Denese Espeut Post
Do you have an estate plan? Estate planning is really the advance preparation for the two things you can count on at the end of your life, death and taxes.
At the time of death, income taxes often create the greatest need for liquidity in one’s estate. When I refer to liquidity, I mean that funds are readily available to the executor of one’s estate for the administration of an estate. In addition to income taxes, other factors that may increase the need for liquidity in one’s estate include probate fees, executor’s fees, trustees’ fees, professional fees and charitable and other cash gifts made in one’s Last Will.
In Canada, while there is no estate tax, there is a deemed disposition of all property owned by deceased person for its fair market value (FMV) immediately before death. What this really means is a deceased person is treated as having sold all of their property just before death for FMV. It does not matter that there is no actual sale or disposition of this property. So, this can create a large potential tax burden for one’s estate.
Let’s consider an example of how this may unfold. Smith is a 68 year old deceased man who is divorced and survived by one healthy adult child. At his death, Smith was the sole owner of 2 pieces of property, his primary residence and a recreational cottage. Let’s assume that Smith purchased the cottage for $75,000 many years ago and its FMV is now $350,000. He was also the sole owner of shares in a private corporation (FMV of $400,000) which he incorporated early in life. Smith also owned an RRSP valued at $250,000 and named his child as his beneficiary.
Smith’s estate will pay considerable tax in the year of his death. Assuming Smith claims the principal residence exemption for his primary residence, his recreational cottage will be deemed to have been sold for its FMV, $350,000, just prior to his death. This will result in a capital gain of $275,000 ($350,000 - $75,000) for tax purposes. As Smith started his corporation, the initial cost of his shares would likely have been nominal. With an FMV of $400,000 at death, Smith will have a $400,000 capital gain for tax purposes. Further, the full amount remaining in Smith’s RRSP, $250,000, will be fully taxed. In our simple example, Smith has a $675,000 capital gain of which, one half will be added to his income in the year of death ($675,000/2 = $337,500). In addition to the extra income of $337,500, we must add the fully taxable RRSP amount of $250,000. So, Smith has additional income of $587,500 resulting from the deemed disposition which is over and above his typical income sources. Of course, this amount would also be taxed at Smith’s highest marginal tax rate.
Please keep in mind that the above example is a simple example and does not consider various tax exemptions and tax planning strategies that can be adopted in order to minimize the tax payable by an estate upon death. Such exemptions and strategies may include the capital gains exemption, principal residence exemption, spousal rollover and pipeline planning for corporations amongst others. Also, there are also some personal planning strategies that can be implemented during life to achieve one’s intended dispositions and goals upon death. It will be important to speak to your legal and tax advisors as you are working through your personal and estate plan.
Tax resulting from a deemed disposition on death essentially means that there is tax to pay without a corresponding income source because the deceased person has not actually sold any assets which would result in an influx of cash. Unless the estate of the deceased person has resources within it to cover a large tax burden, life insurance should be considered. One important benefit and a fundamental use of life insurance is the provision of cash to satisfy not only the income tax burden realized in the year of death, but the other potential estate costs which increase the need for liquidity mentioned above. If Smith had insurance on his life, payable to his estate upon his death, Smith’s estate would receive a tax-free cash payment which could then be used for his liabilities and other estate needs. Typically, life insurance will be the least expensive way to fund estate liabilities (compared to borrowing money or liquidating assets for example) and it is paid exactly when it is needed.
Take the time to go speak with your insurance advisor, determine if life insurance would benefit you and if so, the amount of coverage required based upon your personal circumstances and the manner in which the insurance policy should be owned.