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By Brian A. Lee
Illustration: Jason Schnieder
 A GUIDE ON HOW TO AVOID PROBATE TAXES FOR THOSE WHO ASSIST IN ESTATE PLANNING
Remember the cliché that says the lawyer who represents himself has a fool for a client? Well the same could apply to anyone considering do-it-yourself estate planning, especially when the main objective is to reduce the amount of probate tax. Financial planners have often seen cases where an adult child is named as joint tenant with right of survivorship (JTWROS) — which can help reduce probate taxes — however it crystallizes a capital gain resulting from a deemed disposition. As a result, the capital gains are taxed immediately as opposed to later, which is not the intended outcome.
The cost of prepaying tax is only one potential consequence of using JTWROS as a probate planning technique. Other problems — transfer of ownership to an unintended recipient, creditor access to all the assets of either joint tenant and loss of principal residence deduction — can arise.
Consider the case of an older woman who registers her son's name on the title of her principal residence and sizeable securities portfolio. The reason for changing her sole ownership to a JTWROS is to avoid probate tax upon transfer of the estate and give the son control over the mother's assets in the event of her failing mental or physical capacity. However, there are undesirable outcomes.
Let's say the mother's securities portfolio has been owned for some time and has a low adjusted cost base for tax purposes. Canada Customs and Revenue agency views a transfer of ownership as a deemed disposition, which will cause a taxable capital gain on 50% of the total portfolio. Thus, the tax owing upon the deemed disposition at the time of the mother's future death is accelerated forward to the date of transfer. Given the choice of paying the tax today or later, later is better, because payments are postponed.
As for the mother's principal residence, there is no accelerated tax event upon a deemed disposition as a result of joint tenancy. But this may create a tax problem later. If the son is living elsewhere, he cannot make use of the principal residence deduction. When the house is sold he will pay tax on the taxable capital gain on his 50% ownership from the date of joint tenancy. If the mother stayed in the house as sole owner, there would have been no tax payable on the sale of the house, thereby achieving a superior tax outcome.
Another twist to this scenario is when the son and his wife move in with the mother. Should the son die before the mother dies, Ontario's Family Law Act severs the joint interest and the son's estate acquires a 50% interest in the property as tenants in common. If the son's will leaves all his assets to his wife, the mother will have a new roommate, which may not be an ideal situation.
Or let's say the son has a heavy financial burden. Under property and banking law, banks and secured creditors of the son are permitted to collect on his debts, and as a result of the JTWROS arrangement, creditors are permitted to look to the mother's share of the assets. From a creditor perspective, the son's assets are 100% of the house and 100% of the securities portfolio. The mother's financial half of the residence can be used to meet the financial obligations of the son. In the end, she could lose her house and her securities portfolio.
Let's look at the more relevant probate points and solutions that can be used in probate planning. Most provinces levy a probate tax or estate administration fee to grant certificates of appointment. These certificates give judicial confirmation that the individual purporting to be the estate trustee (formerly known as executor / executrix) is in fact named in the will and has been properly appointed. Typically, banks and investment dealers require the document prior to releasing assets held at their institutions. Outside of third-party requirements or challenges to the will, there would be no requirement for a certificate for proper distribution of the estate, as the estate trustee has authority in the will to act as trustee. If there is no will, the court appoints an estate trustee.
Probate tax is based upon the estate's value. Every province has its own method of charging the fee. In Ontario, with the highest fees, the levy is $5 per $1,000 (0.5%) estate value up to $50,000, and $15 per $1,000 (1.5%) thereafter. So an estate valued at $5 million would have an estate administration tax of $74,500. For an estate valued at $250,000, the tax would be $3,250. Consequently, a rational investor would consider a cost-benefit analysis for any planning scenario, as there are out-of-pocket expenses with creating and implementing a sound financial and estate plan.
Not all assets are included in determining estate value at the time of death, and there is no estate administration tax on such assets. For example, joint tenancy assets are not part of the estate at death, nor are proceeds of life insurance contracts, registered retirement savings plans and retirement income funds that are payable to a named beneficiary. Out-of-province real estate and shares of a family business also don't require probate. Such shares may be transferred to the intended recipients outside of a will and therefore avoid the probate tax. However, well-drafted documentation is a must.
Probate planning should be done in the context of a broader estate and financial planning exercise and should explore the goals and objectives of the client, involve data collection and analysis and make recommendations as to the most desirable way to proceed. Finally, the accepted plan should be implemented and periodically monitored. Within the scope of an estate and financial plan, probate tax should be addressed in the context of its relevance, the solutions available and the cost and desired outcome of implementing the recommendation.
One method of removing assets from a probated estate is to transfer them to a trust. The terms of the trust would allow for the payment of income and/or capital to an individual (known as the beneficiary) and stipulate what is to happen to the assets upon death. This way all the assets of the trust are not part of the estate and therefore not subject to probate tax.
However, there may be a tax event upon a transfer of assets to a trust as a result of deemed disposition rules. Therefore, this works best where there is no capital gain. The transfers of cash or Canada Savings Bonds are examples of property that will not have a capital gain. However, interest on CSBs or cash balances is taxed at the highest rate.
Under special trust arrangements, such as alter ego and joint partner trusts, there
is a possibility to avoid a deemed disposition. To qualify for these types of inter vivos trusts, the settlor (the individual who transfers assets to a trust) must be at least 65 years old at the time of settlement (the asset transfer to a trust). The benefit of the alter ego and joint partner trusts is that they are taxed at the settlor's graduated rates of tax — other inter vivos trusts are taxed at the highest marginal rates.
However, an inter vivos trust arrangement may be more expensive than the cost of the probate tax. At the time of the settlor's death, the assets of the trust may be transferred to the ultimate beneficiary or transferred later. If the assets stay in the trust, the income is taxed at a flat rate, being the highest marginal rate. This may be acceptable if the beneficiary is already paying tax at this rate. However, if the assets are part of an estate, then transferred to a testamentary trust, the beneficiary could save $14,000 a year in taxes.
Giving to beneficiaries while still alive is another way to avoid probate tax, as the assets are not transferred through an estate. Making a gift of them may defer future capital gains taxation to a date later than the giver's death. However, it can accelerate a tax event caused by a deemed disposition at the time of gifting. In addition, the application of attribution rules can assign some types of taxable income back to the individual who has transferred the assets.
A deceased's debts don't usually reduce the estate's value and therefore don't reduce the probate fee. There is an exception for encumbered real estate assets, or such secured debts as a mortgage or debenture registered on title. That is also true for the valuation of a company's common shares. While the corporate debt may not be unsecured, it does reduce the value of the share, and therefore the probate tax.
A spousal trust is any trust created by a taxpayer under which his or her spouse is entitled to all the trust's income that arises before a spouse's death, and no one but the spouse may receive benefit, both income and capital, from the trust.
Spousal transfers are complex, and there are ways to avoid probate if a taxpayer transfers property to his spouse or a spousal trust. The transfer is deemed to have occurred at the taxpayer's adjusted cost base unless the taxpayer elects otherwise. So, a gift or sale of property to a spouse for less than fair market value will not result in a deemed disposition at fair market value, and taxes on any gains are deferred until the time the assets are sold. While inter vivos transfers of assets do not attract probate, let's not forget the tax benefits of testamentary trusts versus inter vivos trust and the attribution rules.
Like trusts, proceeds from life insurance policies with a named beneficiary (or transfer to an insurance trust) are exempt from probate tax. To avoid probate, some people transfer money to a universal life insurance policy with a named beneficiary. Although there are benefits to using life insurance strategies, the one-time saving of 15% probate tax is small when compared with a 3% annual fee on some universal life policies.
Multiple wills can reduce probate, but because of the complexity, it is considered an aggressive planning technique. Multiple wills should be drafted by a professional with particular emphasis on keeping the wills in force and not revoking one another. The concept behind multiple wills is that not all assets need to be probated. For example, it may only be necessary to probate such assets as bank balances or securities accounts where the financial institution demands a probated will to release the assets. Therefore, one could organize the assets by dealing with all the assets requiring probate into one will and those not requiring probate in another.
Examples of assets not requiring probate would be assets held in jurisdictions other than Ontario. This would require a will to be drawn in accordance with the law in those jurisdictions where the assets are located.
Avoiding the estate administration fee (probate tax) involves structuring the ownership of assets and their transfer in such a way as to avoid probate of the will to effect a distribution of assets. Because of the complexity of the issue, getting professional legal, tax and financial counseling to address financial and estate planning is highly recommended.
Brian Lee is a candidate for the CFP designation. He is a senior auditor with RBC Financial Group in Toronto
Technical Editor: Ian Davidson, MBA, CFP, CA, RFP, vice-president, Assante Capital Management in Toronto | 
