A TAX PRIMER FOR ESTATES

Date: 28 Oct, 2019

At the outset, we are a law firm and we do not provide tax advice.  However, we strongly urge our clients at the earliest possible date to retain the services of a qualified and designated accountant to assist in filing the various tax returns that are necessarily filed as a result of the death of the testator.

This is not simply the tax return covering the last year of the life of the deceased.  There generally is a requirement that the estate file one or more returns to cover the income and expenses of the estate.

The topics discussed below are pointed out in the most simplistic (relatively speaking) of terms possible and are only raised as a method of ensuring that an executor indeed does follow our advice and retain the services of a qualified accountant.

There is no capital gains exemption for real estate owned by an estate.  We are all well aware of the fact that our principal residence during our lifetime is shelter from any capital gains the home enjoys.  Our principal residence may have appreciated significantly as has been enjoyed by most properties in the GTA over the last decade.  However, this capital gain exemption does not extend to an estate.  The amount by which a property appreciates in value from the date of death until its liquidation is treated as a capital gain and taxed.  If their increase is significant, a great deal of tax may be incurred.  This is important when making decisions regarding the administration of an estate.

One year limitation for capital loss carryback.  The death of a tax payor triggers tax under Section 70.5 of the Income Tax Act.  A tax payor is deemed to have disposed of all of his capital property at its fair market value immediately before his or her death.  The taxpayer’s estate is responsibile for the payment of any tax payable by the deceased on the gains so reported.  There are some exceptions, the primary one being a rollover to a spouse.  In general terms, to qualify for a spousal rollover, the property transferred as a result of death must be transferred or distributed to either the deceased taxpayer’s spouse or common law partner or a qualifying spousal trust.  However, for the spousal rollover to be successful, it must be done within 36 months of death.

There is a double taxation problem dealing with shares held in a private company.  There are a number of planning technics available to reduce or eliminate the risk of double taxation on private company shares.  These need to be actively looked at and an executor who is managing an estate that includes such shares must seek competent tax advice on a prompt basis.

There can be complications when an estate is in the midst of litigation and an executor or an estate trustee during litigation must be alive to these problems and seek the court’s guidance.

Graduated rate estate status (“GRE”).  An estate generally is taxed at the highest marginal rate and is granted virtually no deductions that the deceased had while alive.  One exception is the creation of a GRE.  To do so, the estate must designate itself in its very first Income Tax Return as the individuals’ GRE and the estate must qualify and continue to qualify as a testamentary trust.  A GRE may not receive a loan or advance from one of the beneficiaries.  A GRE has the following benefits and these only exist for a three year period.

  1. Graduated tax rates – a GRE is taxed at a graduated rate applicable to individuals rather than the highest marginal rate which presently is 53.3% in Ontario. (thank you Justin Trudeau)
  2. Non calendar year end – a GRE is not required to have a December 31 year end.
  3. Charitable Donations – their treatment is far more flexible when made by a GRE.
  4. Capital loss carryback- the benefit under section 164 (6) of the Income Tax Act is only available to an estate that is a GRE.
  5. No part 12.2 tax – GREs are exempt from this tax which can apply when an estate has non-resident beneficiaries and earns certain types of Canadian source income.

The Moral – get a good accountant.

An estate freeze what is it and why should it be done

Date: 17 Oct, 2019

There is a very common tax-planning method called an estate freeze. The tactic is endorsed by the Canada Revenue Agency — as “garden-variety tax planning,”

The following is an example of an estate freeze.

Ms. Successful has built a company, now worth $30 million. She expects it will grow significantly in value by the time of her death, but if she gives the company to her children at that time, they’ll have a huge tax bill. One-half of capital gains are taxable when capital properties are willed to the next-in-line andmore than 25 per cent of accrued capital gains would be owed on the death of a taxpayer in the top income bracket.

So, Ms. Successful freezes the estate. First, she exchanges her $30 million in common shares for $30 million in preferred shares with a fixed redemption amount of $30 million, meaning the value of the preferred shares cannot exceed $30 million. The preferred shares are granted sole voting and control rights.

In exchanging the common shares for preferred shares, the Ms. Successful secures $30 million but denies herself the gains produced as the company grows. Ms. Successful’s children then purchase common shares — initially with zero value — in which that growth is captured. The children “buy” shares for $0, and worth nothing so no tax is triggered.

Ms. Successful continues to control the company and lives off the $30 million, while the company grows to $200 million and the common shares owned by the children increase in value. Without the freeze, that capital transfer would include a $50 million tax bill, but because of the freeze, no common shares are transferred whenshe dies and that’s a tax savings of $45 million. The successors will pay capital gains tax but not until they dispose of their shares, which could be many years later.

Estate freezes are a very valuable tool to assist in legitimate succession planning. Freezes are not reserved for the rich but used by the average business owner.

Estate freezes facilitate the transition of businesses between generations or key employees in an orderly and tax-neutral way.

The mechanics of the estate freeze vary widely, but they usually involve an owner who has enough value in their business to retire on and wants to sell it or bequeath it — either to family, employees, management or others with a connection to the business — allowing them to buy in at a nominal price.

An estate freeze doesnot reduce tax but merely defers it and is a solution to the liquidity issue arising if the shares were sold or transferred and money was owed to Canadian Revenue Agency with all the cash locked up in the shares. These risks result in most businesses not surviving a transition in ownership.

An estate freeze allows one to open the door to new people, who can then get in on that ground floor without having to spend money they do not have.

Remember that most small businesses have access to an exemption of $867,000 for capital gains tax on shares. The societal criticism of estate freezes is it allows high-net-worth families to avoid significant amounts of tax on inter-generational transfers of capital.

Estate freezes can be further embellished by Ms. Successful no longer taking a salary after the freeze. Any payment she receives from the company can be used to redeem or buy back her $30 Million in preferred shares. If she lives long enough, all of her preferred shares will have been redeemed by the company further reducing if not eliminating any tax on her estate’s interest in the company.

Estate Complications with Estate Trustees

Date: 17 Oct, 2018

Sometimes, third parties who are not related to the deceased may be appointed by the court as an estate trustee.

It has been our experience in highly contested estates when competing parties will not agree on permitting the other acting as estate trustee, the court has the ability to appoint a third party.

On consent, we have even had the situation where a solicitor in our office has been appointed as an estate trustee during litigation.

An example set out in the Taylor Estate decision was a fight between appointed executors/siblings. The Court held that the situation was obviously unworkable, due to the conflict between the siblings.

The court selected and appointed a mutual agreed third party.

Under the Estates Act, a named executor has the ability to nominate a third party to act as estate trustee which can be successful with the court’s authority.

One has to be careful in not looking to a third party who resides outside of Ontario. Looking at S.6 & 29 of the Estates Act, the court can only appoint an estate trustee with a will to a non-resident of Ontario who has the consent of the majority of the persons living in Ontario who otherwise are entitled to apply for such an appointment.

Clearly, there is a considerable expense in having an outside party so appointed as they rarely will act unless they are paid to do so.

This leads back to the author’s own prejudice against naming multiple executors. It is a recipe to create conflict when none is necessary. As we discussed elsewhere, testators often wish to name all of their children as joint executors as an expression of their equal love for them. This is a failed logic for that love should be expressed in the naming of the equal beneficiaries rather than the complication of multiple executors.

Estate Trustee, Civil Procedure and Punitive Damages: The Power of the Courts to do More than they Were Asked For

Date: 06 Mar, 2014

In a previous blog post[1], I discussed the role of estate trustees and the consequences they face when they fail to live up to their fiduciary duty. The estate trustee is responsible for carrying out the last wishes of a person who died. Their fiduciary duty imposes responsibilities to look after the estate in a trust worthy manner with an eye to the interests of the beneficiaries. This is even more important when the estate trustee is looking after the estate for the benefit of children. This is the scenario that existed in Walling v Walling where the deceased appointed his brother as trustee over his estate. The deceased’s sons were minors at the time, therefore the will required the estate trustee to look after the estate until the youngest boy reached 21, at which point the trustee was obligated to turn over the estate to the boys. Unfortunately, this never happened and the children were forced to bring legal action to recover their father’s estate.

This case is important because it highlights the court’s power to impose significant penalties, even penalties that go beyond what the plaintiff is asking for, when the facts demand it. Punitive damages are a special type of money award that the courts can give. Typically, damages are awarded for specific harm, punitive damages are different though. They are designed as a punishment for conduct that the court deems particularly offensive to society. Their use is fairly rare in Canada but they will be used when the facts show a clear need.

This case warranted punitive damages because the trustee was exclusively responsible for a severe harm done to the children. By denying them their inheritances, the estate trustee made it difficult financially and limited their post secondary education opportunities. Furthermore, the trustees actions in excluding the children from their father’s funeral and denying them any significant sentimental mementos were particularly offensive. He was in a position of power and trust and he broke that trust to exploit the vulnerable children. The judge looked at the facts and award $100,000 in punitive damages. This was double the amount requested by the boys. The judge said it was warranted because a lower award would not properly reflect the court’s abhorrence of this type of conduct. Additionally, the judge was to use this award as a clear deterrent to others who may try similar actions in the future.

In litigation, there are rarely any certainties about the outcome the judge will provide. The court’s focus is upon justice and the judge’s decision will bear that in mind. In situations where a judge thinks a large amount is required they can go beyond what the parties have requested. Doubling punative damages in this case was warranted because of the specific effects that the estate’s actions had upon the children. This is certainly a rare occurrence, but it happens with enough regularity that people should take note of it.

The lawyers at Dale Streiman Law have practiced estate litigation for decades and are experts in all facets of estates law. They can help resolve any estate disputes in a timely and cost effective manner.