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Will Planning

22/09/2011


The phrase “In this world nothing can be said to be certain, except death and taxes” is attributed to Benjamin Franklin in a 1789 letter. With proper planning, however, the tax bite on death and in the future can be reduced significantly.

Key Facts

The planning relies on two key facts:

  1. The Income Tax Act (the “Act”) treats a trust as a separate taxpayer
  2. The Act allows for property to “roll over” to a spouse on death (including a common-law or same-sex spouse) without triggering a gain

Categories of Trusts

There are two main categories of trusts:

  • Inter Vivos (meaning a trust set up while someone is still living) and;
  • Testamentary (meaning a trust set up on the death of an individual, generally through a will).

Like an individual, a testamentary trust has the benefit of marginal income tax brackets, so the lower the amount of taxable income earned in a year, the lower the income tax rate that is applicable to that income.

For Example

Let’s assume Mr. Jones has shares in his own B.C. private company (“Opco”) that are worth $1 million. Mr. Jones’ will provides that on his death his shares of Opco transfer to his spouse, Mrs. Jones. On the transfer, no gain will be realized. However, if Mrs. Jones wants to pay herself a dividend on the Opco shares (and assuming she is already in the top marginal tax bracket), a $50,000 dividend will cost almost $17,000 in tax.

However, Mr. Jones could amend his will so that instead of transferring to Mrs. Jones directly, the Opco shares are transferred to a testamentary spousal trust for the benefit of Mrs. Jones. The transfer will still occur on a rollover basis so that no gain is realized. The difference is that the $50,000 dividend received by the spousal trust will only attract about $2,500 of tax, saving $14,500. The after-tax dividend of $47,500 can then be paid to Mrs. Jones without any further tax. If this is done on an annual basis, the tax savings can really add up.

In addition, by reducing the value of Opco over time by paying dividends, this reduces the eventual gain to be realized by the spousal trust when Mrs. Jones passes away. Even if Mrs. Jones is not in the top income tax bracket, this kind of planning can be beneficial by not having the income taxed in her return. For example, if the dividend income would cause her to have to repay her Old Age Security, this will not occur if the income is first received by the spousal trust.

Let’s also assume that Mr. Jones has three children. If he leaves investment property (say an interest-bearing portfolio) equally to his children, each child will report the interest income in their own income tax return and pay tax at their marginal income tax rate. If we assume that they are all in the top tax bracket, $25,000 in interest each will cost them almost $33,000 in tax (combined for the three children).

However, if Mr. Jones also amends his will so that the investment portfolio goes into three separate trusts (one-third each for each child) and each trust earns $25,000 in interest, the combined tax is about $11,000 for the three trusts, saving $22,000 a year.

For more information, please contact your local MNP Tax advisor.

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