Key Canadian Estate Tax Planning Considerations for Your Future

As a tax advisor at Venter Accounting and Tax, I often emphasize to clients that effective estate planning is not just about preserving wealth, it's about ensuring your legacy is passed on efficiently, with minimal tax implications and unnecessary complications. In Canada, while there is no traditional "estate tax," the Income Tax Act imposes deemed dispositions of assets at death, which can trigger significant capital gains taxes. This article explores essential estate planning strategies from a Canadian tax perspective. Remember, these are general insights; personalized advice is crucial, so feel free to reach out to me, Dave, for a consultation.

Will Planning and Keeping Things Up to Date

A well-drafted will is the cornerstone of any estate plan. It outlines how your assets will be distributed upon your death, appoints executors, and can include provisions for trusts or guardians for minor children. From a tax viewpoint, reviewing and updating your will regularly, especially after life events like marriage, divorce, birth, or a family member's disability is vital to ensure it aligns with current tax rules and minimizes liabilities.

Probate is the legal process where a court validates your will and grants authority to your executor to administer your estate. In Canada, probate fees (often called estate administration taxes in some provinces) are calculated based on the estate's value and vary by province (i.e., up to 1.5% in Ontario or British Columbia). These fees can be substantial, but strategies like joint ownership with right of survivorship, beneficiary designations, or certain trusts can bypass probate for specific assets, reducing costs and delays. Always consult a legal professional alongside your tax advisor to integrate tax efficiency with probate avoidance.

Spousal Rollovers

Spousal rollovers provide a tax-deferred transfer of assets to a surviving spouse or common-law partner upon death. Generally, capital property (like shares or real estate) can roll over at cost basis rather than fair market value, deferring capital gains tax until the surviving spouse disposes of the asset or passes away, unless an election is filed to trigger the capital gain.

For this to apply, the property must vest indefeasibly in a qualifying spousal trust or directly to the spouse. Key requirements include: the transferor and trust must be Canadian residents; the spouse must be entitled to all income during their lifetime; and no one else can access the capital or income while the spouse lives. This rollover extends to inter vivos transfers for living spousal trusts. It's a powerful tool for deferring taxes, but elections can be made to trigger gains if beneficial (i.e., to use losses or exemptions). Note that changes after the trust's creation won't disqualify it, but careful drafting is essential to avoid tainting the trust.

Beneficiary Designations on Registered Accounts

Designating beneficiaries on registered accounts like RRSPs, RRIFs, TFSAs, and life insurance policies is a simple yet effective way to bypass probate and ensure tax-efficient transfers. For RRSPs/RRIFs, naming your spouse as beneficiary allows a tax-deferred rollover to their own registered plan, avoiding immediate taxation. For TFSAs, successor holder designations (for spouses) keep the account tax-free without impacting contribution room.

Without designations, these assets fall into your estate, potentially triggering taxes and probate fees. Review designations regularly, as they override your will. This strategy not only defers taxes but also provides quick access to funds for beneficiaries, reducing administrative burdens.

Inter Vivos Gifting of Assets During Lifetime to Reduce the Taxable Estate

Gifting assets while alive (inter vivos) can shrink your estate, lowering potential taxes at death. Transfers to family members or trusts at fair market value may trigger capital gains, but using exemptions like the lifetime capital gains exemption (“LCGE”) for qualified small business corporation shares.

Gifts must be genuine and documented to avoid attribution rules, where income from the gifted property is taxed back to you. For minors or spouses, prescribed-rate loans can enable income splitting without attribution if interest is paid annually. This approach also allows you to see your gifts in action and potentially qualify for intergenerational business transfer rules, which offer lower capital gains rates when passing businesses to children.

Brief Discussion on Types of Trusts

Trusts offer flexibility in estate planning, allowing control over asset distribution while providing tax benefits. Here are key types relevant to Canadian tax planning:

Alter Ego Trusts

An alter ego trust is an inter vivos trust for individuals aged 65 or older, where the settlor is the sole beneficiary during their lifetime. Generally, assets are rolled into the alter ego trust on a tax-deferred basis. Benefits also include probate avoidance, creditor protection, and privacy, as the trust doesn't go through public probate. Upon the settlor's death, the trust is deemed disposed, but planning can defer taxes further. Ideal for those wanting control without immediate tax hits.

Spousal and Joint Spousal Trusts

A spousal trust (testamentary or inter vivos) defers taxes via rollover, with the spouse as sole income beneficiary. No one else can access capital during their life. Joint spousal (or joint partner) trusts extend this to couples over 65, allowing both to be beneficiaries. Assets roll over tax-free, and upon the second death, the trust distributes to heirs. These trusts facilitate income splitting, protect assets from remarriage risks, and defer gains, but require careful compliance to maintain qualifying status.

Estate Freezes: How It Works and Why It's an Important Planning Tool

Estate freezes are a cornerstone of advanced Canadian estate planning, particularly for owner-managers of private corporations. This strategy "freezes" the value of your assets at their current fair market value (“FMV”), capping your future tax liability on death while transferring growth to the next generation tax-efficiently. Given the deemed disposition rules at death, where assets are taxed at FMV, an estate freeze prevents your tax bill from ballooning as asset values rise.

How an Estate Freeze Works

Typically implemented through a corporate reorganization, an estate freeze involves exchanging common shares for fixed-value preferred shares (redeemable at current FMV). New common "growth" shares are issued to family members, a family trust, or a holding company at nominal value. This shifts future appreciation to the growth shares, while you retain control via voting preferred shares.

For example:

- You own Opco worth $5 million. You freeze by converting to preferred shares redeemable at $5 million.

- A family trust subscribes to new common shares for $1, benefiting your children.

- Future growth (e.g., to $10 million) accrues to the trust's shares, not yours.

Key methods include:

- Internal Freeze: Reorganize existing company capital.

- Holding Company Freeze: Transfer assets to a new Holdco on a tax-deferred basis under section 85.

- Partial Freeze: Retain some growth shares for flexibility if you need future income.

Price adjustment clauses protect against CRA FMV disputes, adjusting share values if challenged. Safe income calculations are crucial for inter-corporate dividends to avoid recharacterization as gains under section 55.

If values decline post-freeze (i.e., economic downturn), a "refreeze" can reset preferred shares to current lower FMV, restoring income-splitting potential.

Why It's Important

1. Minimizes Tax on Death: Fixes your deemed disposition at current FMV, deferring growth taxes to heirs.

2. Facilitates Income Splitting: Post-freeze dividends on growth shares can split income with low-tax family members (subject to TOSI rules, effective since 2018, which tax "split income" at top rates unless exclusions apply, like active involvement).

3. Multiplies LCGE: Crystallizes your LCGE (up to ~$1 million per person in 2025 for QSBC shares) and allows family to claim theirs on future growth.

4. Creditor and Probate Protection: Using trusts adds layers of protection; assets in trusts avoid probate fees (up to 1.5% of estate value).

5. Succession Planning: Enables smooth business transfer, potentially qualifying for intergenerational rules offering lower gains rates when selling to children.

However, pitfalls exist: income attribution rules if you retain too much control; deemed dividends on transfers between related parties; and potential double taxation without proper estate planning. US citizens face immediate US tax implications, so cross-border advice is recommended before undertaking estate freezes.

In practice, freezes suit appreciating assets like businesses. Benefits include probate savings, creditor shielding, and family harmony by clarifying inheritance. Always involve valuations and legal documents for CRA compliance.

Year-End Planning Contemplating Estate Planning

As year-end approaches (i.e., December 31 for many corporations), integrate estate considerations into your review. Use this checklist, inspired by professional guidelines, to assess:

• Have you reviewed your business succession plan? Consider freezes, EOTs for employee sales (up to $10M tax-free gains until 2026), or intergenerational transfers for lower rates.

• Are distributions subject to TOSI? Ensure family dividends qualify for exclusions to avoid top-rate taxation.

• Does your estate plan include updated wills and trusts? Check for changes in family dynamics or asset values.

• Have you maximized gifting or loans for splitting? Pay interest by January 30 to maintain low-rate taxation.

• Is your company optimizing deductions/credits? Time asset sales/purchases; claim SR&ED or clean energy ITCs.

• Have you planned for liquidity on death? Ensure insurance or reserves cover taxes; consider redemptions to grind down freeze shares.

Ask: What are my terminal tax liabilities? How can I defer or reduce them? Am I leveraging trusts/freezes effectively? A year-end review uncovers savings and aligns with long-term estate goals.

At Venter Accounting and Tax, we're committed to helping you navigate these complexities and think about your future to help you plan for the next generation. Contact me, Dave, to discuss how we can tailor these strategies to your situation.