Estate planning can include probate planning. Probate is a process by which a court issues a Certificate of Appointment of Estate Trustee. The Certificate confirms a deceased’s last will and the appointment of an estate executor (also known as estate trustee). A Certificate is generally required by banks and the land registry system before the executor can access a deceased’s bank deposits or sell a deceased’s real property.

If a Certificate is required, then any applicable probate tax must be paid. In Ontario (each province has different probate rules), the probate tax is levied at approximately 1.5% of the date-of-death fair market value of a deceased owner’s assets. For example, a $2 million dollar house and $500,000 in bank deposits would together be subject to $36,750 in probate tax in 2023. An arrangement that obviates or reduces the probate tax is desirable to many Ontarians, so planning around it can be worthwhile.

Joint ownership is one arrangement that can help avoid probate when an owner dies, if it is implemented correctly. Unfortunately, many individuals and the lawyers they employ approach joint ownership superficially, focusing only on saving the 1.5% probate tax, but failing to consider income tax/capital gains tax exposure, which for Ontarians can be as high as 53.53%, as well as the legal risks that joint ownership can engage. Income tax/capital gains tax cannot be avoided by probate planning. In the best case scenario, capital gains tax can be deferred (usually, through income tax/capital gains tax planning) and, in the worst case scenario, faulty probate planning can accelerate or even unnecessarily inflate the capital gains tax. 

What is joint ownership? Joint ownership is an arrangement where, for legal purposes (but not necessarily for income tax purposes), each of the multiple owners has an undivided interest in the same property (meaning that they together own the whole, rather than separate parts, such as in a ”tenancy in common” arrangement). Joint ownership is available to bank accounts, real estate and other assets. A key feature of joint ownership is survivorship. Survivorship means that, if one owner dies, the surviving owner(s) automatically accede to the deceased owner’s interest on death without any further legal steps (other than the documentation of the death), and, where the arrangement is documented appropriately, generally without the need to deal with the property under a Certificate of Appointment of Estate Trustee, thus avoiding probate and probate tax.

It is very important to be aware that joint ownership can be “beneficial” – meaning that ALL the joint owners have not only the title documents to the asset, but also enjoy other rights and obligations that come with property ownership, such as the right to any income from the property and the obligation to pay property taxes. Alternately, joint ownership can be “legal” only – meaning that the joint ownership is to hold the title to the property only, while the real rights and obligations of each of the joint owners are set out under another agreement, such as a trust deed. For example, when probate tax planning is done via joint ownership, often, a “legal only” ownership is intended for the additional joint owner, as the original owner retains all beneficial interests in the property until death, while the instructions for dealing with the property after the original owner’s death are provided separately. On the other hand, a true gift of the property can also be achieved by adding an additional joint owner to the title.

In a common scenario, an older parent, often a widow or widower, asks a real estate lawyer to add one of their adult children as a joint owner on the title of the parent’s home or cottage. The parent’s objective is not to give the child beneficial ownership of the property at that time, but for the child to hold the title such that, on the parent’s death, the child could continue holding the title via survivorship and avoid the need to obtain a Certificate in order to be able to sell the property and share the proceeds with the other children. Unfortunately, as is frequently the case, the real estate lawyer does not analyze or document the parent’s intentions. On the real estate deed, the lawyer describes the transfer “from parent” “to parent and child, jointly” in exchange for “$2 and natural love and affection”, instead of using language such as “from beneficial owner to trustees for no consideration”, which would be the correct way to document the parent’s intended transfer. In order to achieve the arrangement desired by the parent, there would also be a bare trust agreement between the parent and child in place to state that, until the parent’s death, the parent shall remain the sole beneficial owner of the property, while the child will act as a bare trustee and, on the parent’s death, carry out the parent’s testamentary instructions that are set out in the parent’s will or secondary will. (If none of the parent’s other assets are expected to require a Certificate for dealing with after death, then a single will can comprise the parent’s testamentary instructions, but if the parent has other assets that would necessitate a Certificate for dealing with, the parent would have a primary will for dealing with such “probatable” assets and a secondary will for dealing with those assets that would not require a Certificate, such as the parent’s jointly owned property.) The real estate lawyer also fails to advise the parent and child to seek tax, valuation and other legal advice prior to the transfer.

What are the implications of such above-described transfer? I will first discuss the income/capital gains tax implications and lastly the legal implications.

Language in a property transfer deed that refers to consideration of “$2” and “natural love and affection”, supports an interpretation that the addition of the child as a joint owner, for legal and income/capital gains tax purposes, was a non-arm’s length sale or a gift to the child of a 50% beneficial interest in the property. (For income tax purposes, a change from one beneficial owner to two joint beneficial owners is a transfer of 50% of the property interest by the original owner.)

For income tax purposes, a gift or a non-arm’s length sale (other than those to a spouse) of any portion of a capital asset is deemed to be a disposition at fair market value. Dispositions of capital property must be reported on the disposing taxpayer’s tax return. The fair market value of the disposed property must be determined by a qualified professional. The difference between the fair market value and the owner’s original cost of the property is generally what comprises the capital gain on the property, 50% of which is generally subject to taxation at the taxpayer’s applicable income tax rate, unless the capital gain is exempted from tax. For Ontario-resident taxpayers, the highest marginal tax rate is 53.53% in 2023. The capital gain may be taxable or it may be exempt under a program such as the principal residence exemption. Where the disposed property is a home that is exempt from capital gains tax, failing to report its disposition, even where no actual tax is payable, is subject to a penalty of up to $8,000.

The legal implications of joint ownership transfer I described in the “common scenario” above can also be severe. If the joint ownership transfer is not documented as a “legal” arrangement only, the adult child’s legal risks can expose the entire property. For example, if the child has a serious car accident with adjudicated damages beyond their insurance coverage or other creditor claims, the property may be seized by such creditors. Jointly owned real estate can also be severed by one owner without notice to the other owner(s) into separate, “tenants in common” shares. If the child is dishonest or vulnerable to bad influence, he or she could sever the joint tenancy and either mortgage or sell his or her 50% share. Finally, on the parent’s death, the child may refuse to share the property with the other intended beneficiaries of the parent’s estate, entangling the estate in a court battle and thereby triggering probate and probate tax with respect to the disputed property. In my practice, it has been joint bank accounts and joint titles to property that have caused the biggest problems in estate administration and have created the biggest rifts among the surviving family members. In one memorable example, a daughter, whom a mother had added as a joint holder to the mother’s bank account for the purpose of probate planning, instructed the bank to freeze the mother’s account, preventing the mother from both, being able to afford her living expenses and from being able to pay a lawyer to fight the daughter in court.

Bank employees are very quick to offer joint accounts as a probate planning option, but they do not provide any substantial guidance to customers nor require that the joint account holders obtain independent legal advice on the associated risks prior to settling joint accounts. Moreover, some bank branches distribute literature about estate planning that teach the distinction between “beneficial” and “legal only” joint bank accounts, yet in their practice banks themselves decline to recognize such a distinction. I think that bank legislation should be changed with respect to joint accounts, but until then, Ontarians, who are contemplating transferring their property into joint ownership for probate planning, whether the property be real estate or bank accounts, should obtain qualified legal and tax in advance.

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Estate Planning with Trusts

I receive many calls from clients who inquire whether trusts can help them pay less in taxes. Some are under the impression that settling a trust can help lower taxes or avoid them altogether. Is this impression correct?

Please note: I try to simplify my commentary here by referring to individuals as “he”. Please note that this pronoun is used merely for convenience and is not meant to suggest any gender bias.

Before discussing the taxation of trusts, it’s important to first consider what a trust is. Very generally, a trust is a legal arrangement where an owner of a property (the settlor) entrusts the property to another person (a trustee) with instructions to hold that property for defined beneficiaries. The key goals of trusts are to separate the rights attaching to the transferred property into legal ownership rights and beneficial ownership rights and to impose specific rules on trustees for the management of that property.

Trusts can be settled during one’s lifetime or after death, as instructed in one’s will. The simplest example of a trust is a deceased person’s estate where the deceased in his will has appointed an executor (also known as an estate trustee) and instructed him to which beneficiaries to transfer his estate. During the estate administration period, the executor acts as the legal owner of the estate assets – for example, unless the will instructs otherwise, he can generally sell any real estate and liquidate any investments. However, unless the executor is also a beneficiary of the estate, the executor has no personal entitlement to the assets of the estate and must distribute them or their proceeds to the beneficiaries.

Not all countries recognize the concept of trusts (or the concept of an estate with an executor). Trusts originated in medieval England where some women could not own land; men going away for military service transferred the legal ownership of their land to trustees so that they could safeguard the enjoyment of the land for their families. Trusts are an old common law construct, but one that remains relevant today.

What are the advantages of trusts? Trusts have many advantages as well as disadvantages. Trusts can be helpful when there is a need to provide for a minor or spendthrift beneficiary, to protect a disabled beneficiary’s entitlement to social disability income or an inheritance from marital or creditor claims, to hold an important family asset such as a company’s shares, to control a family legacy for after death, or to create a charitable organization. A trust instrument contains binding rules that specify how the trust property is to be applied for the benefit of the defined beneficiaries. A trust may be the only thing that someone can control, to an extent, after death.

A notable complexity of trusts is that there can be no trust without a trustee, so appropriate trustees, who would be in a position to manage the trust for the required period of time, must be secured. The trustees must be able to prudently invest trust property, attend to its protection (such as insuring it), keep detailed accounting records, file trust income tax returns, provide trust activity reports and make distributions to the beneficiaries as required under the trust deed. Sometimes the most qualified trustee is a trust company. Trustees’ responsibilities are demanding and for that reason arm’s length trustees are usually compensated for their work. Sometimes the legal fees of settling a trust, the trustees’ compensation and accountants’ fees can simply make a trust unaffordable to many families.

Trustees bear personal responsibility for carrying out their duties as they are fiduciaries when they act in that capacity, however, even though they act as fiduciaries, if the wrong trustees are appointed, a trust can be harmed. There is no “trust police” to pre-empt trust mismanagement. If the beneficiaries observe their trust being mismanaged and the trustees refuse to cooperate, the beneficiaries’ only option generally is to seek the assistance of the court. If the beneficiaries are infirm, seeking the court’s assistance can be challenging because incapacitated or minor persons must be represented by a litigation guardian in court processes. Finally, if there is no fiduciary liability insurance in place and the trustees cannot personally compensate the losses, the beneficiaries may have no recourse at all.

I recently came across an example of a mismanaged trust. One of my clients was appointed as a trustee of a trust but delegated the tax filings of the trust to an accountant because he felt that a professional would be best suited to prepare the trust’s tax returns. This was a reasonable delegation to make. The accountant kept all books and records of the trust at his office and also directed all Canada Revenue Agency correspondence there. Many years into the trust’s existence, however, the trustee discovered that the accountant had failed to file the trust tax returns on time, so the late filing penalties and interest essentially doubled the trust’s outlay to the CRA. Naturally, the beneficiaries of the trust were unhappy, because the trust’s funds were unnecessarily diminished, while the trustee felt wronged by the accountant. It remains to be seen whether any kind of compensation will be obtained by this particular trust.

Another drawback with trusts is that, at the present time in Canada, trusts generally have limited advantages, if any, in terms of income taxation. Trusts are generally taxed at the highest marginal tax rate (approximately 54% in Ontario) on their income, unless the trust’s income is annually distributed to its beneficiaries, in which case the beneficiaries pay income tax at their own tax rates on that distributed income. Most trusts do not qualify for the principal residence capital gains tax exemption if they hold a residential property for the use of family members. Further, most trusts are subject to a deemed disposition and reacquisition of the trust property every 21 years, which triggers the taxation of the accrued capital gains on the property of the trust, which gains are also taxed at the highest marginal tax rate.

Transferring assets into a trust, unless it is a spousal or an alter ego trust (these trusts are discussed below), happens at fair market value. This means that, if someone transfers a property with accrued gains to a trust, such as a building or the appreciated shares of a company, the transfer is a disposition at fair market value for tax purposes to the settlor and the accrued gains are taxed in the hands of the settlor of the trust in the year the transfer takes place. This tax aspect of trusts is what often prevents clients from settling family trusts, because clients do not want to accelerate the payment of tax on their appreciated capital assets. Trusts, however, remain useful in the “estate freeze” context – where, generally, newly issued qualified small business corporation shares with nominal value are given to a family trust and, in due course, the eventual appreciation of those shares is shared among multiple beneficiaries, thereby multiplying the lifetime capital gains exemption. Where this arrangement qualifies, it can significantly lower a family’s income tax outlay.

Clients are also sometimes surprised to learn that, once property is transferred to a trust, it belongs to the trust and the settlor cannot get it back (unless it is a joint spousal or an alter ego trust, of which the settlor is a beneficiary and can transfer the trust’s assets to himself). If a family trust deed allows for trust property to revert to the settlor, tax attribution rules would cause the income of the trust to be attributed to the settlor and taxed in his hands, undoing any tax planning the settlor had pursued.

When interest rates were low, some clients made large cash loans to their family trusts for the purpose of investing the loaned cash and then splitting the investment income among the trust’s beneficiaries. Such arrangements required the trust to pay a “prescribed” interest rate to the lender on the loaned cash, which was previously 1%, and the lender had to include that 1% interest in his income. The trust would get a deduction from its income of that 1% interest expense. Where the investment generated sufficient investment income, this arrangement could help a family lower its income taxes to an extent. At the present time, the “prescribed” interest rate is 5%, so few new prescribed rate loan arrangements are being utilized at this time.

There are currently only a few types of trusts that enjoy a more favourable tax treatment. These include alter ego trusts (where the only beneficiary can be the settlor of the trust) and spousal and joint spousal trusts (where the only beneficiaries can be the settlor’s spouse or the settlor and his spouse). Transferring capital assets to such trusts can be done on a tax-deferred (rollover) basis, rather than at fair market value (this is discussed above). Additionally, these trusts are exempted from the 21-year deemed disposition rule and they also enjoy the principal residence exemption with respect to a home that is transferred to such a trust. Unfortunately, on the death of the beneficiaries of such trusts, all accrued gains on the trust capital assets are taxed at the highest marginal tax rate in the trusts. In contrast, if an individual had personally owned his capital assets, on death, he would be taxed on them at his own applicable tax rate, which may or may not be the highest marginal tax rate.

Sometimes alter ego and spousal/joint spousal trusts are used for the purpose of probate tax planning. As I discussed in my earlier 2023 contributions to the Islington Times, probate tax is levied in Ontario at the rate of 1.5% of the value of assets of a deceased person’s estate. If the decedent’s assets are in a trust, they are generally no longer part of his estate (unless they are in a bare trust, which was discussed in my 2023 summer contribution to the Islington Times), so if he properly documented his post-mortem instructions in the trust deed, probate may be avoided, saving the 1.5% tax. However, where the highest marginal tax rate applies to the accrued gains on the trust capital assets on death, the higher capital gains tax may outweigh the 1.5% probate tax savings. If the objective of settling a trust is merely to save the probate tax, tax modelling is recommended to determine whether the benefit will outweigh the cost.

Other considerations from the income tax perspective when settling a trust include the jurisdiction of the tax residence of the settlor, trustees and of the beneficiaries. If the trustees reside in another country, the trust may lose its Canadian tax resident status and trigger unfavourable tax outcomes. Similarly, if there is a non-resident beneficiary of the trust, the trust may be subject to additional taxation in Canada. Trusts settled in Canada can also have repercussions in other countries. For instance, I recently assisted a trust that had a Canadian-resident trustee but that had been settled by an American tax resident who had failed to obtain proper tax advice prior to settling the trust. The result was that the Canadian trust property was taxed in the U.S. as passive foreign investment company income, in the hands of the settlor, causing a very large unplanned tax outlay.

So, what is the verdict? Can trusts help lower taxes? I think that the answer to this question depends on the multitude of factors that apply to trusts and the personal situation and objectives of the potential settlor and his intended beneficiaries. A qualified legal and tax advisor should be consulted before any decisions are made about settling any trust.