Every dark cloud is supposed to have a silver lining. It takes some searching to find any sliver of silver in the economic storm clouds that have been buffeting the world lately, but a sliver there might be.
It might be an opportune time to do some estate planning.
Canada’s death tax is imposed through the capital gains tax system. On death, one is deemed to dispose of all one’s assets for fair market value. If the assets have risen in value, this deemed disposition results in a deemed capital gain and the deemed capital gain usually results in an obligation to pay real money to the Canada Revenue Agency.
If assets are left to a surviving spouse, the taxable event is deferred until the death of the surviving spouse. But this merely puts off the day of reckoning.
One tactic for dealing with the deemed disposition on death is to conduct an estate freeze. In order to illustrate a typical estate freeze structure, assume that the parents own investment assets with a nominal tax cost and an inherent capital gain of $1 million. Tax on that capital gain would be $220,000. The parents restructure their ownership interest by capping the value of their interest in the assets at the current value of $1 million. Any future growth in value accrues to the next generation (usually through a family trust controlled by the parents). The parents retain control over cash flow from the investments so that the assets continue to produce an income for the parents.
The result of the estate freeze is that the parents still have access to income but have capped the exposure of the estate to capital gains tax on death. Since the value of the parent’s interest will never grow in value, the capital gain on death will never grow. Death tax is no longer a moving target. This allows the parents to adopt some strategies to deal with the future capital gains tax liability. In some circumstances, the parents can take income from the assets in a way that reduces this capital gains tax liability over time.
So how does the economic crisis fit into this?
By implementing an estate freeze at today’s reduced values, parents can arrange to have those future death taxes based on the reduced values that are prevalent in today’s depressed market. This leaves more of the estate intact for the next generation. As long as the parents continue to have access to income from the investments and continue to control the investments, it does not matter that the eventual recovery in economic value accrues to the benefit of the next generation. The parents would control cash flow, which is usually more important than continuing to accrue capital gains.
When our Prime Minister pointed out that the economic crisis had resulted in lots of bargains for investors, he was certainly not thinking about the potential impact on future tax revenues. For Canadians who have been concerned about looming capital gains taxes on death, however, the declines in the market present an opportunity to lock in those lower values for estate planning purposes.
-- Shelley J. Spring
The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.
