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The perils of trying to avoid probate taxes charged on estates

by Wayne Cheveldayoff, 2003-06-22

In thinking about the estates they will leave behind, individuals most often focus their attention on probate taxes. Some are so adamant about avoiding probate taxes, which can be more than 1% of the assets left behind, that they sometimes get into probate-avoiding arrangements that trigger unintended capital gains taxes or other negative consequences. Given the complexities, getting professional advice is highly recommended.

Probate taxes are levied by most provincial governments as an administration fee for processing wills and providing certificates that permit estate trustees to effectively transfer assets to heirs. This fee varies from province to province. Ontario has the highest fees, amounting to 0.5% on estate value up to $50,000, and 1.5% thereafter. On an estate valued at $200,000, the tax would be $2,500. For a $1 million estate, the tax would be $14,500.

One estate-planning technique used to avoid probate taxes involves the transfer of assets into joint tenancy (with right of survivorship) with an adult child. In effect, the parent and his or her child become joint owners of the asset and when the parent dies, the child becomes the sole owner of the asset.

This works to avoid probate taxes because the asset held in joint tenancy is outside of the will and therefore its value is not used in calculating the probate tax.

Parents often get into these arrangements without proper legal or tax advice because the technique seems relatively cheap and simple and sometimes no more complicated to do than putting another name on an account. It also is seen as an easy way to allow a child to manage the assets in the event the parent is mentally incapacitated.

However, one problem is that such an arrangement can trigger unanticipated capital gains taxes. When transferring an asset to a spouse, capital gains taxes are deferred until the spouse passes away. But when transferring an asset to a child, the half transferred is deemed by the tax authorities to be sold at fair market value. If that value is higher than cost, there is a capital gain, and half of the gain must be declared as income in the year the joint-tenancy arrangement is implemented.

Another problem could come up if the asset is a principal residence, which is normally exempt from capital gains taxes. The child becoming the joint tenant would not be able to have another principal residence, thereby reducing his or her tax flexibility and savings in the future.

One thing seldom considered by a parent is that the creditors of the child would have access to the entire asset, not just half, if the child has financial trouble. From a creditorís perspective, the childís assets are 100% of the house or bank account, not just 50%.

Also, parents usually donít consider the family law implications. If the child becomes divorced, the childís spouse may have a claim on the asset and could trigger an unwanted sale of the home or other asset held in joint tenancy.

A second technique used to avoid probate taxes is the gifting of assets to children. Again, this would be regarded as a deemed disposition and capital gains taxes could apply immediately, rather than upon death.

However, a more fundamental problem could occur if the gifting individual intends to rely on the asset to pay medical or other expenses. If the child has a spouse, or gets into financial difficulty, the money may simply be unavailable when needed.

A third technique is the use of trusts. Working with an estate lawyer, it is possible for Canadians over the age of 65 to set up a special trust to hold assets without triggering capital gains taxes. The assets in the trust must be used for, and income attributed to, those setting up the trust. But upon death, the assets pass to the beneficiaries of the trust without triggering probate taxes.

An obvious drawback is the cost. The setting up of a trust could cost in the order of $5,000 to $10,000 once all legal and other fees are included. Thereafter, the cost of administering a trust is at least $2,500 a year and could be much higher depending on the complexity.

Thus, depending on the size of the estate, if one lives for 10 or 20 years after setting up the trust, the cumulative cost could easily outweigh any savings of probate taxes.

The same is true for the fourth common technique, which involves stashing cash in universal life insurance plans. Insurance proceeds are not subject to probate taxes. However, the fees involved can be substantial, although this approach could work well for very sizeable estates.


Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. He can be contacted at wcheveldayoff@yahoo.ca.

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©2003 Wayne Cheveldayoff