Avoiding probate fees, or the estate administration tax as it is called in Ontario, is a pre-occupation amongst many Canadians. This is particularly true in jurisdictions where the rate is considered excessive. The top rate in Ontario is currently 1.5%, but Nova Scotia has a higher rate at 1.695%, and neither province has an upper limit on the total paid.
To put this in perspective, the top estate administration tax rate in Ontario translates to $15,000 per million dollars of estate value with the other $985,000 staying in the estate to pay debts and taxes and then be divided amongst the beneficiaries. Proportionately, the tax is small which does not explain the effort expended to avoid it that can be worse than the perceived problem.
One of the most common probate planning strategies attempted is the use of joint ownership. For example, a parent will transfer an investment account, or even his/her home, into joint names with some of the children or maybe a favourite grandchild. The investment account would be stated to be “joint with rights of survivorship” and the real estate would be registered as “joint tenants”.
This sounds simple enough, but it is important to understand all of the implications of joint ownership. Here are the lesser-known facts about joint ownership:
An example will help illustrate. Let’s say Fred has three children and his spouse has predeceased him. He lives in the GTA and his home value has soared. As a result, he decides to transfer his principal residence, which is now worth $2.4 million, into joint tenancy with his three children. For easy math, we will assume the purchase price was $400,000. The estate administration tax on $2.4 million is $36,000. However, it would take only an increase in the value of the property of about $200,000 for the income tax consequences to start to outstrip the estate administration tax savings.
The three quarters of the home that no longer qualifies as a principal residence would result in a taxable capital gain when sold and the marginal rates of the children would apply. If they are in the top tax bracket, a relatively small increase in house value overtakes the probate savings but the risks remain. Aside from Fred losing control of his home, suppose child #2 edeceased him leaving two children who Fred wanted to get the parent’s share and this is how his Will is drafted. Those two grandchildren will not share in the proceeds of the sale of the home since it will pass outside the estate and, therefore, the Will.
If we now assume Fred has an investment account worth $2.4 million and the same cost base of $400,000, the harsh consequences of a transfer to joint names with the children is more significant, as well as immediate. Fred would have an immediate taxable gain of $2 million and a taxable capital gain of $1 million. Assuming a combined federal/provincial marginal rate of 50%, this would result in $500,000 of income tax owing in the year of the transfer.
The Supreme Court of Canada considered a similar situation to the example of Fred transferring his investment account into joint names with his adult children. However, in that case the parent argued that he was just transferring the “right of survivorship” and the court curiously agreed. Regrettably, the court overlooked a serious logic error with this proposed strategy, as well as the fundamentals of trust law, and the decision has been greatly criticized as a result. In addition, some people have tried to extend the application of the decision to situations where it was never intended to apply further complicating matters.
The options for minimizing the estate administration tax in ways that do not create more problems than they solve are limited. One of the best options is the use of a trust. Another is the use a secondary Will for non-probatable assets such as private company shares, although this is not an option in all provinces.
For clients focussed on minimizing the estate administration tax, I would suggest that they not get distracted from the true purpose of estate planning, which is structuring your affairs in an orderly fashion that reflects the unique needs of your family and does no trigger unintended income tax consequences or undue risk to self or beneficiaries. Sometimes a pound of cure can be worse than the disease.