Tax and estate planning: What you need to know about gifting to family members (Part three)

Our previous two blog posts talked about income tax implications when gifting to spouses and adult children. While the income tax implications are significant, the non-tax considerations outlined below may be just as important to keep in mind when making a gift. As always, please consult your advisors and/or other professionals regarding your personal situation.

Non-tax considerations when gifting assets to family members 

Probate planning

Probate refers to the process of obtaining court certification to grant legal authority to the executor in estate administration. An executor is also known as an “estate trustee” in Ontario and as a “liquidator” in Quebec.

Probate costs vary by province and may or may not be a significant concern, depending on the fee rate as well as the importance of other estate objectives to the testator (the person who makes the will or gift). Generally, residents in provinces with high probate taxes, such as Ontario or British Columbia, may wish to reduce probate costs so that more estate assets are preserved to be passed to the estate beneficiaries.

Reducing probate fees is mostly associated with reducing the value of assets “passing through” the estate, because probate fees are generally calculated based on the fair market value of the assets at death that form part of the estate (though some provinces have a flat fee).

Some common probate planning strategies include naming a beneficiary on a registered plan and adding a joint owner on non-registered assets under a joint tenancy with right of survivorship (unavailable in Quebec), discussed in more detail below. These strategies allow the proceeds to be passed to the designated beneficiary or the joint owner(s) outside of the estate, thereby reducing the size of the estate and the associated probate costs.

However, probate planning can sometimes be overemphasized to the point that arguably more important estate goals are overlooked, such as certainty over estate distribution and control over assets beyond death. For example, adding one of several children as a joint owner or as beneficiary on a registered plan may result in an uneven estate distribution, potentially causing family discord after death.

Example

Maria lives in Ontario and has three adult children, Alfred, Bernard, and Catherine. Maria intends to leave equal benefits to all her children upon her death. She owns $100,000 in her registered retirement savings plan (RRSP) and non-registered investment account, respectively. The rest of her assets are also worth around $100,000.

Maria thought that she could reduce probate fees by naming Alfred as a direct RRSP beneficiary and Bernard as a joint owner (i.e., joint tenant with right of survivorship) on her non-registered account. The rest of her assets left in the estate will go to Catherine. There are a few important considerations with respect to her strategy.

First, there will be a deemed income inclusion from the RRSP when Maria dies with the resulting tax payable by her estate. Technically there is a joint and several tax obligation on the deemed income inclusion between the estate and the beneficiary, though practically the estate is primarily responsible for the taxes. Since there is no requirement to withhold taxes upon an RRSP distribution upon death, Alfred can receive the entire RRSP free of tax, with the estate (and indirectly, Catherine) paying for the income tax on the RRSP.

Second, Maria is deemed to have disposed of her ownership in the non-registered account despite the right of survivorship provision. Again, the income tax burden from the deemed disposition is borne by her estate (and indirectly, Catherine). Bernard will receive the entire account outside of the estate without paying taxes. (For a more detailed discussion on income tax implications regarding adding an adult child as a joint owner, please refer to our last blog post.)

Third, if Maria’s other assets require probate, the entire value of her estate will be included in the calculation of probate fees, which are also payable out of estate assets. Catherine’s share may be greatly reduced by the taxes, debts and obligations payable by the estate. Things can be exacerbated if Maria’s other estate assets are not liquid since generating cash-flow to pay for estate expenses may be difficult.

This is a simplified example illustrating the potential complications triggered by executing do-it-yourself  probate planning strategies. Despite Maria’s intent to “equally” distribute her assets to her children, her intent will be frustrated leading to an unequal distribution. Professional advice is extremely important in this area to avoid unintended consequences in the estate distribution process.

Joint tenancy vs. tenancy in common

Property held jointly may be owned under either a joint tenancy with rights of survivorship (JTWROS) or tenancy in common (TIC) arrangement.

A JTWROS arrangement provides two or more individuals with an equal and undivided beneficial interest in the property. Upon the death of one individual, the deceased’s interest in the property passes to the surviving owner(s) proportionally.

In a TIC arrangement, each owner may have disproportionate interest in the property. The surviving owners of the property do not have a right to the deceased’s ownership share. Instead, the deceased’s ownership share of the property passes to his or her heirs according to the instructions left in his or her will; otherwise, it is distributed in accordance with the laws of intestacy in the province or territory the deceased lived in. TIC ownership arrangements are unavailable in Quebec.

Having the appropriate type of joint ownership is essential in estate planning to reduce probatefees, avoid creditor claims, and ensure the gift is passed to the desired recipient. Generally, in a true JTWROS arrangement (where both joint owners have an equal legal and beneficial ownership interest in the property), the assets bypass the estate and are excluded from the probate tax calculation upon the death of the first owner. The deceased’s interest is received by the surviving owner(s) outside of the estate.

Where one or more of the owners only possess legal title but not beneficial ownership, the common law presumption of resulting trust may apply (explained below). We first briefly review the concept of legal and beneficial ownership.

Legal vs. beneficial ownership

Legal and beneficial ownership are the two types of ownership in common law. Legal ownership generally means having one’s name registered on the title of the property. Beneficial ownership generally means having the right to enjoy and use the property.

In most cases, legal and beneficial ownership reside with the same owner. However, in some situations, legal and beneficial ownership can be separated. For example, the trustee of a trust acquires legal ownership over the trust property, whereas the trust beneficiary has beneficial ownership.

It is also possible to grant someone legal ownership on a property without extending beneficial ownership, such as one scenario in the example of Jay and Don in our last blog, where adult children can be added as a joint legal owner without being entitled to beneficial ownership.

Beneficial ownership determines the income tax outcome. For example, when a parent adds an adult child on his or her joint investment account as a legal owner only (meaning the parent does not transfer beneficial ownership to allow the child to use the funds for him/herself), there are generally no immediate income tax consequences since there has not been a disposition for income tax purposes. The parent continues to be responsible for the income tax on the entire account during the parent’s lifetime as the sole beneficial owner.

Gifting an account to an adult child without extending beneficial ownership comes with certain risks, one of which is the common law presumption of resulting trust, as explained below.

Presumption of advancement vs. Presumption of resulting trust

As explained in an earlier article we wrote, the presumptions of advancement and resulting trust affect estate distributions absent a clear intention of gifting.

The presumption of advancement has limited application, as it generally only applies to property owned as JTWROS between spouses, as well as a gift from a parent to a minor child. The presumption of resulting trust applies to all other relationships, including the gratuitous transfer (i.e., a gift) of property between a parent and an adult child. 

Therefore, the common-law presumption of resulting trust may apply when a parent adds an adult child as a legal owner only but does not make clear the intention to gift the amount to the child upon the parent’s death. The presumption generally assumes that if the adult child is a joint tenant without any beneficial ownership in the property, he or she is holding the property in trust for the estate of the deceased parent. In other words, the jointly held property is considered part of the deceased parent’s estate for probate purposes and will not automatically pass outside of the deceased parent’s estate directly to the adult child.

In practice, the presumption often applies when an estate beneficiary who does not benefit from the joint arrangement attempts to “pull the property back” into the estate so that he or she can share in the value of that property. That said, the presumption of resulting trust is rebuttable by proving the giftor’s (here, the parent’s) intention to gift the property to the recipient. The onus of proof is on the joint owner (here, the adult child who has legal title but was not granted beneficial ownership of the property).

One way the parent can minimize future disputes about the property’s ownership is to draft a “side document”, preferably with the help of a lawyer. The side document typically involves a statutory declaration, outlining the exact purpose for which the adult child is being added as a joint owner of the property. This document does not guarantee the outcome of the property distribution but does give the arrangement greater legal legitimacy if it is challenged by beneficiaries of the estate, and generally removes any uncertainty regarding the parent’s intentions as to how the property is to be distributed upon his or her death. Alternatively, clear instructions on the intent of the joint arrangement may be left directly in the parent’s Will documents. Either way, individuals will need to obtain legal advice on how to best execute.

For a more in-depth discussion on the presumption of resulting trust, please refer to our previous articles Resulting trusts and registered plan beneficiary designations, Resulting Trusts & Joint Accounts, and our Tax & Estate InfoPage, Joint accounts (please contact Invesco Client Relations department at 1.800.874.6275 for a copy of the Tax & Estate InfoPage).

Dangers of joint ownership

Lastly, although joint ownership can be an effective estate planning tool, there are some caveats about using it.

First, the gifting parent may lose control over the property during his or her lifetime. Even if children are added as legal owners only, they generally have the ability to give administrative instructions to the financial institution about various transactions. Moreover, it may not be possible for the parent to redeem or carry out certain transactions without the approval of the joint owner (the child), depending on the account set-up. The required co-operation from children may cause unnecessary administrative difficulties for parents, especially if the relationship subsequently deteriorates.

Second, the joint property may be subject to creditor or family law claims of the child, who is an owner of the jointly held property. Creditor claims may inadvertently reduce the funds otherwise available to the parent during his or her lifetime. Similarly, if the child goes through a marriage breakdown, the child’s spouse may have a claim against the property in the joint account.

Third, it is not possible to make a family gift in the case of an “out of order death”. For example, if a parent adds multiple children as joint owners on a property but intends to have each child’s share passed to their respective children, this may not be achieved through a joint tenancy arrangement if one of the children pre-deceases the parent. In that case, the predeceased child’s share will be shared equally amongst the surviving children and will not go to the predeceased child’s heirs.

Lastly, when the jointly-held property is a real property, a portion of the principal residence exemption for income tax purposes may be lost. For example, if the parent adds a child as a joint owner on the parent’s house, and the child has his or her own residence, then a portion of the capital gain on the parent’s house may become taxable if the child chooses to use his/her exemption on his/her own residence. In contrast, if the parent were to retain full ownership on the house and does not own another principal residence, the capital gain incurred (from the deemed disposition) upon the parent’s death may be fully sheltered.

This article provides some general non-tax considerations when making gifts, with a focus on jointly held property, but by no means covers all situations or considerations. Professional advice pertaining to each individual’s personal situation is crucial in developing an effective estate plan.