Estate Planning: What is involved?

Estate planning is a personal responsibility for all of us, and it requires careful thought and a sharp mind to achieve the desired objectives. The primary objective is to pass along the family’s net assets to the surviving spouse, children, grandchildren, and charitable foundations. Of course, in carrying out this objective we want to leave as much as possible to our survivors, which requires some income tax planning so that we don’t leave it to the government. This requires some careful planning because most of the assets held at death are usually taxable in some way, so the governments will get their share. After all, good financial planning has called for us to build our wealth and delay paying income taxes, but there comes a day when the taxes must be paid.

What are the tax rules upon death?

Our tax rules provide that upon death we are assumed to have sold all of our properties so that tax authorities can do a final accounting for what we owe. Yet, they have provided a few opportunities to delay the resulting taxation, for most, by allowing property to transfer on a tax deferred basis to our surviving spouse. Another opportunity is to leave property to charitable organizations, resulting in charitable donation tax credits. This is further improved by being allowed to avoid capital gains on capital property left to a charity.

Filing the final tax return

Upon death, the estate is required to file a final tax return for the deceased person, which requires that accruing investment income be taxed, and accruing capital gains be realized for tax purposes. Other opportunities exist to file two or three tax returns upon death for incomes that are receivable, but not received at the time of death. That income can be placed in a second tax return. And the estate benefits from a second set of personal tax credits, as well as a low marginal tax rate of a second tax return. For example, in a recent case, we were able to file a separate return for a professor who had significant royalty income from his writing work, which was receivable after death. By placing this in a separate tax return the estate saved over $12,000.

Accrued capital gains

More common is the passing along of marketable securities or real estate with accruing gains to one’s spouse. The capital gains that have built up over the years can continue to be deferred until sold by the inheriting spouse, or until subsequent death. This can include a gain on real estate property, stocks and bonds, private company shares, artwork, etc. Substantial capital gains will have built up over the years and will result in considerable tax at the time of the last of the two spouses to die.

Let’s not forget that, in some cases, there are capital losses that may be accruing or may have arisen in prior years. These can be deducted against gains in the final tax return, so you would not want to defer all gains, but rather record just enough gains to offset the losses that are available.

Estate planning for last to die

An even tougher situation arises when planning for the last to die, and we don’t know who will die first. So, we must do the planning for each of us as if we were the last to die. This means your Will needs to consider two situations: if you are the first to die, and if you are the last to die. This is possible by providing for both scenarios in your Will. But it does require that you consider who owns what, and what is the best way to arrange ownership of your assets in contemplation of death.

How can charitable giving fit into your estate plan?

You will also want the opportunity to consider charitable giving, as this is a way to reduce what you leave for the taxman. It feels much better to make important charitable gifts to those causes you believe in than to leave the money to be taxed. But this creates a problem: If you leave funds to charities, then there is less money to go to your family members. And we usually believe that charity begins at home. You want to ensure that your descendants have enough money to live in some comfort and continue the lifestyle they are accustomed to. But don’t plan to leave them too much, or they will not to be able to earn money on their own, thinking always that they can lean on the bequests you make. It is important for young people to learn to make their own way in the world, and not to expect handouts.

Consider the following in your estate plan

Think about the following proposition: You may want to leave $100,000 to your favorite hospital because they are doing great research and providing care to our fellow citizens. If you do so, you will save about 50% of this amount in income taxes and can leave that savings to your children or grandchildren.

If you want to leave the $100,000 to your descendants, you may have to pay tax on any capital gains that go along with that sum of money. The government might get $25,000 or $40,000 of the $100,000. If you want to give money to your children, and you want to give money to your favorite charity this requires serious planning and good knowledge of what you own and what you need to live successfully for the rest of your life.

Final thoughts

You also need to think of your worldwide assets, and like several Canadians, you may have investment property in the United States or elsewhere in the world. Most countries have an estate tax, but Canada has an income tax system that extracts its estate tax by making you pay tax on your final income tax return. So, you need to consider your assets around the world and can consider how you can avoid taxes in these other jurisdictions as well.