

living expenses of a disabled child.

When an individual’s income level drops upon retirement, he or she will benefit from income

deferral. If a person’s income does not decrease because investment income is substituted for

employment income, the strategy of deferring income does not apply.

Working Canadians who make contributions to the CPP/QPP and their company pension

plans are using an income-deferral strategy—although they may not think of it in this way.

The use of RRSPs, RESPs, and RDSPs is a voluntary income deferral strategy.

Registered Retirement Plans

Registered retirement plans are registered with the Canada Revenue Agency (CRA), so that

tax advantages can be received by the plan owner.


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Registered retirement plans include:

Registered Retirement Savings Plans (RRSPs);

Registered Retirement Income Funds (RRIFs);

Locked-in Retirement Accounts (LIRAs);

Life Income Plans (also locked-in).

Registered Retirement Savings Plans (RRSPs)

RRSPs are the best-known of the registered plans. They are individual pension plans that take

the place of, or supplement, employer-sponsored pension plans.

The benefits of an RRSP are:

the immediate direct tax savings because contributions are deductible from income before

tax;

the compounding of returns at pre-tax rather than after-tax rates enables the investment to

grow faster;

the ability to split pension income with the spouse by making contributions to the spousal

RRSP;

their portability (they are not tied to a company like a private pension plan).

Contributions are deductible against income, for tax purposes, to prescribed limits.

Investments within an RRSP are not taxed until withdrawn. All types of returns within the

plan—whether capital gains, dividends, or interest—are taxed on the same basis when

withdrawn; they are taxed at the same rate as employment or interest income. Thus, the plan

holder does not receive the benefit of the lower tax rate for dividends or capital gains earned

within the plan.

Should funds be borrowed to make RRSP contributions?

Borrowing to make RRSP contributions can be justified if the loan is repaid within a year or

if income in a particular year results in a higher than normal tax bracket. Borrowing is also

justified if the return on the funds invested in the plan is higher than the cost of borrowing.

The interest cost of the loan is not deductible and could cost more than the benefit received.

It also makes sense to borrow if a reasonable portion of the repayment can be made out of the

tax refund from the contribution.

A taxpayer can estimate an RRSP tax refund and borrow these funds to increase his or her contribution by that amount so that more money is invested to compound in the plan.

Why do so few people contribute to RRSPs?

There are a variety of reasons why people do not invest in RRSPs. The advisor must ensure

that people who make this choice are fully aware of the investment growth they stand to lose

by not taking advantage of RRSPs. Potential contributors should also understand the


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flexibility of contributions (i.e., there is no minimum contribution and there is no requirement

for annual contributions).

Comparisons should be drawn between rates of growth and tax consequences of registered

and non-registered plans.

What are the opportunities for tax-planning with RRSPs?

The effect of compounding returns in an RRSP at a higher net rate than possible outside an

RRSP means that savings grow at a much faster rate in an RRSP.

Therefore, the maximum amount possible should be contributed to RRSPs every year,

beginning as soon as the investor is able.

Taxpayers should hold non-registered investments only when their RRSP contribution room

is used up.

If the lifetime $2,000 overcontribution limit is made 15 years or more before withdrawal, the

compounding on this more than compensates for the double taxation faced by the taxpayer on

withdrawal.

Is it better to pay down a mortgage or contribute to an RRSP?

Paying down a mortgage or reducing other debt typically takes priority over RRSP

contributions.

The following factors will justify the decision to pay down a mortgage rather than contribute

to an RRSP:

if the rate of interest on the mortgage is much higher than the return on the RRSP;

while paying down the mortgage, the unused RRSP deductions can be carried forward.

The following factors will justify the decision to continue making RRSP contributions rather

than paying down a mortgage:

if the income level is high, the tax savings gained through an RRSP contribution could

outweigh the benefit of paying down the mortgage;

the longer the time before retirement, the greater the benefit of compounding returns in

the RRSP.

The benefits of paying down the mortgage and making RRSP contributions can be combined

by using the tax refund from the RRSP to make an additional mortgage payment.

To enhance the after-tax benefit of splitting RRSP contributions with mortgage repayments:

RRSP contributions should be made at the beginning of each year;

mortgage payments should be made at the same time as income is received (i.e., biweekly

or monthly).

Other Uses for RRSPs

Owning an RRSP permits the plan holder to take advantage of the Home Buyers’ Plan and

the Lifelong Learning Plan.


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The Home Buyers’ Plan

The Home Buyers’ Plan is available to a home buyer with an RRSP who has not owned a

home for at least five calendar years up to and including the current year (considered a first-

time buyer).

In order for a home to qualify, it has to be purchased prior to October 1 of the year following

the withdrawal, and it has to be used or intend to be used as a principal residence no later than

one year after acquisition.

Up to $25,000 can be withdrawn from an RRSP; if both spouses are to be joint owners of the

property, each can withdraw $25,000. No interest is charged on the loan and the withdrawals

are not considered as an income withdrawal from the RRSP.

The property must meet eligibility criteria.

The funds withdrawn are not taxable as income but must be repaid in equal annual

instalments over a 15-year period, starting in the second year following the year of

withdrawal.

If the amount repaid exceeds the minimum amount to be paid in any one year, the annual

amount in subsequent years is reduced.

If an amount less than the minimum is repaid, the shortfall must be included in the plan

holder’s taxable income for that year.

Funds must have been contributed to the RRSP more than 90 days before they can be

withdrawn.

If the plan holder dies with a Home Buyers’ loan outstanding, the outstanding amount of the

loan is taxed.

Having participated in this plan in the past does not prevent the person from participating

again, as long as the person has not owned a home for at least five calendar years, up to and

including the current year.

Lifelong Learning Plan

A person is allowed to withdraw up to $10,000 per year from his or her RRSP, over a four-

year period, as long as the total amount withdrawn does not exceed $20,000 to help finance

their or their spouse’s education.

The person for whom the withdrawal applies must be a student in full-time training or post-

secondary education.

Registered Education Savings Plans (RESPs)

Registered Education Savings Plans (RESPs) are a savings program developed by the

federal government to encourage parents to save for the post-secondary education of their

children. As of 2007, the annual limit on RESP contributions was eliminated. The cumulative

lifetime RESP contribution limit is $50,000.

The federal government, through the Canada Education Savings Grant (CESG),

contributes to the plan according to family income (e.g., on the first $500 you put into the

plan, CESG could add:


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Up to $100, if your net family income is $41,544 or less

Up to $50, if your net family income is between $41,544 and $83,088

The CESG is based on the annual contribution. Thus, if a contribution in any one year does

not entitle the plan holder to receive the maximum CESG, that amount of CESG is forfeited

for that year.

RESP contributions are not tax deductible, but they offer a tax deferral opportunity, since

growth accumulates tax-deferred in the plan.

The investments in the RESP fund may include mutual and segregated funds, stocks, bonds,

and foreign investments.

Withdrawals from the plan are taxable in the hands of the beneficiary when he or she begins

to pay for his or her education.

Contributions can be made to a plan for 31 years (35 years if the beneficiary has a disability)

and the plan can exist and earn tax-sheltered income for an additional four years (35 years),

after which it must be wound up.

There are three types of plans:

a family plan;

a non-family plan;

a group plan.

A family plan RESP allows multiple beneficiaries, as long as they are related to the

subscriber by blood or adoption. Contributions can only be made until the beneficiary is 31.

A non-family plan can have only one beneficiary, but the beneficiary does not have to be

related by blood to the subscriber and can be any age when named.

A group RESP is operated by group plan dealers on a pooling principle, in which the

beneficiaries named by a subscriber under a contract will receive payments from the plan

when enrolled in a qualifying program. If a beneficiary fails to qualify for payment,

contributions are refunded and the earnings are distributed among other beneficiaries.

Contributions to a group plan are calculated by the actuary of the sponsoring foundation.

RESP Limitations

Payments can be made to a beneficiary once the person is enrolled as a part-time or full-time

student in a qualifying educational program.

A beneficiary cannot receive more than $5,000 during the first 13 weeks of post-secondary

education unless pre-approved by the government.

After 13 weeks, there is no limit.

Contributions to a RESP can be made up to the year in which the beneficiary turns 31 in a

family plan. On termination, if the funds are not used for education purposes, the contributing

parents may transfer up to $50,000 of the accumulated RESP income into their respective

RRSPs, as long as the RESP plan has existed for at least ten years, and that the parent has

sufficient RRSP contribution room available. Otherwise, the deposits to the plan can be

withdrawn and the investment income is taxed at the contributor’s marginal tax rate plus a


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20% penalty (principal is received tax-free because it was paid with after-tax dollars). If no

beneficiary attends a post-secondary institution, the government grant portion must be repaid

without interest.

The Canada Learning Bond is also available to assist in education savings for lower-income

Canadians.

In Alberta, the Alberta Centennial Education Savings Plan also provides grants.

Is It Better to Use an In-Trust Account as an Education Fund?

An in-trust account is an alternative to an RESP. The child is registered as the owner. The

parent(s) can make any amount of non-tax-deductible contributions. Capital gains are taxable

to the child. The income earned by the trust is attributed to the contributors. There are no

CESG grants. They cannot be rolled over into a contributor’s RRSP.

The advantage of the in-trust account is that there are no limits on contributions and no

restriction on use of the funds.

Registered Disability Savings Plan

This plan has been designed to assist parents or family to save for the long-term financial

security of a child with a disability.

It is similar to a RESP.

Funds can be invested tax-free until withdrawn.

Contributions are eligible for a Canada Disability Savings Grant. Funds can also be invested

in a Canada Disability Savings Bond.

To be eligible the contributor must be a parent or legal representative of a disabled person

who is a resident of Canada and eligible for the Disability Tax Credit.

Contributions are limited to a lifetime maximum of $200,000, with no annual limit.

Contributions are permitted until the end of the calendar year in which the eligible recipient

reaches 59 years of age.

The federal government will contribute from 100% to 300% of RDSP contributions, in the

form of the Canada Disability Savings Grant, to a maximum of $3,500, and up to $1,000

annually in Canada Disability Savings Bonds, depending on the income of the beneficiary

family.

Income Splitting

Splitting income between spouses and children enables income in a family to be spread so

that a lower overall tax rate applies.

Increasing the investment base of the lower-income spouse also splits income; the spouse in

the higher tax bracket pays the family expenses so that the spouse in the lower tax bracket is

able to save and invest. This person is taxed on the investment income at a lower tax rate.

Family members may also transfer assets to each other either by gift or sale, but the transferor

is deemed to have made the transfer at fair value, except for spousal transfers.


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For transfers between spouses, the transferor must make an election upon filing his or her tax

return (for the year of the transfer) to have the property transferred at fair value. Otherwise, it

is deemed to have been transferred at its cost base. This may result in a capital-gains tax

liability for the transferor. The income earned on the asset (including capital gains) is still

taxable to (attributed to) the transferor, unless the transferee spouse pays fair market value.

The secondary income (e.g., income on income) is taxed to the transferee.

Other income-splitting strategies include:

The spouse in the lower tax bracket taking an equity loan on his or her share of the

principal residence and investing the funds. The income gain is the difference between

the cost of the loan and the earnings on the investment.

Swapping different classes of assets between tax brackets (e.g., moving non-income-

producing assets to the spouse who is in the higher bracket in exchange for income-

producing assets to the spouse who is in the lower bracket).

When a business is family-owned, splitting income between the business owner and the

spouse and children by employing the spouse and/or children in the business. This will

reduce the income of the business owner. Ideally, his or her income is then taxed at a

lower marginal tax rate. Splitting enables a non-earning spouse to earn income (at the

cost of losing the dependent-spouse credit) and the child to use his or her personal tax

exemption.

Using Inter-vivos (“living”) trusts: an inter-vivos trust allows a person to transfer assets to

the beneficiaries of the trust while maintaining control of the assets as trustee.

Assigning CPP: As a strategy for tax saving through income splitting, the higher-income

spouse can direct up to 50% of his or her CPP benefits to the lower-income-earning

spouse. This may be done provided both spouses are over age 60. If this is done, a portion

of the recipient spouse’s CPP is automatically transferred back to the first spouse. If the

transferring spouse has high CPP benefits and the recipient spouse has low, or no, CPP

benefits, the assignment can effectively transfer up to half of the CPP income to the

lower-income spouse. The amount that can be transferred, up to a maximum of 50%,

depends on the length of time the spouses lived together as a proportion of their total

contributory period.

Using a small business corporation: small business corporations with a spouse or minor

child as a shareholder are exempt from the income attribution rules. Capital gains on the

disposal of shares of a small business corporation qualify for the $750,000 lifetime

capital-gains exemption. These companies can be used for income splitting and estate

freezing with spouses and children.

Using a Spousal RRSP: when a person contributes to a spousal RRSP, the person claims

the deduction for the year the contribution was made and the spouse pays tax on the

withdrawals when they are made. The tax on withdrawals is at the spouse’s tax rate,

which must be lower than that of the contributing spouse for this strategy to be effective.

Example: Lucy has a marginal tax rate (MTR) of 50% and her husband, Harold, has a

MTR of 26%. Lucy’s CPP benefit is $750 a month or $9,000 annually. Harold’s CPP

benefit is $250 a month or $3,000 annually. Before income splitting the household tax

bill would be:


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Before Splitting:

Lucy, $4,500 ($9,000 x 50%)

Harold, $780 ($3,000 x 26%)

Total: $5,280

After splitting:

Both are now receiving $6,000 annually. ($12,000 ÷ 2)

Lucy now pays $3,000 in tax ($6,000 x 50%)

Harold now pays $1,560 in tax ($6,000 x 26%)

Total household tax bill is now $4,560 for an annual saving of $720.

Attribution rules of the CRA are strictly enforced. The Income Tax Act requires that:

when a gift is made to a child who is less than 18 years of age, income (but not capital

gains) is attributed to the parent and secondary income is attributed to the child;

when the child is 18 or older, income and secondary income are attributed to the child;

when a gift is made to a spouse, income (including capital gains) is attributed to the

transferor spouse and secondary income is attributed to the transferee spouse;

Attribution rules also apply to the sale of property or loan to a child or a spouse (unless fair

market value is paid for the property, or the prescribed rate of interest is paid on the loan).

Splitting of Retirement Income

Retirement income splitting means transferring retirement income between spouses or

common-law partners in order to lower the overall taxes payable for a retired couple.

Up to 50% of income that qualifies for the pension income-tax credit can be allocated to a

spouse or common-law partner.

Retirement income that is eligible for income splitting for people 65 and older includes

lifetime annuity payments under an RPP, an RRSP, and an DPSP, plus payments received

from a RRIF.

For those under 65, eligible income includes lifetime annuity payments made through an RPP

and certain death benefits.

Retirement income splitting is most beneficial for retirement couples when one of the spouses

has higher retirement income and is in a higher marginal tax bracket than the other.

Retirement income splitting is also beneficial if one or both of the spouses are 65 and

receiving OAS payments. OAS benefits are clawed back once a person’s annual net income

reaches $67,668 (2011) and completely clawed back when the net income reaches $109,764

(2011). The ability to split retirement income may put one or both spouses under the $67,668

threshold, so that they can each receive the maximum OAS benefit.


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Family Loans

In certain circumstances, loans made by a high-tax-bracket family member to another family

member in a lower tax bracket will attribute income and gains earned on the loaned funds to

the borrower, not the lender.

Attribution rules will not apply if:

interest charged on the loan is at prescribed rates;

the interest on the loan is paid by January 30 of the following calendar year.

The term of the loan is based on the 90-day Treasury bill rate in effect at the beginning of the

preceding calendar quarter.

If interest rates are expected to increase, the interest rate on the loan may be locked in

indefinitely (to the benefit of the borrower).

If interest rates are expected to decline, the loan can be repaid and a new loan arranged to

take advantage of the lower rates (also to the benefit of the borrower), although a disposition

of assets to repay the loan may give rise to tax consequences.

The Principal Residence and Tax

A principal residence is exempt from capital-gains tax. When more than one property is

owned, the property to be designated the principal residence can be selected when a property

is sold to determine which will produce the largest capital gain.

The principal residence exemption is calculated by the formula:

number of years as principal residence + 1 = percentage of tax-free capital gain

number of years that the property has been owned

A client can face significant tax liability on the sale of property that is not the principal

residence. It is therefore necessary to determine which property would have the largest gain

and therefore result in the greatest benefit from its designation as the principal residence. To

do so:

begin with principal residence exemption formula to determine how much of the capital

gain will be tax-free;

then, determine the actual proceeds of disposition by:

− subtracting the selling expenses;

− subtracting the adjusted cost base (i.e., the cost of the property) to give the total

capital gain;

− applying the percentage from the formula to the total capital gain.

50% of the capital gain will be taxed in the year it is reported


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For example, if a client purchased property in 1980 and designated that property as the

principal residence until 1995, in 2000 the principal residence exemption formula would be:

1995-1980 = 15 + 1 = 16

2000-1980 = 20

16/20 = 80% (therefore, 80% of the capital gain on this property under these conditions is tax

free) If:

Property sells for $670,000

Selling costs 53,600

ACB 197,000

Capital gain 419,400

80% exemption 335,520

Net capital gain 83,880

50% subject to tax 41,940

Then, $41,940 is subject to tax on the sale of this property under these conditions.

The Use of Business Losses

Business losses result when costs exceed revenues. These losses are generally referred to as

“non-capital” losses.

A taxpayer can deduct business losses from income from other sources, including

employment.

Losses can be deducted in the year they were incurred or they can be carried forward

indefinitely or back three years.

Certain losses from small businesses can be claimed as an Allowable Business Investment

Loss (ABIL) by the investor (e.g., sole proprietorships). ABILs are deductible from all

sources of income and not just capital gains.

Their use reduces the level of earned income that determines the RRSP contribution limit.

Too many business losses can adversely affect non-refundable tax credits.

A taxpayer’s ABIL for a taxation year equals two-thirds of the taxpayer’s “business

investment loss” for the year. Business investment losses arise on arm’s-length dispositions

of shares or debt held in a Canadian-controlled private corporation. In some cases, an election

can be made to trigger an ABIL (where no actual disposition takes place) where the debt has

become “bad” or the corporation has become bankrupt or insolvent.

What are the tax planning implications of business losses?

Business losses are deductible only from personal income when the business is

unincorporated. Therefore, if losses are expected in the early years of a business, it is better

not to incorporate.

Once a business is incorporated, losses can only be deducted from corporate income.

Offsetting business losses against income can be directed at the years in which the highest

marginal rate of tax will apply to the owner of the business.


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ABILs can be converted into capital losses if unused in the forward period and applied

against capital-gains income.

As stated previously, losses reduce earned income and affect RRSP contribution limits and

the use of tax credits. Caution is best employed when planning for the utilization of losses.

In order to deduct losses the business that is creating losses must be a real business and not just a hobby or pastime. For a middle-income earner, when earned income is decreased by losses, RRSP contribution limits are reduced (a negative effect), but it is also possible that the marginal tax rate of the taxpayer will be decreased (a positive effect).

Tax Planning and Investment Income Investment income is derived from interest, dividends, and capital gains.

Interest-bearing investments entail a low level of risk and a general absence of effort to

buy and sell.

Dividend-bearing investments entail preservation of capital and general absence of effort

to buy and sell.

Capital-gains investments entail the risk of loss of capital and a degree of effort to buy

and sell.

Due to the different tax treatment of income from these three classes of investments, the

after-tax yield on interest income is generally lower than the after-tax return on either

dividend income or capital gains.

The high risk of capital gains is partly offset by the ability to capture capital losses. But

timing differences in realizing the capital gains and losses, and restrictions in the right to

offset losses against gains, reduces the practicality of making use of capital losses.

Investing for growth usually involves the possibility of capital losses. Capital losses can be

offset for tax purposes against capital gains. If there are insufficient gains, the losses can be

carried back three years and forward indefinitely. The time value of money reduces the value

of losses that cannot be utilized immediately to offset taxable gains.

Often, investors are reluctant to sell an investment that has a capital gain because of capital-

gains-tax liability. They are, therefore, deterred from finding other investments that are

potentially more productive. This causes an investment “lock-in effect.”

Taxpayers have an incentive to convert heavily taxed forms of investment into lightly taxed

forms of income. This may be at the cost of yield on the investment.

Most investment tax planning seeks large, immediate tax deductions against future taxable

assets (e.g., if an investor borrows to invest in capital properties, the interest expense on the

loan is 100% deductible immediately and 50% of the future capital gain is taxed at the

investor’s marginal rate).

Another strategy depends on increasing the value of the capital property through cheaper

financing. Thus, interest is reduced and capital gains are increased.

The lock-in effect keeps investors in investments that produce a lower yield because of their fear of tax on capital gains.


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The Taxation of Interest

Interest income is 100% taxable at the investor’s marginal tax rate.

If an investor received $765 in interest and is in the 35% marginal tax bracket (federal and provincial taxes combined), he or she must pay in tax: $765 x 35% = $267.75

The investor keeps $497.25 ($765 – $267.75).

The Taxation of Dividends

Dividends from shares of Canadian corporations receive preferential treatment for tax

purposes. Dividends from foreign corporations do not receive this preferential tax treatment.

Dividends that are paid by the following corporations are grossed up by 45% and are subject

to a federal tax credit or 19% of the grossed-up dividend:

Public corporations in Canada that are subject to the general corporate income tax rate

Other corporations in Canada that are not Canadian Controlled Private Corporations

(CCPCs) and are subject to the general corporate income tax rate

CCPCs to the extent that their non-investment income is subject to the general corporate

income tax rate

Here’s how to determine the taxable dividend income from a Canadian public corporation that is subject to the general corporate income tax rate based on the dividend tax credit::

If the investor received $765 as dividends from the Canadian corporation, he or she would include $1,109.25 in income for tax purposes ($765 + 45% = $1,109.25) The $344.25 ($1,109.25 – $765 = $344.25) is called the gross up. $1,109.25 is the taxable dividend income

Total federal tax payable is calculated as the taxable dividend income multiplied by the investor’s federal tax rate (note: not marginal tax rate). If the investor's federal tax rate is 26%:

$1,109.25 x 26% = $288.41 in total federal tax payable

The dividend tax credit is 19% of the grossed up dividend income (not of the total federal tax payable) or 27.55% of the actual dividend received. $1,109.25 x 19% = $210.76 is the dividend tax credit

The federal tax payable is the total federal tax payable less the dividend tax credit:

$288.41 – $210.76 = $77.65 is the federal tax payable on the dividend received

Provincial tax must then be calculated. There is also a provincial dividend tax credit and a provincial tax rate to be applied, both of which vary by province. Let us assume that, in the province where the investor lives, the provincial tax payable nets out at 8.5% of the taxable dividend income (after the provincial dividend tax credit and any provincial investment surtax).

$765 x 8.5% = $65.03 in provincial tax payable

Total tax payable is net federal tax payable plus provincial tax payable.

$77.65 + $65.03 = $142.68

The investor keeps $765 – $142.68 = $622.32


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The Taxation of Capital Gains

Capital gains and losses on capital property (i.e., investments) are taxed under the capital-

gains tax rules. In general, a capital gain arises on the disposition of capital property for a

higher amount than its cost, adjusted for essential fees and other allowable costs of holding

the asset.

For tax purposes, capital losses (other than a special capital loss known as a “business

investment loss”) may only be deducted from capital gains to determine the taxable capital

gain and may be applied to capital gains in the three immediately prior tax years or may be

carried forward indefinitely, so as to reduce future taxable capital gains.

If the investor earns $765 more than he or she paid for shares, he will have to pay capital-gains tax on 50% of the increase. $765 x 50% = $382.50

The investor pays tax on the taxable portion of the gain at his or her marginal tax rate. If that rate was 35%, the tax liability will be: $382.50 x 35% = $133.87 in taxes

The investor will keep $631.13 ($765 – $133.87).

The Taxation of Mutual Funds

The adjusted cost base (ACB) of mutual funds is the basis from which tax is calculated.

The ACB is the investment cost + gross dividends received each year (the tax on the

dividends has been reported and paid in each year).

Capital gains, or losses, will be based on the proceeds from the sale, less the ACB. Costs of

purchase or sale would also be deducted.

When interest, dividends, foreign income, and realized capital gains are reinvested in mutual

funds, the cost base increases.

On disposition, the cost base is deducted from proceeds to determine capital gains.

Capital losses can be carried back three years against capital gains and forward indefinitely.

When an investor owns mutual funds in an RRSP, all growth is taxed as interest income on withdrawal.

What Are Other Means of Investing?

Oil and Gas Ventures

100% of Canadian exploration expenses may be deducted in the year they are incurred.

Development expenses can be written off on a 30% declining-balance basis.

Up to $2 million of Canadian exploration expenses flow through to individual investors,

where they are 100% deductible.

The purchase price of these investments may be amortized on a 10% declining-balance basis.


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Certain expenses incurred within 60 days of year-end may be deemed to have been incurred

on the last day of the previous calendar year, and the flow-through shareholders can claim the

tax benefits.

50% of the writeoffs for individual investors enter the cumulative net investment losses

(CNIL) calculation.

A tax credit for royalties can be claimed in Alberta; tax rebates can be claimed in B.C.,

Alberta, and Saskatchewan.

Mining Exploration Investments

Mining exploration and development expenses that flow through to an investor can be 100%

deducted from other income.

Unclaimed depletion allowance earned before 1990 is 25% deductible from current profits.

Limited Partnerships

A limited partner shares the profits and losses of a limited partnership with other limited

partners. The percentage of profits or losses received are reported as income, whether the

profit has actually been received or not.

A limited partner cannot be sued for the debts of the partnership.

A limited partner’s tax deductible losses cannot exceed the amount that he or she invested in

the partnership.

Whole and Universal Life Insurance

Exempt whole or universal life insurance policies accumulate investment income tax-free

within specified limits and, at the death of the life insured, the entire proceeds from the policy

pass to the beneficiary(s) tax-free.

Farming

Canada Revenue Agency does not recognize farming losses if there is no expectation that the

farm will earn a profit or if the farm is solely for personal use.

Gains on the disposition of qualified farm property are eligible for the lifetime capital-gains

exemption of $750,000. Qualified farm property includes:

property used by the taxpayer or his family for farming in Canada;

shares of a family farm corporation and interests in family farm partnerships or trusts.

If a transfer of farm property occurs for less than current fair market value, any subsequent

capital gain or capital loss on the property is attributed to the transferor if:

the property it is transferred to a child under 18;

the property it is subsequently sold by the child while he or she is less than 18;

the transferor resides in Canada.


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Transfer of “Qualified Farm Property” by a Farmer to His or Her Child

A transfer during the lifetime of the farmer to his or her child can be made on a tax-free basis,

as long as the child carries on the farming business. The child is deemed to have acquired an

eligible capital property and made an eligible capital expenditure in the same amount as the

deemed proceeds.

A child receiving farm property does not have to continue to farm the property in order to

benefit from the rollover, but that child cannot transfer the property as farm property to his or

her children unless the property continues to qualify as farming property.

These same attribution rules apply to shares in a family farm corporation or a family farm

partnership where the transferor’s spouse or child has been actively working for the

corporation or partnership.

The ITA allows the rollover provision to apply to a family farm left to a spousal trust. On the

death of the spouse, the rollover continues and the children receive the farm property at the

surviving spouse’s adjusted cost base for the farmland and undepreciated capital cost (UCC)

on any depreciable farm property.

As long as the farm is retained by the family it is not taxed.

The Extended Meaning of a Child under the ITA

The ITA definition of child includes:

a legitimate or illegitimate child of the taxpayer or his spouse’s children;

adopted children;

a person wholly dependent on the taxpayer for support;

the son-in-law or daughter-in-law of the taxpayer;

grand- and great-grandchildren.

Some Caveats Regarding Tax Shelters

The income-earning potential of the shelter should take precedence over possible tax savings

when considering tax shelters for investments.

Investors should be certain that the investment will yield higher returns as a reward for the

high degree of risk assumed.

Also to be considered:

the share of profits to be received by the investor, the accuracy and reasonableness of

forecasts;

the reputation of the management;

the vendor’s compensation and record with previous tax shelters;

the liquidity of the investment;

possibility of liability to supply more funds;

the certainty of tax writeoffs;


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the validity of the Canada Revenue Agency tax shelter identification number.

The “general anti-avoidance rules” (GAAR) in the Income Tax Act allow the government to re-adjust almost any transaction, unless it is undertaken primarily for non-tax reasons.

Stock Options

A stock option plan is an employee incentive that also works to the benefit of the employer

by attracting and retaining employees.

A stock option plan gives (“grants”) qualifying employees the right to buy shares (by

“exercising” the options) in the company (or a subsidiary) at a price (the “exercise price”)

that is usually lower than the projected fair market value of the shares. Usually employees

have to exercise the option by a certain “exercise date.”

Employee Options on Company Stock

A stock option plan allows the employee to buy the employer company’s shares at a set price

for a stated period. The option is usually less than the stock’s market value when it is granted.

Stock options can be acquired for both public and private Canadian Controlled Private

Corporations.

When an employee is given the opportunity to buy the shares, it is called an option. When the

employee actually pays for the shares, the option is exercised. The year during which the

option can be exercised is called the year of vesting.

When the option is exercised, the taxable benefit is the difference between the amount paid

and the fair market value of the stock on the exercise date. This amount is included as

employment income in the year the option is exercised (e.g., an option to purchase 1,000

shares at $29; if the market value of the shares is $35 when exercised, the $6 is included as

employment income).

However, the adjusted cost base is the price at which the shares are exercised.

A deduction equal to 50% of the taxable benefit is available when:

the shares are common shares;

the exercise price is the fair market price or higher when the option is granted;

the transaction is at arm’s-length.

Employees who are granted stock options for a publicly owned company may defer tax on

$100,000 per year to the point at which the shares are sold, instead of when the option is

exercised, providing they are:

Canadian residents;

dealing with their employer at arm’s-length;

not a specified shareholder who owns more than 10% of the company shares.

Also to qualify for this deferral the total amount paid for the shares must be equal to or

greater than the fair market value of the shares when the option was granted.


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The $100,000 annual limit applies to the year the employee gains the right to exercise the

shares, not when the option is exercised.

If the value of the shares declines, there will still be a taxable benefit.

An employee of a CCPC records a taxable benefit when the option is exercised and the shares

acquired.

When these shares have been held for two years or more, 50% of the benefit realized when

the shares were sold can be deducted from tax. The shares do not need to be common shares,

and the exercise price may equal or exceed the fair market value of the shares when the

option was granted.

A Restricted Stock Plan

Such a plan restricts the transfer of shares or the dividend rate of the shares.

Shares are acquired at a discount from market value.

The restrictions are removed when certain targets, such as earnings performance, are met.

If the targets are not met, the shares can be re-acquired at their issue price or less.

If the restrictions are lifted, the shares can be sold and a capital gain realized.

Employee Acquisition of Partly Paid Shares

This plan allows an employee to buy Treasury shares of the employer’s company at fair

market value. A low initial payment is followed by scheduled payments over a period of time.

A balance may be due at the end of the period.

A Phantom Stock Plan (Notional Ownership)

This plan allots notional ownership of a number of shares to an employee who then

participates in dividends and any increase in the market value of the shares.

Payment is in the form of a bonus included with taxable income for tax purposes.

Capital stock is not diluted by notional ownership.

The bonus is a tax deduction for the employer.

Since shares are not actually owned, the employee does not risk personal funds, as with a

stock option or stock purchase plan.

Incorporation

Incorporating an Active Business

Since corporate income is generally taxed at a lower rate than personal income, incorporating

can provide tax benefits.

For example: if a taxpayer receives $100,000 from an unincorporated business, the entire

amount is taxed as personal income. If the business is incorporated, the taxpayer could take

$50,000 from the business, and leave $50,000 in the business. The $50,000 taken would be

taxed as personal income and the $50,000 remaining in the business would be taxed at the

small-business tax rate of approximately 12% federal tax.


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A corporation limits liability of shareholders; business-related expenses can be deducted from

tax. When the shareholder dies, the corporation continues.

Disadvantages to incorporation include the costs to incorporate, the need to file a separate

corporate tax return each year, and the additional work to maintain annual corporate minutes

and records required by government.

Eligibility

In order to receive the small-business tax rate on net income up to $300,000, the business

must generate income from an active business in Canada and be a Canadian-Controlled

Private Corporation (CCPC). Personal-service businesses are not eligible for this rate.

Incorporating an Investment Holding Company

These are Canadian-controlled private corporations that individuals use to hold their

investments.

Advantages only accrue to individuals with the highest marginal tax rate.

Personal Service Businesses (PSB)

CRA deems a corporation to be a PSB when it is:

providing services; and

if the individual performing the services to another taxpayer would, if it were not for the

existence of the corporation, be regarded as an employee of the entity to which the

services were provided and;

if the individual owns more than 10% of the corporation; and

if the corporation employs fewer than 6 full-time employees; and

if the fee for services is not received from an associated corporation.

A PSB cannot claim the Small Business Deduction for its income and maximum corporate

tax rates apply.

There are numerous non-tax disadvantages of PSBs intended to dissuade all but the most

determined from creating and operating a PSB.

Specified Investment Business (SIB)

An SIB is a business with fewer than six full-time employees that earns passive income from

property including dividends, rentals from real estate, etc.

SIBs are not eligible for the small business deduction.

The Tax-Deferred Transfer of Property to a Canadian Corporation

A taxpayer may transfer capital property (other than real property), eligible goodwill,

resource property, and inventory to a Canadian corporation on a tax-deferred basis for at least

one share of the corporation and non-share consideration (usually cash or notes).

If the non-share consideration exceeds the tax cost of the property transferred to the

corporation, the taxpayer will realize a capital gain on that amount.


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Neither capital gains nor the recapture of depreciation are incurred by the transfer of

marketable securities, real estate, or equipment to a Canadian company.

Income is not incurred by the transfer of inventory to a company.

If the transfer of an asset confers a benefit on other shareholders, the benefit will be attributed

to the transferor and capital gains will ensue.

How Is Life Insurance Taxed? A major benefit of all types of life insurance policies is that the death benefit is paid to the

beneficiary tax-free.

However, if the beneficiary of the policy is the estate of the life insured, then the proceeds

will be subject to probate fees.

Premiums paid for all forms of individual life insurance (i.e., not used in a business as key

person insurance) cannot be deducted from tax, except:

if the policy is assigned as collateral for a loan if the loan has been taken for the purpose

of making a profit. The lesser of the premium or the net cost of pure insurance (NCPI: the

amount that reflects the mortality charge) is deductible.

if the policy is donated to a registered charity (the taxpayer will receive a tax credit for

the amount of the premiums).

Whole life insurance and universal life insurance have tax issues that derive from the cash

values of such policies.

When these policies are surrendered, absolutely assigned, become non-exempt, or are

converted to an annuity, a disposition is said to occur. On disposition, any taxable gain on the

policy is reported to the policy owner. The taxable gain is the cash surrender value (CSV)

minus the adjusted cost basis (ACB), and for policies issued since 1982, the ACB is further

reduced by the net cost of pure insurance (NCPI).

The ACB is a dollar representation for tax purposes of the policy owner’s cost of the policy.

The higher the ACB, the lower the taxable gain; the lower the ACB, the greater the taxable

gain.

Whole life insurance premiums build a policy reserve that can be accessed for policy loans

and other non-forfeiture benefits. A loan is considered a partial disposition of the policy. The

amount of the loan must be declared as income in the year in which it is taken. As the policy

owner repays the loan, he or she can deduct from taxable income the lesser of the amount of

the repayment or the policy gain reported when the loan was taken, minus deductions claimed

on previous income-tax returns for previous repayments.

Universal life policies are a combination of investment and insurance. Taxation is based on

whether the policy is exempt or non-exempt. This is partly determined by when the policy

was “last acquired” (that is, if it has been reinstated since first issued) by the policy owner.

Policies last acquired before December 2, 1982, are exempt from policies in which the

amount of investment growth is not tied to the amount of insurance coverage.

An exempt policy does not tax growth in the policy until its disposition.

A non-exempt policy owner must report the income that is accruing in the policy yearly.


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Income is measured in an exemption test in which a notional policy is established that

duplicates the real policy. To be considered exempt, the growth must be less than an amount

specified as the maximum tax actuarial reserve (MTAR). If the growth exceeds the MTAR,

the policy owner has 60 days to make changes to the real policy to restore its exempt status.

Once a policy fails the exemption test, it is always a non-exempt policy.

How Does Tax Affect Retirement Planning? Retirement planning balances income against dreams.

If net income can be increased through reduced tax, more dreams are achievable.

There are three sources of income for Canadians who have retired and meet the required

criteria:

government pensions;

registered retirement plans (e.g., Registered Retirement Savings Plans);

private pensions (also called Registered Pension Plans).

A single limit (in 2010 the higher of $22,000 or 18% of earned income; in 2011, $22,450;

after that the dollar amount will be indexed to inflation) has been imposed as the annual

amount a taxpayer can pay into all tax-assisted retirement plans.

This limit includes contributions made by the taxpayer and his or her employer. Thus,

taxpayers have the same tax incentives, whether they contribute to a Registered Retirement

Plan (RRP), Registered Retirement Savings Plan (RRSP), or a combination of the two plans.

Government Pensions

Canadian government retirement pensions include:

Old Age Security (OAS);

Guaranteed Income Supplement (GIS);

The Allowance;

Canada Pension Plan (CPP)/Quebec Pension Plan (QPP).

Old Age Security

The government begins to claw back OAS benefits when an individual’s earnings are

$67,668 (2011); above $109,764 (2011), the entire pension is eliminated.

Strategies to minimize a client’s income level so that they can avoid some or all of the

clawback include:

Starting to receive CPP earlier to reduce the amount of income received;

Splitting CPP benefits;

Maximizing RRSP contributions and deferring the deduction until the OAS starts;

Repaying any outstanding balances for the RRSP Home Buyers’ Plan or Lifelong

Learning Plan


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Before turning 64, realizing capital gains that would be due by the time the client turns

71. It will be necessary to weigh whether the client is better off facing the resulting tax

bill and losing less OAS benefits later or holding the investment longer.

Withdrawing required funds from an RRSP or RRIF that belongs to the spouse in the

lower tax bracket;

Paying off all debts before age 64, so a higher income is not necessary for debt payment;

Splitting of retirement income;

Consider investments with deferred capital gains rather than investments that generate

interest or dividends. The gain will be deferred until the investment is sold or the death of

the client.

Using a line of credit rather than withdrawals from RRSPs or RRIFs to meet cash-flow

needs;

Moving an investment portfolio into an investment holding company where the income

will be taxed in the name of the corporation;

Moving an investment portfolio into an inter-vivos trust, since the clawback does not

apply to income earned in an inter-vivos trust. Income can be paid to the client or left in

the trust to grow.

Considering an alter-ego trust so that the transfer to the trust is tax-deferred;

Considering a reverse mortgage to withdraw income from the home. Income received

must make the cost of setting up the mortgage and interest costs worthwhile.

If it is not possible to avoid the clawback every year, aiming to avoid the clawback in

some years.

Guaranteed Income Supplement and the Allowance

These benefits are paid to low-income Canadians.

Canada Pension Plan/Quebec Pension Plan

These two plans have identical benefits; CPP is administered by the federal government for

all residents of Canada; QPP is administered by the Quebec provincial government for

residents of Quebec.

Contributions to CPP/QPP are tax deductible; benefits are taxable.

Payments are made regardless of other income; there is no clawback.

Registered Retirement Plans

As seen previously, all income from a registered plan is taxed as interest income.

Withdrawals from an RRSP are subject to a withholding tax, as follows:

Up to $5,000: 10% (Quebec 21%);

$5,001 to $15,000: 20% (Quebec 26%);

$15,001 +: 30% (Quebec 31%).


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The gross amount of funds withdrawn from an RRSP are added to the plan holder’s taxable

income for that tax year and taxed at the individual’s marginal tax rate.

To continue deferral of tax after the termination of the RRSP, it can be converted into RRIF

or annuity.

Payments from a RRIF are in the form of an annual minimum withdrawal; its amount is

determined by the age of the plan holder, the date on which the RRIF was established, and

other factors, such as whether the plan has been changed since it was first established.

Payments above the minimum are subject to a graduated withholding tax, just like an RRSP.

The RRSP can be converted into a term certain annuity, paid to the annuitant or his or her

estate for a fixed term; a life annuity, paid to the annuitant for the duration of his or her life; a

joint-and-last-survivor life annuity, paid to the annuitant for his or her life and then to his or

her spouse for the duration of his or her life.

Registered Pension Plans

The maximum pension benefits of an RPP are restricted to 2% of the average of the

individual’s best consecutive years of pay, multiplied by the number of years of service.

Small business owners may elect to pay themselves larger salaries to gain a higher pension

benefit, instead of receiving dividends from the business. The cost of doing so is higher

taxable current income.

RPP pension benefits can be split according to the rules for splitting pension benefits.

To continue tax deferral of RPP funds, an RPP can be transferred to:

a Locked-in RRSP, also known as a Locked-in Retirement Account (LIRA);

a Life Income Fund (LIF; except in Saskatchewan);

a Locked-in Retirement Income Fund (LRIF; in Newfoundland and Manitoba);

a Prescribed RRIF (in Saskatchewan and Manitoba);

another Registered Pension Plan;

a deferred life annuity.

A Locked-in Retirement Account (LIRA) is a form of Locked-in RRSP into which pension

benefits may be transferred from an employer’s plan when the employee leaves the company

prior to the age of retirement. LIRAs are generally subject to the same restrictions on the

withdrawal of funds as the original pension plan. On retirement, the funds in a LIRA can be

used to purchase a life annuity or transferred to a Life Income Fund, Prescribed Retirement

Income Fund, or Locked-in Retirement Fund by age 71.

Under the following circumstances funds in a LIRA can be unlocked:

serious financial hardship;

shortened life expectancy;

non-residency;

assets are below a certain level as established by the province in which the account is

based.


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An Alberta resident who is at least 50 years old may, with the consent of their spouse or

partner, unlock up to 50% of the value of their LIRA at the time it is being transferred to a

Life Income Fund or annuity.

A life annuity restricts the amount of withdrawal to that which is provided in the annuity

contract. The annuity can be prescribed or non-prescribed; a prescribed annuity sees the

annuitant paying the same amount of tax with each annuity payment, whereas a non-

prescribed annuitant pays more tax in the early years of the annuity and less as time passes.

Over time, the same amount of taxable income is declared regardless of which type of

annuity is owned.

A LIF is the same as a RRIF for tax purposes; it is unlike a RRIF in that there is a maximum

amount that can be withdrawn.

What Are Tax Issues for Small Business Owners?

How Expenses Affect Tax

Interest on a loan is deductible if the loan is used to earn income from a business or property.

A life insurance policy may be used to secure a loan for a business. The premium can be

deducted from taxable business revenue if the institution requires the policy as a condition of

lending, the policy is assigned as security and interest payments are usually also tax-

deductible.

If the owners of a corporation expect a lower future marginal tax rate they may consider

increasing current expenditures to shift taxable income from the current high rate to the

expected lower future rate.

Should a Business Incorporate?

The income from a Canadian Controlled Private Corporation (CCPC) is typically taxed at a

lower rate than personal income. If a CCPC business owner’s personal income is taxed at a

higher rate than the CCPC, it may be sensible to incorporate, and take a salary from the

business rather than paying personal rates of tax on business income.

This strategy is a tax deferral; tax will have to be paid by shareholders when the corporation

pays dividends.

However, once incorporated the business owner loses the ability to deduct business losses

from personal income.

Therefore, it is wise to postpone incorporation until the business is profitable.

Capital cost allowance is the writing off of the cost of major business purchases (furniture,

computers) over time.

Capital cost allowances may be held off until years of higher income in order to lower the tax

payable in those years.


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Is It Better to Receive a Salary or Dividends or Both?

Businesses with more than $200,000 of income should consider accruing bonuses to reduce

income to the lower rate. The accrued bonus must be paid within 179 days after the

corporation’s year-end in order to be a deductible business expense.

The choice between dividend and salary should take into account the advantage of salary in

avoiding minimum tax liabilities and the disadvantage of higher payroll taxes and the

combined marginal tax rates of both the individual and the corporation.

Income splitting in a business is achieved by paying dividends to family shareholders. It is

also accomplished by employing family members and paying them reasonable salaries.

Tax Benefits Realized When a Business Is Bought or Sold

The sale price of a small business is usually a compromise between vendors and purchasers

that gives tax benefits to both parties. If the purchasers purchase shares, they will forgo future

capital-cost-allowance deductions that would have been gained when buying all the assets

directly; if the vendors sell assets, they will forgo the $750,000 capital-gains exemption that

would have been received by the sale of the shares.

Deciding between selling assets or selling shares is complex and requires the services of a tax

specialist.

What Is a Crystallization?

A lifetime capital-gains exemption of $750,000 is available to Canadian residents for the year

in which the qualifying assets are sold. This exemption can be used to offset tax liability on

sale of a small (qualifying) business.

A gain can be established (crystallized) by transferring shares of an operating company to a

holding company. The cost base of the shares of the holding company is increased and capital

gains for the owner of those shares will accordingly be decreased.

The company must be a Qualified Small Business Corporation in order for the shares to

qualify for the capital-gains exemption.

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Chapter 2 Estate Planning

The advisor must be aware of estate-planning issues that will affect his or her client. To do so requires

an understanding of:

the basics of estate planning;

the importance of a will;

personal trusts;

estate freezes;

how to deal with a cottage or family business.

What are the Basics of Estate Planning? The plan for transferring assets from one person to others is called estate planning.

An estate plan takes into account tax, legal, as well as business and personal circumstances.

The estate-planning cycle begins with the creation of wealth. During this period, wealth will

be a combination of assets and liabilities; insurance will be important to cover liabilities in

the event of the death of the primary wage earner. For instance, in the early years of home

ownership, the client will have some equity in a home and will likely have debt in the form of

the mortgage. If the wage earner dies, insurance can reduce or eliminate the mortgage.

The next phase of estate planning is the preservation of wealth. At this time, wealth will be

comprised of more assets than liabilities, and the need for insurance may be reduced. Again,

using the home-ownership example, at this point in the wage earner’s life, equity will have

grown and the mortgage will be substantially reduced. Insurance may not be required to

eliminate the mortgage, or, if so, the amount of insurance would be greatly reduced.

The final phase of estate planning is distribution of wealth by transferring the estate to

beneficiaries. Decisions must be made about who will receive some or all of the estate, how

the transfer(s) will be accomplished and when.

The steps the advisor will follow in the estate-planning process with the client are to:

set objectives

gather and analyze information

develop strategies

document plans


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monitor and modify plans

implement plans

Set Objectives

Setting objectives requires assessing immediate and future needs, in addition to the wishes of

the estate owner about how property is to be transferred and to whom. It ensures that:

a person’s assets are distributed as wished;

dependents are provided for;

erosion in the value of a person’s estate through the payment of income tax or legal costs

is prevented or minimized.

Gather and Analyze Information

Information gathering will identify all the assets of the estate and its liabilities. This should

include the “tax cost” of assets.

Develop Strategies

Developing estate-planning strategies addresses the transfer of the estate. This can be done

while the estate owner is living by:

selling property at fair market value;

gifting property at fair market value;

setting up an inter-vivos trust that is administered by a trustee. The grantor of the trust

places assets with the trustee for beneficiaries.

When property is sold or gifted, capital gains may be taxable to the seller/giftor.

Exceptions to the rules of capital gains include transfers of:

property to a spouse or spousal trust;

qualified farm property, shares of a family farm corporation, or an interest in a family

farm partnership from a farmer to child;

property from a person to a corporation (under certain rules).

Certain rules exist that prevent persons who are not dealing at arm’s length from deferring tax

on gains by transferring property for an amount below a property’s fair market value.

After death, property may be transferred:

to a designated beneficiary. Designating a beneficiary prevents transfer of the property to

the estate and avoids costs of probate and claims of creditors.

by joint tenancy that transfers the property to the surviving joint tenants;

by trusts;

by a will;

by intestacy (under applicable provincial legislation).

Chapter 2 — Estate Planning

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Monitor and Modify Plans

Again, changes in the life of the testator must be monitored, so that estate plans can be

adjusted accordingly. Some changes that must be considered are:

marital status;

value of assets;

births and deaths in the family;

health of the testator, spouse, and beneficiary;

marital status of beneficiary or family member;

specific bequests;

business conditions;

life insurance;

property ownership;

named beneficiary, executor, trustee, guardian, or power of attorney;

changes to tax laws and family laws.

Implement plans

Implementation of plans after death is best left in the hands of a competent executor.

Choice of an executor should be based on finding a person who is financially astute,

knowledgeable about laws of probate, taxation, and inheritance, and sympathetic to the needs

of beneficiaries.

Consideration should be given to:

the size and complexity of the estate;

compensation for the executor. It is best to determine this beforehand or the courts will

determine the fee from a schedule.

the availability of the executor.

A testator should also specify a guardian for children.

A power of attorney appoints a person to manage the affairs of another who has become

incapable of looking after himself or herself, during his or her lifetime. This ceases on death.

A living will is a power of attorney that appoints a person to make health-care and similar

decisions.

What Documents Are Needed? Certain client documents must be obtained and reviewed in order to discuss estate planning.

These include:

marital agreements;

power of attorney documents;


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life insurance policies;

investment statements;

tax returns for the previous two years;

tax cost basis details;

a will;

registered and non-registered pension-plan statements;

separation or divorce papers;

mortgage papers;

a list of assets, including the names of all registered owners;

business agreements.

What Assets Must Be Considered in the Estate Plan? Cash and other liquid assets. The transfer of these assets (cash, Guaranteed Investment

Certificates, and government savings bonds, etc.) does not result in any tax consequence for

the deceased person and his or her heirs.

Life insurance contracts. The proceeds from life insurance policies are not taxable to the

beneficiaries.

Pension income. If an annuity is received by the deceased, and it is transferred to the

surviving spouse, there is no tax consequence.

RRSPs and RPPs. An RRSP or RPP with a spouse as the beneficiary can be transferred

without taxation. In the case of a non-spousal beneficiary, the accrued amount in an RRSP is

taxed in the hands of the deceased (except in certain circumstances involving a dependent

child or grandchild).

The family residence. The accrued value between the purchase date and the date of the

transfer of a family residence upon the death of the owner is not taxed, provided it is claimed

as the “principal residence.” This exemption applies to only one residence per family.

What Should Appear on an Estate-Planning Checklist? Does your client have a will? Do its provisions still conform with his or her wishes?

Do any modifications of the provincial laws concerning matrimonial regimes or the family

patrimony require revision of the will?

Is a holograph will legal in the province?

Does your client have an asset-distribution plan that minimizes probate fees?

Is the spouse the beneficiary of your client’s RRSP, RIF, and/or pension fund?

Does your client have unused tax deductions that might compensate for the capital gains

resulting from transferring assets prior to his or her death?

Is the creation of a testamentary trust necessary to ensure the financial comfort of the

dependents after death?


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Does your client have adequate life insurance?

Who Comprises the Estate-Planning Team The composition of the estate-planning team will be determined by the size and complexity

of the estate, and may include:

family members;

a lawyer;

an accountant;

a business valuator;

an estate appraiser;

a funeral director;

a gift planner;

a grief counsellor.

What Is the Importance of a Will? All clients should have a will.

A will appoints an executor (a liquidator in Quebec), and directs the flow of assets into and

out of the estate.

Wills may be handwritten (called holograph wills), prepared by a lawyer (or in Quebec and

B.C. by a notary), or generated on preprinted or computer-generated forms.

The will must be signed in the presence of two witnesses. If the will is handwritten, it needs

to be signed by only the testator.

Neither witness may be a beneficiary of the will.

What Happens if There Is No Will?

A person dies “intestate” when he or she dies without a will.

Provincial legislation outlines the distribution of assets in the event of intestacy.

Intestacy legislation varies slightly between provinces; however, in all cases of intestacy

where there are no living blood relatives, the estate goes to the provincial government.

A spouse will not automatically be the beneficiary of the deceased, especially when there are

children. However, some provinces will:

give the spouse an interest in the family home;

provide a preferential share of the estate;

provide protection under family law.

Intestacy is inadequate for individuals who:

live in a same-sex or common-law relationship;

have second marriages;


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have children from a previous marriage or illegitimate children;

have children or other dependents with special needs;

want a private, not public, trustee, and guardian to manage assets on behalf of minor

beneficiaries;

want his or her spouse to receive the entire estate;

want to make a charitable contribution after death.

Intestacy does not allow for tax planning, can be expensive to administer for minority

beneficiaries, and cannot deal with special bequests and issues related to the age at which

minors are to receive bequests.

What Types of Wills Exist?

Formal/Traditional Wills

The formal/traditional will must be signed and must be witnessed by two people in the

presence of each other and the testator. Each page should also be initialled.

Witnesses cannot be a beneficiary or a beneficiary’s spouse, and must have reached the age

of majority.

Holograph Wills

A holograph will is a will that is entirely handwritten by the testator, and does not require

witnesses.

Multiple Wills

Ontario recognizes the concept of multiple wills.

Under this practice, two separate wills are drawn up, with an executor named in each will.

Wills in Quebec

If a Quebec resident dies intestate, his/her property is divided among family members

according to law. If there are no family members, it goes to the state.

In Quebec, a person who dies can have his or her property transferred only by a will or a

marriage contract.

Contents of a Will in Quebec

Identifies the testator and the date of the will.

Revokes all former wills and codicils or specifies which part of any former will or codicil

remains in force.

Identifies the heirs and legatees and describes the property passing to each.

Designates, and sets out the powers and obligations of the “liquidator” (i.e., the executor) of

the succession.


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A minor may inherit, but lacks the legal capacity to administer his or her patrimony except to

meet ordinary and usual needs. Prior to his or her majority, the inheritance is administered by

his or her tutors. By law, the tutors are the child’s parents, unless someone else is designated

in the will.

Patrimony comprises all of a person’s rights and obligations (i.e., a person’s right of

ownership in a house or car, or a person’s right to have a sum of money). These rights that

have an economic value are called patrimonial rights; they are the assets of a person.

A person’s debts also have an economic value, and are part of the patrimony. They represent

a person’s liabilities.

Other rights that have no monetary value are called extra-patrimonial rights.

Forms of a Will in Quebec

It may be written by hand and signed by the testator (holograph).

It may be made in the presence of witnesses.

It can be made before a notary and signed by the notary, the testator, and a witness.

Any person of legal age may act as a witness (except an employee of the attesting notary who

is not also a notary).

The will is retained by the notary, while the testator receives a notarial copy.

Notarial wills are deemed to be notarial deeds, and as such are not subject to probate; probate

fees are not charged on the assets on death.

International Wills

In order for an international will to be valid, it must have been made in a country that is in

compliance with the convention that allows for international wills.

Such wills are valid in every country that has signed a reciprocal convention (e.g., treaty),

regardless of the domicile of the testator where the will was executed or where the testator’s

assets are located.

This type of will may be useful if the testator has assets that are located in several different

jurisdictions, when these jurisdictions recognize the will as conforming to their respective

requirements.

Which Assets Are Covered in the Will?

Assets that flow through the estate (thereby covered by the provisions of the will) include

those registered in the name of the deceased, in the name of the estate, and those registered as

tenants-in-common, wherein each owner has a divided interest in the property.

Assets that do not flow through the estate include those with a named beneficiary (e.g., life

insurance and RRSPs), property held as joint tenants with the right of survivorship, assets

held in trust.

The estate may still be required to pay income taxes on those assets that do not flow through

the estate.


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How to Ensure the Will Meets the Client’s Needs

It is the goal of most clients to have their beneficiaries receive an equal share of the estate. To

do so requires complete disclosure of all assets and a proper estate plan.

The value of assets destined for beneficiaries can change over time, such as the value of an

investment account.

Different rates of tax on various assets may also mean that beneficiaries are not treated

equally.

It may be necessary to flow all assets through the estate and thus incur higher probate costs to

ensure an equal after-tax distribution of the estate.

It is essential to ensure that the will is not contradictory and addresses all assets.

Wills should be regularly reviewed to keep them up to date with possible changes in the

testator’s circumstances.

Special Clauses in the Will

Special clauses may be used to:

give additional powers to an executor (e.g., investing estate assets)

appoint guardians for minors

establish testamentary trusts (trusts established after death)

compensate executors

allow for contingencies (e.g., an executor predeceasing the testator).

What Is an Executor?

An executor is the person(s) named in the will who is responsible for administering the

estate and for carrying out the terms of the will.

Alternate executors should be named in the will to replace a deceased or unwilling primary

executor(s).

Executors must be able to carry out their duties in an informed and objective manner, and be

aware of the potential liabilities that may flow from his or her obligations to the estate, the

spouse and beneficiaries of the deceased, and to the Canada Revenue Agency (CRA).

Additionally, the executor must be fair to family members, and if trusts have been set up, be

able to fulfil duties for several years. It is also helpful if the executor is conveniently located.

The Advisor as Executor

Some firms prohibit their advisors from acting as executors for the estates of clients. Others

allow it, but prohibit them from earning commissions while acting as such.

The advisor may base his or her decision to be an executor on:

whether he or she wants to take on this responsibility;

the opinion of the compliance department of the firm employing the wealth manager;

the relationship with the client;


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whether he or she hopes to continue as wealth manager for the beneficiaries.

Corporate Executors

Appointing a corporate executor (e.g., a trust company) may be warranted where the estate is

large and complex, where family disputes exist, where long-term trusts have been established

in the will, and where family members or others are unable or unwilling to act.

The role of the corporate executor will be to:

establish an investment strategy for assets;

deal with beneficiaries fairly and equally;

provide trust services.

Corporate trustee fees can be costly.

Powers of Executors

The will sets out most of the powers of the executor.

If the will is silent on specific powers to invest, some provinces set out these powers in a

Trustee Act, while others follow the “prudent investor standard of care” test for the

investments that an executor or trustee selects.

Usually the will allows the executor to:

distribute the assets in kind to the beneficiaries;

purchase and sell assets on behalf of the estate;

borrow on behalf of the estate;

make discretionary tax decisions for the estate;

invest on behalf of the estate;

employ specialists for the administration of the estate (e.g., accountants).

Discretionary tax decisions can be made to benefit the estate. They include:

making a spousal RRSP contribution after death;

transferring assets to a spouse to defer capital-gains tax;

deciding if any assets are best held in a spousal trust established by the will.

Allowable investments as set out in a typical Trustee Act include:

securities of all levels of government;

Canadian first mortgages;

GICs;

term deposits;

bonds and shares (common and preferred) of corporations that pay dividends which meet

certain minimum requirements.


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The conservative nature of these investments is designed to discourage the executor or trustee

from speculation.

In Quebec, administrators have either “simple administrative powers” (aimed at

preservation of estate assets) or “full administrative powers” (which permit investing estate

assets in order to increase the value of the assets in the estate or trust).

What Is the Prudent Investor Standard of Care?

The Trustees’ Acts in most jurisdictions now refer to the “prudent investment standard of

care test.” This means that executors and trustees must consider the following when

investing:

general economic conditions (e.g., inflation, deflation);

tax consequences;

interest and dividend income, capital appreciation and preservation;

liquidity needs of the estate.

When this test is followed, the records of the executor or trustee must clearly show that the

above factors were used as guiding principles.

How Are Executors Compensated?

Executors may be compensated as follows:

o at 1% to 2.5% of the value of assets that flow into or are distributed from the estate;

o at 1% to 5% of the income earned by the estate, and for the administration of any

testamentary trusts.

Fees charged must be in relation to the time and effort for the work performed (i.e., 2.5% of

disposition of a very simple and straightforward asset may well be inappropriate).

Appointing Guardians for Minor Beneficiaries

Testators may appoint the guardians of minors in their will.

The appointment is not binding on those appointed, but if the appointment is accepted by the

provincial court, the temporary guardian applies to the court to obtain legal custody of the

minor(s).

It is customary to provide a bequest to the guardian in acknowledgement of the role that is

being fulfilled.

What Is a Common Disaster Clause?

Sometimes called a survivor clause, this clause gives instructions on what is to be done with

the estate in the event that a person and his or her spouse dies at the same time or within a

certain period of time (usually 30 days).

It avoids the payment of double probate fees on the same assets.


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Per Capita and Per Stirpes

If an individual leaves an inheritance to children on a per capita basis, each child must be

alive at the death of the testator in order to inherit. The estate is divided equally among living

children.

If an individual leaves an inheritance to children on a per stirpes basis, then the

grandchildren will inherit the portion of the estate that their parent would have received had

he or she not predeceased the testator.

Restrictions of Testamentary Freedom

There are very few restrictions on the disposition of an estate, except:

a family member (defined by provincial legislation) who is financially dependent on the

testator must be provided for in the testator’s will; otherwise he or she may apply to the

court to seek support;

a spouse must be provided for, even if it is at the minimum legal level.

A person who is not competent cannot make a will or alter the terms of a will.

How Is a Will Changed or Replaced?

Wills should be reviewed and/or updated following all significant events, and at least every

two to three years.

Wills may be amended by adding or revising clauses (called codicils). These must be

witnessed in the same manner as the original will.

If the will is out of date and there are many changes to the will, a new will is prepared; new

wills should state that they revoke and replace previous wills and codicils.

Spousal Rights

In the absence of a valid marriage or cohabitation contract, provincial family law legislation

governs a spouse’s entitlement to an interest in the estate of a deceased spouse.

A spouse may file a claim against an estate in the event that he or she has not been

adequately provided for in the will of a deceased spouse.

In Ontario, on the death of a spouse, the surviving spouse is entitled to an equalization of net

family assets. If the spouse receives less than half the value of the assets, the spouse can

apply for equalization.

A spouse can accept less than 50% of his or her entitlement.

As a general rule, spouses should use independent legal counsel, be completely open in

respect of the financial situation, and understand any rights that are being waived.

In some cases, a spouse may accept an estate plan that provides less than his or her legal

entitlement. However, in order to ensure that a client’s estate plan will not be challenged, a

couple should prepare a marriage contract to complement their wills.


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Ongoing Support Payments

Some divorce agreements stipulate that the death of the supporting spouse releases him or her

and his or her estate from further spousal and/or child support obligations. Others provide that

the obligations continue against the estate.

Divorced clients may consider obtaining life insurance to cover ongoing spousal or child-

support payments.

What Is a Power of Attorney?

A power of attorney is a legal document. It appoints a person to look after the financial affairs

of someone who becomes incapacitated due to sickness, accident, or other mishap. In

Quebec, a power of attorney is called a mandate.

A power of attorney for property can be general or limited. A general power of attorney

bestows a wide range of rights on the attorney; the attorney is even allowed to borrow money

on behalf of the client. A limited power of attorney constrains the actions of the attorney.

In some jurisdictions, a power of attorney for personal care authorizes a person to make

personal decisions if the person becomes incapacitated.

In Quebec, a Mandate Given in Anticipation of Incapacity appoints a person or trust

company to act for a person who becomes mentally incompetent.

The Mandate may grant simple administrative powers (i.e., to allow limited investments

aimed at preservation of assets), or full administrative powers (i.e., to allow a wide range of

investments designed to increase assets).

Provincial public guardians act for incapacitated individuals who have failed to execute a

power of attorney or grant a mandate.

Living Wills

Living wills are also called advance health-care directives; they can be included in a power of

attorney or as a separate document. They are considered to be part of the estate-planning

process.

Living wills instruct medical practitioners about the type and intensity of medical treatment a

person wants to receive.

A living will is not binding.

How Is an Estate Settled?

Balance Sheet at Date of Death

All assets and liabilities are valued as of the date of death.

This valuation is important for the calculation of probate fees and when applying the deemed-

disposition rules for income-tax purposes.

The valuation establishes the estate’s liability for capital-gains tax and sets the adjusted cost

base for the assets that are transferred to the beneficiaries.


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At death, the valuation will indicate whether the estate is liquid enough to meet the family’s

short-term needs, and if the estate can meet its tax liabilities.

Errors in the calculation may result in tax penalties and/or interest payments.

External appraisers provide an objective valuation.

How Is a Will Probated?

Probate proves the validity of a will. It verifies the will and that the executor has the authority

to transfer assets.

Although it is not used in Quebec, probate is often required by third parties in order to

transfer estate assets. These assets may include:

bank accounts;

real property.

Probate may also be required to satisfy creditors.

Probate fees are based on the value of the estate assets that are passed through the will.

Fees vary by province, with Ontario having the highest fees.

The will is probated either:

where the deceased normally resides; or

if the death has occurred elsewhere, where the principal residence is located.

Reducing the value of assets that are transferred by the will reduces the amount of the probate

fees that are payable.

There are five strategies to reduce the cost of probate:

gift assets prior to death;

register assets as joint tenants with rights of survivorship;

name beneficiaries for RRSPs, RRIFs, and life insurance policies;

create a trust prior to death;

use multiple wills.

Reducing Probate Fees by Gifting Assets

Assets passed by gift prior to death do not form part of the estate for probate purposes.

However, the disposition of the asset may be deemed to have been made at fair market value,

thereby incurring capital gains for the giftor.

If a person receives a gift as an advance on an inheritance, the advance is called an

ademption; an ademption will reduce the amount of inheritance corresponding to the

advance already received. If there is no provision against ademption, the inheritor will receive

the full amount of the inheritance provided in the will, regardless of what may have already

been received.


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Reducing Probate Fees by Registering Assets as Joint Tenants with Rights of Survivorship

When assets are registered as joint tenants with rights of survivorship, the assets are

exempted from the estate for probate purposes. Quebec does not have this type of ownership.

In the event of divorce or bankruptcy of a joint tenant, the assets registered as joint tenants

with rights of survivorship may become encumbered.

When an asset is registered as joint tenants with rights of survivorship, it has two owners.

Thus, the initial owner loses control of the asset.

Re-registering an asset in this form is deemed by CRA as a disposition of part of the asset at

fair market value. If the transfer is made to a spouse, taxes will not be owed. However, if the

transfer is to another party, then 50% of the accrued capital gain will be taxable.

Ownership of property must be transferred before death to avoid probate.

For assets to flow into a testamentary trust, they must first appear in the will. Jointly held

assets may not fund a testamentary trust. Assets held in a living trust are exempt from

probate fees, as they do not form part of the testator’s estate.

A joint-tenants-with-rights-of-survivorship type of ownership must be handled judiciously to

ensure the intended effect is achieved.

Reducing Probate Fees by Naming Beneficiaries for Registered Plans and Life Insurance

Life insurance policies and registered plans held through a life insurance company and in

which the beneficiaries are named do not form part an estate for probate purposes.

Reducing Probate Fees by Creating a Trust

Under new legislation, individuals may transfer assets to an alter ego, or joint-partner, trust

if certain conditions are met. Assets transferred to these trusts do not fall within the estate of

the taxpayer for the purposes of calculating probate fees. This also results in making the

assets unavailable to be put into a testamentary trust under the will.

Although assets held in a living trust are not subject to probate fees, the costs of establishing

and administrating the trust may exceed the savings on probate fees.

Reducing Probate Fees by Creating Multiple Wills

When multiple wills are used correctly, only probatable assets will be subject to probate fees.

The total value of assets within the will will be reduced.

The primary will is used to distribute probatable assets only, while assets that may pass to

beneficiaries without probate (e.g., shares in a private company) are included in the

secondary will.

Only the executor of the primary will needs to apply for probate, and probate fees are payable

only on the assets contained in, and transferred pursuant to, the primary will.

If a testator is uncertain whether an asset is probatable or not, it must be included in the

primary will. If a probatable asset is included in the secondary will by error, the will must be

probated, thus defeating the purpose of the multiple wills (i.e., saving probate fees).


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How Does the Executor Settle Debts and Other Claims?

The executor must try to find all creditors of the deceased. This is done through newspaper

advertisements.

Placing the advertisements ensures that the executor is not liable for claims that are filed once

the estate has been wound up.

The executor is responsible for settling all of the debts of the deceased (highest interest-

bearing debts first), prior to transferring any legacies.

If the executor meets a special need of a beneficiary (e.g., a monetary advance from the

estate), he or she should carefully document it, and justify it to the other beneficiaries.

Executors must examine title deeds and look for jointly held properties.

They must also examine partnership and shareholder agreements to see if they contain

provisions that allow third parties to buy out the deceased’s business interests or shares.

The executor should search for creditor insurance that protects the deceased.

The Client’s Final Tax Liability

On the death of the taxpayer, all RRSPs and RRIFs are deemed to have been cashed, and all

capital assets are deemed to have been sold at fair market value immediately prior to death.

Any taxes that result from these deemed dispositions must be included in the deceased’s final

tax return.

Exemptions on the final tax return include:

the principal residence, and assets left to a spouse, or a qualified spousal trust;

RRSPs and RRIFs left to spouses and common-law spouses, spousal trusts, and some tax

deferrals on these plans are available to dependent minor beneficiaries;

death benefits from life insurance policies.

While most beneficiaries are deemed to have received estate assets with an adjusted cost base

equal to the fair market value of the assets immediately prior to the death of the testator,

spouses and common-law spouses are deemed to have received these assets at their original

adjusted cost base.

Since depreciating estate assets are deemed to have been disposed of at the date of death,

their disposition will result in either a recapture of depreciation or a terminal loss.

An advisor begins the process of minimizing the tax liability resulting from the death of a

client during the lifetime of the client. It is necessary to calculate the amount of tax that

would be due if the client died immediately and, simultaneously, the amount of tax due if the

client lived to a reasonably old age.

In order to estimate a client’s future tax liability at death, assumptions must be made about

the rate of return earned on his or her investments prior to death, and the amount that will be

withdrawn from registered assets over the lifespan of the client.


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What Are the Techniques to Defer or Reduce Taxes? To minimize the amount of tax a client must pay, it is essential to consider:

today’s tax bracket;

the tax bracket expected at and during retirement;

the tax bracket at the time of death;

the tax bracket of beneficiaries.

Techniques to achieve this goal include:

leaving assets with unrealized capital gains (which roll over tax-deferred) to a spouse,

common-law spouse, or a spousal trust;

naming a spouse or common-law spouse (including same-sex partners) as the beneficiary

of RRSPs and/or RRIFs;

naming financially dependent minor children or grandchildren as beneficiaries of RRSPs

and/or RRIFs. If the funds are used to purchase an annuity for the child that matures

when the child turns 18, the income from the annuity is taxed in the hands of the child.

transferring RRSPs and RRIFs to the other spouse on separation or divorce will be on a

tax-deferred basis when there is a separation agreement or court judgment;

transferring the RRSP to the other spouse’s RRSP on death;

making a contribution to the RRSP of the surviving spouse by the estate of a deceased

taxpayer within 60 days of year-end;

applying any unused capital losses against all other types of income that are reported on

the final tax return of the deceased or in the year before his or her death;

using life insurance proceeds to pay estate taxes, thereby preserving specific estate assets

(e.g., business or cottage);

spending money before death, thereby reducing the value, tax liabilities, and probate fees

of the estate;

implementing an estate freeze to cap potential tax liability;

using the $750,000 capital-gains exemption for certain qualified small businesses;

transferring qualified farm properties (i.e., land, shares in farm corporations, farm

partnerships), which can be transferred to spouses, children, grandchildren, and great-

grandchildren without triggering capital gains, and at their adjusted cost bases. The

properties may also qualify for the $750,000 capital-gains exemption, thereby increasing

their adjusted cost base.

claiming losses from the sale of estate assets within the estate’s first year on the final tax

return of the deceased.


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Charitable Gifts

Charitable donations are called “planned gifts” when they are timed to maximize tax savings

(e.g., non-refundable tax credits).

Planned gifts can be incorporated into an estate plan.

Rules Regarding Charitable Donations

Although charitable donations do not qualify for tax refunds, they give rise to non-

refundable tax credits, which may be used to reduce the amount of tax that otherwise may

be payable.

The maximum charitable donation a person can make is 75% of taxable income, or 100% if

the gift is to a Canadian cultural property or to the government.

On death, the maximum amount of charitable receipts that may be claimed on the final tax

return is 100% of the testator’s final income. However, if the charitable receipts exceed this

amount, a tax return for the year prior to death may be refiled to include these excess receipts.

Charitable receipts can be pooled by spouses; they can also be used up to five years after the

year that they were issued.

Making Effective Charitable Gifts

When considering planned gifts, clients should be certain that they are prepared to give up

control of the asset(s) involved and that they can make the best use of the tax receipts; they

should also consider the costs of setting up the gift(s).

Bequests by Will

Bequests by will must precisely set out the name of the charity and the amount of the gift or

give a clear formula to determine the amount.

Gifting RRSPs/RRIFs to Charity

A charity can be named as beneficiary of an RRSP/RRIF and the deceased will receive a

charitable receipt equal to the amount of the gift.

Alternatively, the client may do the following:

designate the estate as the plan beneficiary; then

direct the trustee to donate an amount equal to the value of the plan to the chosen charity.

However, implementing this strategy means that probate fees would be payable on the value

of the plan.

In-Kind Donations

Qualified in-kind donations include capital and depreciating property, leasehold interests,

business inventories, insurance policies, securities, and rights (e.g., royalties).

The amount of the charitable receipt is equal to the fair market value of the gift, when made.

Certain qualified donations (i.e., stocks and bonds, mutual and segregated funds) qualify for a

reduced inclusion rate of 25% for realized capital gains.


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The donor must report any capital gain or loss deemed to have been realized on the gift.

Life Insurance

The premiums paid on a life insurance policy that has been assigned to a registered charity

qualify for annual charitable receipts.

If the proceeds of a policy upon disposition exceed the adjusted cost base of the policy, the

excess must be included in the tax return of the policy holder.

When a client assigns a policy to a charity, the cash surrender value of the policy may qualify

for a tax receipt.

If a testator retains a policy in which a charity is the designated beneficiary, the estate can

claim a tax credit in the amount of the death benefit that goes to the charity.

Cultural Property

Gifts of art or artifacts are eligible for a charitable tax receipt that may be used to offset any

capital gain that may arise when the gift is made.

How Are Personal Trusts Used in Estate Planning?

The Basics of Trusts

A trust is an arrangement whereby a person or company (the “trustee”) manages wealth for

the benefit of a beneficiary(s).

The beneficiary is the person who has a contingent or absolute right to receive the assets held

in trust.

The settlor of a trust is the person who has created the trust and contributes assets to the trust.

The trustee can be a person or organization with responsibility for the assets and

administration of the trust. The trustee has powers to make decisions for the trust and has

legal responsibility to the beneficiary(ies) for its conduct.

A trust separates the legal title to the assets held within the trust from the beneficiary of the

trust.

The terms of the trust are set out in a trust document. The trust owns the assets in the trust and

reports the income arising from the assets, claims tax credits, deducts losses, and pays income

tax.

Trusts are used to control how assets are distributed, often by transferring family wealth from

one generation to another.

A Canadian resident can set up either a domestic trust or an offshore trust.

Offshore trusts may be attractive for various reasons. However, tax considerations and rules

are complex. Moreover, the risks, including risks of fraud, foreign-currency risk, and

political risk, are great, and legal or jurisdictional difficulties may arise.

A trust is created when one party (the settlor), transfers assets to another party who holds

legal title and who has control over the assets (the trustee), with instructions as to how the

assets are to be used for the benefit of main parties (the beneficiaries).


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The person who owns the assets (i.e., the settlor) grants legal title of the assets to a trustee,

who has certain defined duties with respect to the assets, for the benefit of one or more

beneficiaries. A settlor can also be a trustee. A settlor cannot be both a trustee and

beneficiary.

A trust is not a legal entity like a limited company. Procedures, administrative guidelines, and

the responsibilities and powers of the trustee are outlined in the relevant trustee acts, and in

the trust agreement itself.

If a bequest of capital property is made (i.e., an outright transfer of a physical asset or an

investment) to a beneficiary, the beneficiary is called a “capital beneficiary.”

If a bequest of an income interest in a capital property is made (i.e., the distribution of the

income from a specific capital property without the transfer of the ownership of the property

to the beneficiary), the beneficiary is called an “income beneficiary.”

The trustee owes a duty to the beneficiaries, not to the settlor. Therefore, the trustee has a

fiduciary relationship with the beneficiary. This means that he or she must always act in the

best interests of the beneficiary, and can be held to account if he or she fails to act in the best

interests of the beneficiary. A beneficiary can have a claim against the trustee for breach of

trust.

The trust deed (i.e., the actual trust document) sets out the duties and powers of the trustee,

including when and how the distribution is to be made to the beneficiary.

The trust property is beyond the reach of a trustee’s creditors.

The Trust Agreement

The trust document does the following:

it identifies the parties to the trust: settlor, trustee, and beneficiary

it sets out the purpose for which the trust is established

it states and defines the assets transferred to the trust

it sets out the conditions for holding, disposing, and using trust assets.

The trust agreement may grant the trustee(s) full discretionary powers, or limited and very

specific powers, in the administration of the trust.

Beneficiaries of a trust can be:

income beneficiaries;

capital beneficiaries.

Income beneficiaries receive the interest and dividends earned by the trust assets.

Capital beneficiaries receive the capital from the estate when it becomes available (e.g., after

the death of the income beneficiaries), or when the capital is designated for specific purposes,

such as education.

An application must be made to the court to vary or amend any term of the trust.


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What Is the Role of the Trustee?

The choice of trustee is important: the residence of a trust is the same as the residency of the

trustee (i.e., the management and control of the trust). Therefore, if the trust has only one

trustee and the trustee becomes a non-resident, the trust is deemed to be non-resident.

For tax purposes, this means there is a deemed disposition of the assets at fair market value,

which could trigger capital gains.

Specific trustee powers include:

the power to distribute payments to the beneficiaries and to buy and sell investments, in

the best interests of the beneficiaries, and to manage these investments according to a

specified risk level;

the power to make elections under the Income Tax Act;

the power to vote shares held in the trust, and to sign contracts (e.g., mortgages) on behalf

of the trust.

Specific trustee duties include:

accounting for the management of the assets of the trust and acting in the best interests of

the beneficiaries;

protecting and preserving the property held in the trust which includes the use of

insurance;

complying with statutory reporting requirements;

keeping the trust property separate from the trustee’s personal property;

providing information promptly, when requested;

balancing the level of risk with respect to the beneficiaries’ tolerance for risk;

acting with skill, care, and prudence;

acting solely for the benefit of the beneficiary, not the settlor;

acting with impartiality with respect to the beneficiaries (called the “even handed rule”).

In choosing the purchase of assets for the trust, the trustee must balance the need for income

for the trust and the effect such purchases may have on the beneficiaries. Accordingly, a

balanced portfolio may be the appropriate course of action for the trustee.

Provisions in a will or trust agreement can override the “even handed rule.”

Unless specifically authorized by the trust deed, and subject to the “prudent investment test,”

provincial trusts legislation can impose limitations on the investment decisions of trustees.

The trustee must act personally, which means that power cannot be delegated.

A trustee may take advice from experts when deciding which instruments are to be purchased

by the trust, but he or she cannot delegate the overall risk that the trust portfolio should bear.

The trust agreement should allow the trustee to engage the services of a financial advisor, and

make use of discretionary money management.

A trustee may not delegate the power to encroach on the capital of the trust.


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What Is an Appropriate Use of a Trust?

Trusts may be used for wealth management in a number of ways, including:

managing assets on behalf of minor children and incapacitated spouses and other

dependents;

tax planning;

estate freezing;

protecting assets from creditors;

planned giving;

reducing probate fees;

maintaining the confidentiality between settlors and beneficiaries.

Types of Trusts

Inter-vivos, or Living, Trusts

Assets are transferred to these trusts while the settlor is alive.

Income earned by the trust (i.e., income, capital gain or loss, dividend income) is attributed to

the settlor if the trust beneficiary receiving the income is the spouse of the settlor or is a

related minor (except for capital gains in the case of minors).

Income earned by a living trust that, in any year, is not payable to the beneficiaries, will be

taxed in the trust at the top marginal rate.

When a minor reaches 18 years of age, the income can be taxed in the name of the adult

child.

Unrealized capital gains can accumulate in the trust for up to 21 years at a time. Then tax

must be paid as if the asset was sold.

If the settlor wishes to maintain the confidential nature of assets that he or she leaves, he or

she may wish to create an inter-vivos trust.

Assets of a “personal” trust can be transferred to a Canadian resident capital beneficiary on a

tax-deferred basis.

Alter-Ego or Joint-Partner Trusts

These are special types of inter-vivos trusts whereby a person (the settlor) transfers assets

under the following conditions:

the person is at least 65 years of age;

the person, and only that person (or the person and spouse in the joint-partner trust) is

entitled to receive all the trust income in his or her lifetime (or in the lifetimes of both in

a joint-partner trust).

Assets transferred to these trusts roll over on a tax-deferred basis, although an election can be

made to pay tax on transfer of assets. Tax is deferred until the death of the person or of the

surviving partner (i.e., spouse, common-law spouse, or same sex partner in the case of a joint-

partner trust).


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These trusts reduce probate fees, as, for probate purposes, the transferred assets do not form

part of the estate of the first partner to die.

Testamentary Trusts

These trusts are created in a will or other testamentary document in order to manage assets on

behalf of named beneficiaries. They are part of the will and so can increase the cost of its

preparation.

The trust must file an annual tax return.

Trusts are often used to leave inheritances to minor or incapacitated beneficiaries and can be

used to split income.

The income earned in the testamentary trust is taxed at graduated rates.

If a beneficiary were to receive no other income except for dividend income from the trust, he

or she would have no tax on the first $23,000 of dividend income.

These trusts can protect a beneficiary’s inheritance from bankruptcy.

Spousal Trusts

A testamentary trust that provides solely for a spouse is called a spousal trust.

If the spouse is the sole beneficiary, the assets are transferred to the trust on a tax-deferred

basis.

Spousal trusts are used to take advantage of tax savings, and to protect the estate assets in the

event that the surviving spouse remarries.

A spousal trust can provide for a gift over to children (or a testamentary trust for children)

upon the death of the spouse.

Charitable Remainder Trusts (CRTs)

A type of inter-vivos trust, CRTs are created when assets are irrevocably transferred to the

trust, but the income earned by the trust is paid to the settlor and/or the spouse of the settlor

for life.

On the death of the settlor(s), the trust is wound up and the charity receives the remaining

value of the trust assets.

A tax receipt (based on the “present value” of the assets that the charity will ultimately

receive) may be used by the settlor in the year in which the trust was established, or within

the next five years.

The present value of the gift is based on:

the age of the settlor and/or spouse (the older the person, the larger the tax receipt)

the current market value of the assets transferred and anticipated capital appreciation

current interest and discount rates

No charitable receipt will be issued if the present value cannot be determined, or if the gift is

revocable.


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What are the tax consequences of trusts?

Trust assets are owned by the trustee when assets are transferred into an inter-vivos trust; the

settlor must pay capital-gains tax on any accrued gains on the transferred assets (except in the

case of alter-ego or joint-partner trusts).

When assets are transferred into an alter-ego or joint-partner trust, the transfer is tax-deferred

unless the settlor chooses to pay capital-gains tax at that time.

Assets transferred to a “qualified” spousal trust are tax-deferred if the spouse is the sole

beneficiary of the trust.

The trust is liable for tax on income earned through interest, dividends, and capital gains if

these are not payable in the year to a beneficiary of the trust. The beneficiary pays tax on any

income (but not capital) received from the trust.

Testamentary trusts pay tax at the marginal tax rate; income-splitting benefits will arise.

Inter-vivos trusts pay tax at the highest marginal tax rate.

New residents in Canada can be exempt from paying Canadian tax on income and gains for

five years after settlement in Canada within pre-established non-resident trusts. After five

years, the assets may be transferred into Canada without tax.

What are the tax filing rules for trusts?

All trusts resident in Canada must file annual tax returns.

An information return must be filed by a Canadian who transfers any assets into a foreign

trust or if he or she receives a loan or distribution from a foreign trust. The foreign trust may

be taxed whether or not a distribution is made.

If attribution rules are applied, the settlor may have to pay income tax on the income earned

by the trust. A tax specialist should advise on this issue.

There is a deemed disposition every 21 years after a trust has been established (except for

spousal, alter-ego, and joint-partner trusts in which dispositions are triggered by death).

Income, losses, and capital gains for the capital, land, and foreign-resource properties in the

trust must be reported. Capital gains may result for the settlor if attribution applies.

A new rule (the “kiddie tax”) taxes dividends from a private corporation in a trust in which

minors are the beneficiaries at the highest possible rate to deter income splitting.

What are some considerations regarding trusts?

The choice of trustee must be made carefully, based on reliability, trustee fees, and

administration charges.

For disabled beneficiaries, “preferred beneficiary” rules enable the income in a trust to be

taxed to the beneficiary, even though it remains in the trust. This may mean it is taxed at

lower rates.

Offshore trusts may be attractive for various reasons. However, tax considerations and rules

are complex. Moreover, the risks, including risks of fraud, foreign-currency risk, and

political risk are great, and legal or jurisdictional difficulties may arise.


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Offshore trusts may also fail to achieve their objective of reducing the tax liability of the

beneficiary if the trust is subject to tax, or the beneficiary is taxed on the income in the trust,

even though no distribution has been made.

Assets held in a living trust are not part of the settlor’s estate and are exempt from probate. When assets are placed in a trust, there is a disposition that can create capital-gains tax for the settlor

(except for alter-ego or joint-partner trusts)

How Does an Estate Freeze Work?

The Basic Objectives of Estate Freezing

Estate freezing is designed to freeze the value of a taxpayer's “growth assets” so that future

asset growth passes to the taxpayer’s children or spouse. Growth assets consist of stocks,

bonds, and real estate.

In an estate freeze, the accrued value of the assets up to the freeze date accrues to the

taxpayer and subsequent growth accrues to the children or the spouse. On the taxpayer’s

death or on disposition of the assets, the value up to the freeze date, is taxed in the hands of

the taxpayer’s estate (or the taxpayer personally). Any asset value growth after the date of the

freeze will ultimately be taxed in the hands of the taxpayer’s children or spouse.

The Use of Holding Companies and Inter-vivos (Living) Trusts

This is a method of freezing an estate by using a holding company or an inter-vivos trust.

This way, the taxpayer who is seeking to maintain control over the assets—even though the

growth in those assets passes to the next generation—can ensure that a source of income is

still available after the estate freeze and that no immediate tax liability arises on the estate

freeze.

The taxpayer can accomplish an estate freeze by transferring all the common shares into a

newly incorporated holding company and can accept as consideration the holding company’s

preferred shares. The transfer is made at cost, with no taxable capital gains, provided certain

tax rules are followed.

The cost base of the common shares flows through to the preferred shares, so that the inherent

gain in the common shares resides with the preferred shares. The preferred shares are voting,

non-participating, non-cumulative, redeemable shares with a fixed or flexible dividend rate.

The preferred shares are redeemable at the fair market value of the common shares

transferred into the holding company. The holding company’s common shares are issued to

the children (or to a trust for them) in amounts that result in the preferred shares having more

votes than the common shares. Since the preferred shares have a fixed redemption cost, any

future growth in the common shares is attributed to the children.

Therefore, the future growth of the assets accrues to the children. The taxpayer maintains

voting control in the holding company (through the voting preferred shares) and the taxpayer

receives preferred share dividend income. Alternatively, the preferred shares can be redeemed

over time. The fixed preferred dividend or redemption can be set to meet the taxpayer’s

needs.


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If a grantor freezes an asset in an inter-vivos trust, all capital gains on the asset to that point

are taxable to the grantor. Capital gains earned on the asset after freezing are taxable to the

trust.

How to Achieve an Estate Freeze

A simple sale (or gift) of investments to children when stock prices are low can achieve a

simple and less costly method of estate freeze than incorporating a holding company or

establishing an inter-vivos trust.

Again, future growth in the value of shares sold or gifted will accrue only to the children.

If children are minors, attribution will apply.

What Are the Risks of Estate Freezing?

Once in place, all future growth in the “frozen” assets accrue to the children.

The promissory notes or preferred shares taken back by the taxpayer may provide inadequate

income for him/her, depending on inflation or other factors.

The taxpayer may change his/her mind and feel that those who will benefit from the freeze

are undeserving.

The freeze is difficult to reverse and may be very costly.

How to Deal with a Cottage or a Family Business The two issues with distributing assets in the form of a cottage or family business are:

equitable distribution;

tax liabilities that will arise.

Businesses may be transferred between spouses on a tax-free basis.

If a client wishes to leave a small business to his or her children, an estate freeze could be

considered. If a trust is used for the freeze, then after 21 years there will be a deemed

disposition of assets for any unrealized capital gains.

Each child (shareholder) may take advantage of the $750,000 capital-gains exemption for

qualified small businesses.

In addition, the client may wish to purchase life insurance to provide the estate with sufficient

funds to pay any taxes due at his or her death, without forcing the sale of estate assets,

including the business.

If the cottage is not a “principal residence,” on the death of the parent(s)/owner(s), it will be

subject to capital-gains tax.

The client must address how to treat all his or her children equally; sometimes this is best

achieved by leaving business assets to one and an equal amount of other assets or life

insurance to the other(s).


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Death Taxes

Taxes that arise on a person’s death:

Income tax (from the deemed disposition of capital property on death) is shown on the

personal income tax return of the deceased.

Income from RRIFs and RRSPs that are deemed to have collapsed.

Foreign estate taxes or succession duties if the deceased’s property is outside Canada or if

he/she was a citizen or resident of another country.

Income tax is paid when the final tax return is filed. The amount of tax payable for capital

gains and deemed disposition of capital property depends on whether the person has used all

of his/her lifetime capital-gains exemption.

Tax Minimization or Tax Deferral at Death

To minimize or defer tax at death, the estate executor could be required to file four income-

tax returns for the deceased:

the final personal tax return of the deceased;

a separate tax return for “rights or things” of the deceased;

a separate tax return if the deceased was a partner or proprietor in a business enterprise;

a separate personal tax return if the deceased had an interest in the income of a

testamentary trust.

The advantage of filing separate returns is that income is split among returns and full personal

tax credits claimed on each.

Rights or Things

Rights or things include receivables of a taxpayer who reports business or investment income

on a cash basis. These are recorded as “income” on the deceased’s final tax return. Some

examples:

accrued but unpaid salaries;

accrued but unpaid vacation benefits;

unclipped interest coupons on bonds, etc.;

dividends declared, but unpaid;

crops and livestock of farmers;

inventory of a business.

Land that is inventory is not a right or thing. Land that is owned by the decreased is deemed

to have been disposed of immediately before death, and the deceased is considered to have

received proceeds equal to the fair market value. Any accrued profit will be brought into the

deceased’s income.


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Land distributed to a spouse or spousal trust is deemed to have been disposed of at cost, and

the spouse or spousal trust is deemed to have acquired the land at cost. The following

conditions must be satisfied:

the distribution must occur within 36 months of the taxpayer’s death;

the land must vest without restriction to the spouse or trust.

A tax-free rollover is achieved if these conditions are met.

Taxation of “Rights or Things” – Two Available Elective Provisions

The tax on “rights or things” may be paid in instalments, with interest at the prescribed rate,

as long as acceptable security is provided to CRA.

The executor may elect:

to file a separate return for rights or things of the deceased as though the deceased were

another person who is entitled to personal tax credits. This has the advantage of doubling

both the use of certain personal tax credits (single status, married, married equivalent,

dependent plus personal credits) and the use of the individual’s low tax rate.

the beneficiary to receive the right or thing in his or her income in that year rather than

the “right or thing” being taxed in the deceased’s estate.

The Disposition of Capital Property at Death – Two General Rules

Unrealized capital gains on capital property (including depreciable property) must be

declared in the deceased’s final income-tax return, unless specific exempting provisions are

used.

A taxpayer is deemed to have disposed of all capital property, including depreciable property,

immediately before death and to have received proceeds equal to their fair market value. Any

taxable gain that results would be income to the deceased (50% of the capital gains).

The Transfer of Property to a Surviving Spouse

Capital property can be rolled over to the surviving spouse or a spousal trust at its adjusted

cost base.

Capital property must vest to the spousal or spousal trust within 36 months of the death of the

taxpayer.

Depreciable property is rolled over at its undepreciated capital cost.

The ITA permits the deceased’s legal representative to make an election for transfer of any

property subject to a spousal rollover; such a transfer is treated, for tax purposes, as deemed

disposition at the taxpayer’s death. Accordingly, capital gains can be created to offset unused

capital losses.


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Four Types of Non-Deductible Reserves on a Deceased’s Final Tax Return

In the year of death, a deferral of income through the use of reserves is not permitted. The

following reserves are not deductible on the final tax return of the deceased:

reserves for income from property sold in the course of business;

reserves on commissions;

reserves for capital gains;

reserves for disposition of resource property.

A spouse or spousal trust can claim these reserves, even though they originally belonged to

the deceased. Thus it is possible to shift income to a spouse in a lower tax bracket, who can

pay tax as it is received over a number of years.

Circumstances When Two Tax Returns May Be Filed on Behalf of a Deceased Proprietor or Partner

When a proprietor or partner dies between the fiscal year-end of the business and the calendar

year-end, a separate tax return may be filed for this period. Personal exemptions may be

claimed for the deceased on this separate return, even though previously claimed on the

deceased’s final tax return.

Income Beneficiary of a Testamentary Trust

If the deceased taxpayer was a beneficiary of a testamentary trust, the executor can elect to

file a separate personal tax return for the deceased taxpayer’s trust income for the period

between the end of the trust’s last completed fiscal period and the date of death. This election

permits the double use of tax credits (single status, married, etc.).

Allowances for Capital Losses

Capital losses that exceed capital gains for the year of death can be applied against other

income in the year of death and the preceding tax year.

An election may be made to have the deceased incur losses from the estate’s disposition of

capital property.

Conclusion It is recommended that an individual simplify the administration of his or her estate in order

to satisfy responsibilities to family and beneficiaries. To do this, the individual should:

maintain an updated will;

execute a current financial and/or personal power of attorney and a living will, if desired;

maintain a current list of assets, liabilities, and important papers (e.g., location of bank

accounts);

ensure that the wills and a list of assets are stored safely in an accessible place that is

known to the family (preferably not a safe-deposit box, since the will is needed to get

access to the box).


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A holding company can simplify complex estates by reducing the number of jurisdictions

levying taxes on death. For example, the holding company is the owner of all of the assets

located in different provinces and foreign countries. On the death of the shareholder of the

holding company, only the shares of the holding company are transferred to the estate and

subject to tax. The individual assets are not taxed in the jurisdiction in which they are located.

Taxes on death should be minimized by:

the use of tax-free rollovers;

the transfer of at least part of the future growth in the estate before death through an

estate freeze.