Estate Planning: Avoiding the Pitfalls
by David L. Edwards

Retirement approaches.  You’ve worked hard, life has been kind to you, and you are financially comfortable.  You are looking forward to enjoying your retirement years, but know that your are mortal --- should you rearrange your financial affairs so as better to provide for your spouse or make things easier for those who would be left behind on your death?  Should you gift things to your spouse or children during your lifetime?  Should you put your assets in joint names with your spouse or children?  Will the Ontario government implement an inheritance tax?

A lawyer specializing in Estate Planning can help answer these questions.  Spouses then can weigh their concerns against their goals.  The first goal should be to ensure that there are enough assets available to take care of each other.  The husband and wife partnership created the assets and they must not cut themselves short in what may be their time of need.  Once goal number one has been satisfied, the second goal is to make sure that the ultimate beneficiaries receive their bequests in a cost-effective way.

Proper estate planning requires a personalized legal strategy designed to fit your particular needs.  Each situation is different and calls for a different approach.  Depending on the amount and type of a person’s assets, a plan could range from the simplest of Wills to a complicated combination of a Will, a trust agreement, and a holding company.

Each time that we advise clients about their estates we consider a number of different issues.  Let’s work our way through some of the questions that might arise in an estate planning interview.

Joint Tenancy

Our home is owned by me and my husband as joint tenants.  What happens if one of us dies?

The surviving joint tenant becomes sole owner of the house by operation of law.  This is generally true of any jointly owned asset such as a bank account, or Guaranteed Investment Certificate.  Some recent case law suggests that if the facts show that one of the joint tenants was really a trustee (for example a son being a joint tenant of a bank account  in order that banking could be done by the son for the parent) then this presumption of law can be rebutted.  For this reason we advise all of our clients to insert a clause into their Wills to the effect that all their joint tenancies are true joint tenancies and the surviving joint tenant is the true owner of the asset, unless the reverse is clearly specified.  With respect to real estate, it is prudent to register the death certificate and if the property is registered in the Land Titles system, to make an application to change the parcel register.

Spouse as Sole Beneficiary

I have a Will.  Everything goes to my wife if I die first.  We own everything as joint tenants.  What happens when I die?

On your death, your wife automatically becomes sole owner of all your assets by operation of law.  If the assets are not jointly owned, it is likely that probate will be needed.

Probate

What does it mean to probate a Will?

Technically, one no longer probates a Will.  Rather, an application for a Certificate of Appointment of Estate Trustee with a Will is made.  The process is similar and the result identical to the process of probating a Will which was followed for hundreds of years.  For most Wills, this process is a fairly simple procedure.  A Judge reviews the application and if the process has been properly followed, the Judge will confirm that the Will is in deed the deceased's Last Will and Testament and will provide a Certificate of Appointment of Estate Trustee with a Will.  Anyone may rely upon this fact and need not be concerned about whether or not there is a more recent Will, or whether the probated Will is valid.  Once the Certificate is granted, any assets of the estate can then be dealt with by your executor.

Executors

Executor??  What does an Executor do and how do I choose one?

The expression Estate Trustee and Executor are synonymous.  That person is the one who is in charge of administering your estate.  Administering is the keyword.  Your Executor is obligated to fulfill the terms of your Will and must account to your beneficiaries and, if necessary, to the Court.  It is the Executor’s responsibility to pay debts including taxes from the estate before distribution of the assets.  Your Executor may seek professional advice, for example in legal or accounting matters, but ultimately the Executor must approve all actions of those professionals.  As to who the Executor should be, that’s more difficult.  The Executor must be someone in whom you have confidence and trust.  The Executor should not be someone who is older than you and depending upon your age perhaps not even your contemporary.  The Executor may be a family member, close friend, professional advisor (lawyer, accountant, etc.) or trust company.

Child as a Joint Tenant

My spouse predeceased me.  My daughter will inherit my house when I die.  Should I make her a joint tenant with me in order to avoid probating my Will?

That takes us back to my first question.  Your care and support is the most important matter.  By making your daughter a joint tenant your are opening the door to many negative possibilities.  The selling, mortgaging or any other dealing in the ownership of the house is no longer within your control.  If your daughter were injured in a car accident and unconscious, you would be unable to sell your home without either dealing with the person who holds your daughter’s Power of Attorney (if your daughter has given a Power of Attorney to someone), or a Court-appointed person (if the daughter has been declared mentally incompetent).  Also, if your daughter is ever sued successfully for any reason, that creditor of your daughter could complicate any transfer of ownership of your home.  If you ever have a falling out with your daughter, you would have a problem, as she is a co-owner with you.  Whatever your decision is, these possibilities must be considered.

Family Law Act

How does the Family Law Act affect making a Will?

This Act ensures that on the death of a spouse, the surviving spouse must receive at least one-half of the net family assets.  This places the surviving spouse, following the death of his or her partner, in a position which can be no worse than it would have been had they separated during each other’s lifetime.  If the deceased’s Will would produce a worse result, the surviving spouse may elect, within six months of the date of death, to take under the provisions of the Act rather than under the Will.

Taxes

Earlier you mentioned that the Executor must pay debts of the estate including taxes before distributing the assets.  What types of taxes must be paid on the death of the first spouse?

That’s an easy question if all of the deceased’s assets are given to the surviving spouse.  Presently, there are no taxes to be paid,  (either federal or provincial) where an individual leaves his or her estate to his/her spouse. 

What happens if the asset is left to someone other than a spouse?

Generally, an individual is deemed to have sold everything which he owns at his death at the fair market value of that asset.  This could result in a deemed capital gain if the asset is worth more at the time of death than its initial cost.  For example, if Joe bought stock in 1995 valued at $10,000.00 and when Joe die in 2001 it was worth $15,000.00, Joe would have a capital gain of $5,000.00 which would be taxed on the same basis as if Joe had on the date of his death sold those shares for $15,000.00.

Why does this not happen between spouses?

Between spouses there is a “roll-over”.  The surviving spouse acquires the asset at the deceased spouse’s cost base.  When the surviving spouse sells the asset, the built-in capital gain surfaces and the government gets its piece of flesh.  Back to Joe.  If his stock was inherited by his spouse, there would have been no immediate capital gain.  If Joe’s spouse later sold the stock for $20,000.00 she would have a $10,000.00 capital gain.  Her cost base is Joe’s original cost base -- $10,000.00 – and her gain is calculated from that point.  The “roll-over” postpones or defers the tax.  If does not eliminate it.

Wait a moment!  What about my house?

Not to worry.  One of the few exemptions from the capital gains regime is a principal residence.  If you have always used the house as your principal residence, there is no tax payable on its transfer no matter who acquires it.

Holding Companies

Earlier you also referred to holding companies.  What’s that all about?

Holding companies are used when an estate “freeze” is undertaken.  I previously explained that a person is taxed on death by way of a deemed capital disposition.  If Joe owns an asset, such as a business, which is increasing in value, the amount of tax which will be incurred upon his death is constantly increasing as the value of that asset increases.  We can transfer this asset into a company on a “roll-over” (tax deferred) basis.  Joe would receive shares in the company which do not increase in value, but which have sufficient voting rights attached to them to control the company.  The value of Joe’s shares has been frozen at the current level.  Hence the name estate freeze.  Other shares are issued in the company often to the children.  These shares are created so that they increase in value as the asset increases.  In this way the tax on the increase in the value of the asset from the date of the freeze to the date of Joe’s death is deferred until Joe’s child dies or transfers the shares.

Deferral of Tax

Can you avoid that tax?

Generally tax cannot be avoided in the sense that will never be paid.  Often a deferral is the best that can be achieved.  In my example, the tax which otherwise would be payable on Joe’s death is not paid until Joe’s child dies or transfers the shares.  The deferral of taxes is a major benefit.  If Joe’s child retains the stock for twenty years, he will have had the benefits of those tax dollars for that entire period.

Are there no total exemptions from tax?

Yes, there are a few exceptions to the general rule of taxation.  In those cases, although tax would normally be paid, a specific section of the Income Tax Act exempts the situation so that no tax is payable.  The sale of a home which has always been occupied as the owner’s principal residence is one example.  There is also an exemption up to a certain maximum value on the sale of a family-held active business.  Your accountant and lawyer can give you more details.

Trusts

What is an inter vivos trust and what use does it have?

An inter vivos trust is a trust which is created during one’s life.  A trust has many different uses.  In Joe’s situation, a trust would allow Joe from a legal point of view to give something to his children during his lifetime without giving up control of that asset.  For  example, the shares which Joe gave to his children could have been placed in a trust which he controls.  If the company had excess income which he desired to give to his children in an equal or unequal fashion, the trust could allow him to “sprinkle” the money amongst his children in his discretion.  This could be done as often as Joe wished and in each case it could be sprinkled on a different basis.

If an inter vivos trust is established during one’s lifetime, what happens on that person’s death?

On the death of the settlor (the person who started or “settled” the trust), the terms of the trust simply are followed.  Often the settlor is the initial Trustee (the person charged with administering the terms of the Trust – similar to an executor of a Will).  The trust agreement will normally appoint successor trustees or describe a method of appointing successor trustees.  The trust agreement will provide for a time of distribution of the capital of the trust.  Often this is either the date of death of the settlor or a specific point of time following the settlor’s death.

What is a Testamentary Trust?

A testamentary trust is a trust which is created through the Last Will and Testament of an individual.  For example, if a parent should die while his or her children are still young, that portion of the estate which the testator wishes his child to inherit would be placed in trust upon certain terms.  For example, the child may not be entitled to the income from the trust until a certain age and then might receive a portion of the capital at another age and the balance of the capital at a later age.

What are the advantages of a Testamentary Trust?

In addition to the advantage mentioned above, namely that the beneficiary does not receive access to the capital until the terms of the trust have been satisfied, there are also income tax advantages.  It is sometimes prudent to create a spousal trust even when the spouse is receiving the entire estate.  In those circumstances, part of the estate would go directly to the spouse and part would go to a spousal trust.  The net result of this is that the spouse and the trust combined will pay less income tax on the income derived from the estate than would be the case had the spouse received the entire estate and therefore generated all of the income in his or her hands.

Last Word

As you can see, the variations are endless.  The core goal remains the same, however.  Husband and wife must first provide for each other.  Secondly, they should be concerned about other beneficiaries.  Advice on an estate plan can be as varied as the myriad of different circumstances in which people find themselves. 

One word of caution.  Any plan must be as flexible as possible.  The unforeseen constantly happens.  Twenty years ago it was not uncommon for one spouse (usually the husband) to leave a monthly stipend to the other spouse in an amount that at the time seemed generous.  The inflationary period following that person’s death turned it into a miserly amount.  Complexity is sometimes demanded by the circumstances.  Flexibility and simplicity should, however, be the target for most.