Tag: Trust

And to my faithful companion, I leave … – Pets in estate planning

I often refer to estate planning as the process of taking care of yourself now and in future, and taking care of those close to you – now, in future and when you are no longer around.  For the most part, the “those” are human beings, however that is not always the case.

Many people have very strong affection for their pets, and will wish them to be well cared for after one’s death.  For single or widowed seniors in particular, the implications of an owner’s death could be significant for the pet, perhaps even fatal.  Indeed, the pet may have to be ‘put to sleep’ if no family member or close friend is able and willing to step forward, and on fairly short notice.  (See sidebar Love you to death)  

On the other hand, consider the fortunes of Trouble, the Maltese lapdog to whom New York City landlord and real estate maven Leona Helmsley bequeathed the lion’s share of her estate on her death in 2007.  While Ms. Helmsley’s human descendants managed to have the value of the dog’s inheritance reduced, Trouble lived in the lap of luxury for years before heading to the great kennel in the sky.  (See sidebar No Trouble)

Apart from any legal issues, there are some practical concerns that a pet owner should carefully consider in choosing an appropriate successor owner/caregiver:

  • Does the person have the disposition and lifestyle to be a pet owner?  Does the person’s daily routine and work schedule allow for adequate care?  How do travel and vacations factor in?
  • Is the person physically up to the task?  Are there any safety issues (to pet or people), particularly where there are young children in the home?  Are there allergy issues?
  • Is there space to care for the pet?  Do condominium or housing rules allow pets?  What are the municipal bylaws in the case of exotic pets?  (See sidebars Lions… and Lizards…)  

And then there is the matter of money.  As any pet owner can attest, there is the cost of food, accessories, heath checkups, emergency medical care, and possibly boarding when the owner is traveling.  Multiply this by the pet’s remaining life expectancy and that can be a stiff financial burden to place on an individual or family.  On top of that, there can be a significant time commitment that in fairness should be compensated.

In Canada, a pet cannot be named as a beneficiary in a person’s Will or under a life insurance policy, so you can’t give the money to the pet directly.  Rather, pets are considered property, and could be given away during one’s life or be the subject of a gift to the intended caregiver in the owner’s Will.  This could be accompanied by a monetary gift to the caregiver with the understanding that it is to compensate for the pet’s future maintenance.    

If the pet owner is concerned that the caregiver may fail to fully carry out the wishes, it certainly is possible to establish a trust to provide for the cost of the pet’s upkeep.  The compensation to the caregiver would then be based on continuing to provide the appropriate care.  Of course this brings into question whether the right person has been selected, not to mention the complication and cost of drafting the trust and providing for its proper administration.

Above all, keep in mind how beneficiaries and family will respond, as a Will challenge can be costly, time-consuming and acrimonious even if legally unsuccessful.  As with many estate planning issues, open communication of the pet owner’s wishes is key.  It can uncover obstacles and options, and put the owner’s mind to rest that the pet’s creature comforts will be best served. 

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SIDEBAR – Some notable animal successions

Love you to death – An Illinois woman left a $1.3 million estate to some animal charities, but directed that her own cat be euthanized, for fear it would end up in an abusive home.  The executor applied to court, and instead the cat was placed in a home with a reputation for caring for cats.

No Trouble – Leona Helmsley’s dog Trouble inherited $2 million.  It cost over $150,000 annually to maintain her in the lap of luxury to which she had become accustomed, including a personal body guard.  On Trouble’s death 3 years later, the remaining funds went to charity.

Lions & tigers & … lizards, oh my – An Ontario Serpentarium owner died unexpectedly of a stroke at age 52.  With no Will, a dispute arose over his 200+ exotic animals, requiring a six-week trial before his brother was awarded ownership.  The animals were donated to two zoos.

Thanks for the memories – Transferring the family cottage

I met my wife on the May long weekend about a decade ago, on the beach of the cottage that had been my summer home since I was a child.  It was the last – and most lasting – memory of about three decades our family had been there.  Earlier that spring we had decided among us that it was time to move on, and a week later my parents closed the sale to another young family.

For many though, the preferred route is to pass a cottage, cabin or chalet on to the next generation.  With the view from this year’s May long weekend toward summer on the horizon, here are some tax and legal issues to contemplate as a family looks down that road.

From one generation …

A transfer to anyone other than a spouse will trigger capital gains, including a proportionate deemed disposition if a non-spouse is added as a joint owner.  Per the usual calculation, fair market value less adjusted cost base yields the capital gain, half of which is included in the transferor’s taxable income.  Be aware that as this is generally personal use property under tax law, one cannot claim a capital loss if the figure is negative. 

The starting point for ACB will be the initial outlay to acquire the property, plus any capital improvements.  This may also have been bumped by up to $100,000 if steps were taken prior to March, 1994 to preserve the then-eliminated general capital gains exemption.  As with all tax reporting, good recordkeeping is essential.

To counter this tax, quite often the property can qualify for the principal residence exemption.  But bear in mind that the later availability of the exemption will be reduced or eliminated for overlapping years of ownership of other properties held by either spouse, so proceed cautiously.

The spectre of a hefty capital gains tax bill may lead some to delay transfer until the last death of the two parents.  Assuming this is a conscious plan, a sinking fund or joint-last-to-die life insurance policy might be arranged to pay the tax.  On the other hand, if this is the result of procrastination, it could merely guarantee the inevitable sale of the property if the estate has insufficient cash for the purpose.  

While such a delay may defer capital gains related tax, in some provinces the involvement of the estate will attract significant probate tax.  An alternative that may bypass probate and still delay capital gains tax may be to add an adult child as a joint owner while the parents are living, but with the beneficial joint entitlement only passing upon the last parent’s death.  This planning possibility arises out of the Supreme Court’s Pecore decision in 2007, and should be discussed with a lawyer to determine its possible application in an actual family situation.

… to another 

On the receiving end, there are relatively few tax complications where the property is transferred to a single child.  However, where there are multiple children and especially multiple generations involved, things can become challenging.

Joint ownership among siblings (or any non-spouses for that matter), can be messy in two major respects.  First, right of survivorship means that on a sibling’s later death, his/her interest passes to the surviving joint owners, whereas the more likely intention might have been for that interest (or at least the value) to fall to the deceased’s descendants.  Second, the now-deceased sibling’s estate could have a capital gains tax liability, in a sense adding insult to injury since the joint property interest will have passed to the surviving siblings.

An alternative to joint ownership would be to have siblings hold their interests as tenants-in-common, with the result that a deceased’s interest falls into his/her estate.  The drawback here is that it puts probate tax back on the table, not to mention the potential exponential increase in owners as the next generation comes on.

A more flexible alternative may be to establish a trust, of which the family members are beneficiaries.  This could either be an inter vivos trust the parents establish presently, or one or more testamentary trusts created out of their Wills.  Either way, it would be advisable to have a maintenance fund within the trust to facilitate general upkeep as well as capital expenses.

Some further factors that will influence the decision include: if, when and to what extent land transfer tax may apply; whether anyone has creditor concerns; how matrimonial law may apply; and additional complications associated with foreign properties, particularly exposure to US estate tax on properties south of the 49th parallel.    

Of course, this is not exclusively a tax and legal decision, but rather one that can have high emotional stakes.  So if there is already a battle over who gets access when, it may be better to just erect the ‘for sale’ sign and keep the memories intact.

Strategic use of trusts: Managing for tax advantage

The settlement of a trust is a simple step that opens the door to sophisticated wealth planning opportunities.  

In last month’s issue, we touched on the requirements for a trust to come into existence, and canvassed some of the most common ways trusts may be characterized for tax purposes.  

Ultimately though, reducing trust taxes is but an intermediate step toward the ultimate purpose of providing optimal benefit to beneficiaries.  Following are some further ways that a trustee’s careful decision-making can deliver that value to those beneficiaries. 

Income splitting

As a starting point, if settled through a person’s Will, a trust will obtain testamentary treatment, meaning access to graduated tax rates for income reporting.  This obviously compares favourably with the top marginal tax rates that apply to inter vivos trusts (those settled during lifetime).  In effect, the deceased person continues to be somewhat present from a tax perspective.  

It is actually possible to multiply this benefit by establishing multiple trusts, though within limits dictated by the Income Tax Act.  Essentially, only one such trust may be created for each beneficiary designated under a Will.  Still, that’s a side-by-side graduated tax rate vehicle for each person a testator wishes to benefit out of an estate.  

In addition and as discussed in last month’s article, CRA has acknowledged that separate testamentary trusts may be established out of life insurance proceeds and RRSP/RRIF receipts.

Selecting the year-end

The year-end of a testamentary trust may be elected as any day in the full year following the relevant death.  A trustee may use this election to strategically delay income recognition, as beneficiaries must report an income distribution from a trust in the beneficiary’s tax year in which the trust’s year-end falls. 

To illustrate, if a beneficiary receives an income distribution in February Yr 1 from a testamentary trust with a January 31 year-end, that income is deemed to be received on January 31, Yr 2, with the tax due with the filing of the beneficiary’s Yr 2 T1 return in April Yr 3.

Income sprinkling

Beyond initial creation of the trust, there is an art and science to year-to-year trust tax management.  For example, a trustee could selectively distribute annual trust income among beneficiaries to reduce the long-term total tax bill for all beneficiaries.  This could be particularly effective when beneficiaries have little or no income from other sources, so that their basic personal amount credit and low bracket rates might be accessed when otherwise left unused.  

This practice, called ‘income sprinkling’, could be effective in the short-term, but the trustee would have to remain vigilant to carry out the even-hand duty among beneficiaries over the long-term.  

Allocations and elections

A very useful tool for a trustee to tax-manage a trust, whether inter vivos or testamentary, is to employ elections for allocating tax liability on income.  Subject to the trust terms and the Income Tax Act, income may be retained in the trust or paid out to a beneficiary, with associated taxes either paid by the trust, the beneficiary or both.   The table below illustrates how this may operate:    

Taxed to Trust, Allocated to Trust

This is full retention of both income and tax liability in the trust.  One possible application would be a testamentary trust where the beneficiary is at top marginal tax rate and does not need immediate cash.  

From a non-tax motivated view, spendthrift and/or creditor protection trusts may be designed this way.

Taxed to Beneficiary, Allocated to Trust

In limited circumstances, tax liability may be elected to a beneficiary, while income remains in the trust, such as under the “preferred beneficiary election” for a disabled beneficiary.  

At a minimum, enough income would be allocated to use the beneficiary’s basic personal credit, effectively eliminating the tax on that income.

Taxed to Trust, Allocated to Beneficiary

Where the beneficiary needs or must be paid the income, it may be possible to elect to tax the income in the trust.  

For example, a qualifying spousal trust, inter vivos or testamentary, is required by the ITA to pay annual income to the spouse beneficiary.  The tax election decision would rest mainly on whether the spouse or trust has the lower tax rate.

Taxed to Beneficiary, Allocated to Beneficiary

The usual treatment of income is that it is distributed to income beneficiaries as it is earned annually, and the tax liability follows.  

As well, even if a trustee could act more strategically, he/she may decide that tax benefits of retaining income are nominal or outweighed by other considerations, and therefore a full distribution may be the best approach.

A final thought on probate

While not a serious cost issue in provinces like Quebec and Alberta, probate taxes or fees can be as much as 1.5% of incremental estate value, with no cap on the upper end.  Probate avoidance is thus a common goal in estate planning, but it should not be pursued at all costs as it may in fact be a net negative benefit.  

The simplified example in the following chart shows how an incremental $1,000 inheritance fares if it flows directly to a high tax rate spouse or incurs probate tax to flow to that spouse as beneficiary of a testamentary trust.  The difference in values at the end of the first year is small, but by the end of the second year the trust option begins to show the benefit of graduated tax bracket treatment (as the probate tax only applies once), and that gap will widen in following years.

TABLE

                                                                           Direct         Estate/trust

A) Value of benefit                                     $ 1,000.00           $1,000.00

B)  Incremental probate tax (using 1.5%)              n/a                  15.00   

C)  Net funds to invest                                   1,000.00               985.00

D) Annual income (using 5% interest)               50.00                 49.25

E) Tax (using spouse 40%, trust 20%)               20.00                   9.85

F) Net income                                                     30.00                 39.40

G) Value at year-end  [ C + F ]                   $ 1,030.00         $ 1,024.40

H) Value at 2nd year-end                            $ 1,060.90         $ 1,065.38