Last week, we talked about the two recommended approaches to estate planning. One is to simplify the estate process by using beneficiary elections and joint ownership, but with great care and thought.
The goal of that approach is to reduce probate fees, simplify and speed up the estate-settlement process and possibly even avoid probate altogether.
The other approach is to write a will with a lawyer who specializes in tax-effective estate planning and have that will describe testamentary trusts through which the beneficiaries will receive their assets. This strategy usually requires maximizing the size of the estate and the resulting funding of the trusts.
This means higher probate fees, but these are only 0.7 per cent in Manitoba. The long-term benefit could be significant tax savings each year for each beneficiary. However, the Department of Finance has introduced a proposal to limit this benefit to 36 months after death.
If implemented after the comments period, this could limit the tax benefits and result in testamentary trusts primarily being used for their other benefits, such as creditor protection, management for inexperienced beneficiaries and protection against excess spending.
Today, we will focus on the tax planning available under either strategy when a person passes away.
When a person dies, the tax return must be prepared from the previous Jan. 1 to the date of death. This is called the final return or the terminal return. It is due April 30 of the following year, or six months after the date of death if the person dies after Nov. 1.
Although Canada has no estate taxes per se, any capital gains at the time of death must be included in this return, as well as the cashing in of any RRSP, RRIF, pension or other registered assets, all of which are taxable on this return.
If a person dies leaving a spouse, spousal rollovers are available to defer this tax and transfer the future liability to the surviving spouse. Otherwise, taxes will be payable on the various items.
Last week, I was reminded in a presentation by Cheryl Norton, CA of Standard Life Investments, a second tax return can be filed, called a "Rights & Things" return. This provides a second personal exemption, and therefore could make a number of taxable items tax-free.
Rights and things are amounts owing to a person at the time they pass away, such as unpaid vacation pay, unpaid CPP or OAS cheques that arrive after the date of death, even paycheques for pay periods ending before the date of death, but arriving after.
A separate tax return can also be filed for a partner or proprietor of a business. This allows for further income splitting. As well, if the deceased is a beneficiary of a testamentary trust, a separate return might be able to be filed for this income. Each time you can file a separate return and divide the income across more personal exemptions, the less tax you pay.
In the year of death (and carried back to the previous year), charitable donations can be claimed up to 100 per cent of net income. Normally, the limit is 75 per cent.
The estate may be able to make a spousal RRSP contribution and take the deduction on the terminal return, if the spouse is under 71 and the deceased had contribution room available.
Any income earned on the deceased person's assets after death will be taxed on an estate return, due March 31 (for 90 days after trust year-end, if other than Dec. 31) for each subsequent calendar year. Generally, CRA only allows 36 months for the winding up of the estate.
Executors will want to get a clearance certificate from CRA prior to distributing the last of the assets, to avoid any potential tax liability coming back to them. This means arranging the investments so no investment income is earned in the period following the date of filing the last estate return. Otherwise, another return would be due.
My conclusion? Getting good professional tax advice on something this important is a very good idea.
David Christianson, BA, CFP, R.F.P., TEP, is a financial planner and adviser with Christianson Wealth Advisers.