Insurance proceeds exposed under a deceased’s support obligations

At issue

To some lawyers who have practiced in the area of family law, that term may seem a bit of a misnomer.  In my case, it was the first 2-3 years of my legal career, and based on that relatively brief experience, I would suggest that a more apt title might be ‘breakdown-of-family’ law.

Indeed, it was the stress of being regularly immersed in bitter disputes that motivated me toward the more positive atmosphere I found in estate planning practice.

Still, an effective family lawyer can offer much needed stability in the wind-down of a relationship.  And of course where children are involved, there will be a continuing connection that has to be managed.

Insurance supporting support obligations

Apart from division of assets (and leaving aside emotional healing), the focus of the separation agreement is generally on child and spousal support.  And for the party on the receiving end, surety of payment is a paramount priority.

Even for parties who come to resolution on these issues amicably, external developments can nonetheless upset the apple cart.  If a payor spouse/parent becomes incapacitated or dies, a contractual commitment in the separation agreement may not be worth the paper that it is written on.

Thus, life insurance is frequently used (and to a lesser extent disability insurance, though arguably of no lesser need) to support the support obligations.  Commonly, the payor is required to maintain the payee as beneficiary for so long as the support requirement persists.

Milne Estate v. Milne, 2014 BCSC 2112

The Milnes’ relationship lasted for 20 years until their separation in 2011.  At that time, their only son was 17.

On consent of the parties, a court order was issued in 2012 requiring Mr. Milne to pay $1,380 in monthly child support, with equal sharing of costs for the son’s enrolment in a photography program at a local university.  Mr. Milne was required to maintain Mrs. Milne as the beneficiary of an existing $500,000 life insurance policy for so long as he was obligated to pay child support.

In breach of the court order, in early 2013 Mr. Milne changed the beneficiary designation in favour of his new partner.  Mr. Milne died in the summer of 2013.

The executor of Mr. Milne’s estate acknowledged that the change of beneficiary designation was a breach of the order.  However, it was argued that as the insurance was essentially security for child support, any claim should be limited to the value of the remaining support payments.

On reviewing the terms of the order, the judge found that there was “an express temporal link between Mr. Milne’s life insurance obligation and his support obligations.”  As to the quantum connection to support asserted by the executor however, the judge held that the parties “clearly intended Mr. Milne’s insurance obligation to be independent and not stand only as security for his outstanding support obligation.”

The executor urged the judge to consider surrounding circumstances in interpreting the terms of the order.  Among the issues, the judge noted that potentially significant spousal support for Mrs. Milne was yet to be determined, which worked against the executor’s position.

The full $500,000 face value of the policy was awarded to Mrs. Milne.

Practice points

  1. Insurance can support continuity of child and spousal support.  To compel the payor not to divert its intended use, the specific policy and its management should be outlined in the separation agreement.
  2. In Milne, the amount of the insurance was considered independent of the child support, but the terms of a given agreement could prescribe limits.  By similar token, in a case where child support obligations may be larger (and projecting further in time), it is likely that the estate will have an ongoing obligation to those children as dependants even if the policy proceeds are insufficient to fund that need.
  3. Even with explicit terms, parties should discuss with their respective lawyers whether surrounding circumstances may be taken into consideration if the matter ends up before a court.

Last chance for trust planning in 2015

What to do with capital gains in testamentary trusts

With the passage of Bill C-43 in December 2014, most testamentary trusts will be subject to top marginal tax rates. The two exceptions are the first 36 months of a graduated rate estate and a qualified disability trust for a beneficiary who meets the criteria for the disability tax credit.

For most testamentary trusts, the new tax rates kick in on December 31, 2015. While trustees cannot change the law, they may be able to take planning steps to mitigate the damage, at least in the case of investments carrying unrealized capital gains.

Advisors managing such investments should reach out to trustees to inform them about appreciated holdings, so they can take action before it’s too late.

Changes: Timeline and cost

Until now, the main tax distinction among personal trusts has been the way they came into existence. Inter vivos trusts, those created while a person is living, are subject to top marginal brackets and use a calendar year-end. Testamentary trusts are created under a person’s will, and had been entitled to graduated tax bracket treatment. They could also choose a non-calendar year-end.

Both these tax advantages (and others) for testamentary trusts have now been eliminated. As a quick phase-in, existing testamentary trusts will have a deemed year-end this December 31 to bring them in line with calendar year-ends thereafter.

These changes will affect income earned annually in future, understanding that a trust is subject to the combined federal-provincial personal tax rates in the province where it is resident. On the federal component alone, the tax will almost double on the first dollar of income for testamentary trusts for 2016 and beyond, given that the lowest federal bracket is 15% and the highest 29%.

For capital gains, the federal increase will be 7% (since only half of capital gains are taxable). Here are the net differences based on combined rates in each province.

Table: Combined federal-provincial tax rates on capital gains

Province    Top bracket     Low bracket   Difference
BC                      22.9%              10.0%              12.9%
AB                     19.5%               12.5%              7.0%
SK                      22.0%              13.0%              9.0%
MB                     23.2%              12.9%              10.3%
ON                     24.8%              10.0%              14.8%
QC                     25.0%              14.3%              10.7%
NB                     23.4%              12.3%              11.1%
NS                      25.0%              11.9%              13.1%
PE                      23.7%              12.4%              11.3%
NL                      21.2%              11.4%              9.8%

Taking action on capital gains

It may be possible for capital gains to be managed in the face of this development. If a trust holds investments with as yet unrealized capital gains, the trustee may trigger some or all those gains through dispositions.

To be clear on the application of the new rules, there will be a deemed year-end on December 31, but not a deemed disposition of capital assets. This means a trustee must take steps to cause actual dispositions while graduated brackets remain applicable.

For securities, extra care should be exercised to allow for the three business days from trade date to settlement date to ensure gains are realized before the trust’s year-end. As well, trades by the trust and related parties in the month before and after must be carefully scrutinized, lest the superficial capital loss rules be inadvertently triggered, potentially undoing the plan.

For trusts with a non-calendar year-end, there will be two year-ends in 2015. So, it is doubly critical to act with haste for such trusts, as with each passing day, planning opportunities are expiring. There is no grandfathering or carryforward that will make those low rates available in 2016 or later. Simply put, the last opportunity for these trusts to access graduated brackets is in 2015.

Revisiting planning options

Preferential tax treatment has been a useful feature of testamentary trusts for almost half a century. In some situations, it may have been a by-product of other planning priorities such as managing disability needs, controlling asset distribution or providing for minors. Elsewhere, the tax aspects may have been central to the plan. Either way, trustees will begin looking at whether current trusts can or should continue, which may mean more asset movements to come.

Hello new retiree, it’s CRA calling

Beginning tax payments by instalment

We look forward to our lives being simpler in retirement. But when it comes to income taxes, there is a wrinkle that most retirees will not have experienced before – instalment payments.

Reminders for instalment payments are sent from the Canada Revenue Agency (CRA) semi-annually in February regarding March and June due dates, and in August for September and December.

While receiving unexpected correspondence from the CRA may be a bit of a shock, there’s no need to panic. Paying taxes by instalment is not a matter of being unfairly targeted. No, it is simply an extension of employers’ payroll withholding and remittance during working years, which responsibility later rests upon retirees personally through quarterly instalments.

Who has to pay?

A standing feature of our tax system is the requirement for payers of certain amounts subject to tax to withhold and remit a portion to the CRA. Where an insufficient amount has been withheld (usually because the payer has limited information about the payee), the obligation then falls upon that payee.

Common situations include income from rent, non-registered investments, self-employment, multiple employers and – for our purposes –  pension payments of various sorts.

The obligation is triggered if a person’s net tax owing was more than $3,000 in either of the two preceding years, and is expected to exceed $3,000 in the current year. (In Quebec, the threshold is $1,800.)

Calculating the instalment amount

There are three options available for calculating the amount of the quarterly instalment payments:

  1. Non-calculation option – By default, the instalment amount is based on the two preceding years’ income. The CRA will calculate this figure based on your tax records and include it in your semi-annual reminder correspondence. This option is most appropriate when income, deductions and tax credits are consistent from year to year.
  2. Prior-year option – If the current year is expected to be much like the prior year but significantly different from two years ago, this option is a better choice. In this case, it is up to you to calculate the instalment amount yourself. With your prior year’s Notice of Assessment or tax return in hand, you can fill in the required data on a calculation chart available through the CRA website.
  3. Current-year option – If the current year is unlike either of the two prior years, you can calculate the instalment amount using an estimate of your current year’s tax owing. For pensioners, this is likely most applicable in the first year or two of full retirement. As in option 2, the calculation chart can be used, though in this case as more of a guide in coming up with your estimate.

For options 2 and 3, any Canada Pension Plan (CPP) contributions for self-employment and voluntary employment insurance (EI) premiums must be added to the calculated tax owing. Of course, these will not apply to a full-time retiree.

The point of this exercise is not to come up with the least payment possible. Rather you are looking for the option that best estimates your actual/eventual tax liability. In fact, if you choose either option 2 or 3 and the instalment amounts are too low, CRA may charge interest and even levy penalties. (See Interest and penalties below.)

Making the payment

Payment can be made through online banking, by debit to CRA through My Account or My Payment, by mail or in person at your financial institution.

The mailed reminder from CRA will include Form INNS3, Instalment Remittance Voucher. This form is not required for online payment types, but should be stamped when paying at your financial institution and enclosed when making payment by mail (though a cover note with your Social Insurance Number may be sufficient to assist in proper processing of mail payments).

Instalments are due the 15th of March, June, September and December. If any of those dates fall on a weekend or public holiday, the due date moves to the next business day.

Mailed instalments are considered paid on the postmarked date, in-person payments at your financial institution on the date stamped on your INNS3 and online payments on the date the amount is credited to the CRA. If payment by any method is post-dated, it is the later negotiable date that applies.

Interest and penalties

Making a mistake on a calculation or remittance date could be costly. Instalment interest is charged on late and insufficient payments from the respective due date, compounded daily.

The prescribed interest rate for overdue income tax is 5% for January to March 2015, and additional instalment penalties apply if interest charges exceed $1,000. Prescribed rates are adjusted quarterly, based on economic conditions.