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Protect your heirs from the taxman - Part 1
I have always cheered at the bumper sticker that said we are spending our kids’ inheritance. But life is full of uncertainties and death is one of them. None of us know exactly when we will die. Mortality tables are predicting that we will live longer than ever before. But just in case, wouldn’t you want to make sure that as much of your assets are left to the people you intended and not the taxman?
The first step in protecting your assets from the taxman is to understand where the tax burden lies. Many people still believe that you are taxed when you receive an inheritance. In actual fact, the estate is taxed before it goes to the beneficiaries. Besides your regular income earned during the year of death, all your assets are deemed to be disposed at fair market value.
The second step is to know the tax consequences of the value of your estate's assets. There are two taxes that will have impact on the estate. One is a Probate fee - a provincial tax levied on all of the assets. The other is Estate and Income Tax - a federal tax that is levied on certain assets at the date of death, regardless of whether they pass into the estate or go directly to a beneficiary.
Probate fees are levied by the provincial government and are currently 1.4% of all assets over $75,000. Assets held in joint names (such as joint bank accounts) do not go into the estate and are not taxed by probate fees. Insurance proceeds with a named beneficiary also go directly to the beneficiary and are not taxed. Probate fees are only levied on the assets that go into the estate, not the assets that go directly to the beneficiaries. This is why people often put items in joint tenancy. However, caution should be exercised. By trying to avoid probate fees, you may have tripped up and either you or your beneficiaries may have become taxable under the other tax, the Federal Income Tax. Remember that by putting your asset into joint tenancy you may not be giving equal distribution to your heirs. By trying to avoid probate fees with knowledge of all areas concerned, you could cause other problems you may not have intended.
Federal Income Tax is levied based on income in the year of death. Assets held at death are deemed to be valued at Fair Market Value. What this means varies with the asset held. Generally speaking, the following applies:
- Fixed Income Assets (such as bonds, term deposits) - no tax implications except the interest earned to date of death;
- Principle Residence - generally no tax implications for the period of time that you have lived in the residence provided you have only one residence and provided that the property is under one acre;
- Qualified Small Business shares or Qualified Farm Property - a very definite definition applies. If you qualify there is a tax-free exemption of up to $500,000 on profit per individual. If your shares or property do not qualify, then it is taxed just as any other capital property and there is no exemption; and
- Mutual Funds, Stocks, or Equity in Other Assets such as real estate etc. - this is taxed on the increased value of the assets since they were purchased. In some cases the cost of the asset has been bumped up by a special election made in 1994, 1995 or 1996.
All taxable income is added together and becomes the taxable income in the year of death. As you may be aware, the federal income tax rates increase as your income goes up. If you earn over $80,000 in the year of death your tax is roughly 50% of the income.
To summarize, two steps in protecting your assets from the taxman are to know where the tax burden lies and to understand the tax consequences of your assets. Only by becoming more knowledgeable about your estate can you ensure the taxman is kept at bay as much as possible.
Joyce Smith is president of JA Smith & Associates Inc. Certified General Accountants and Certified Financial Planners. The firm offers financial and tax planning advice for both individuals and business.
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