Tax Apportionment for Estate Clarity: Pick Up the Pieces
Posted on June 27th, 2022 by Don Anderson
Posted on June 27th, 2022 by Don Anderson
Accumulating a significant RRSP portfolio? Own a treasured vacation property? Run a family business?
If so, then making an effort to define just how those assets will be divided should be among the first of your estate planning decisions that will eventually guide your executor(s). Specifying how each of the estate and final taxes is to be funded upon your passing should follow. By leaving a well-defined path for your executor and beneficiaries in your will and associated codicil, your time spent on this topic may bring significant clarity and harmony to your family members and other beneficiaries later. Further discussion can be found below. While you're here, enjoy the powerful saxophone playing of Candy Dulfer, as she "picks up the pieces". After all, Legato is all about creating that smooth transition of music and legacy! |
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"Tax apportionment" is an estate planning term that means exactly how it sounds: deciding how the taxes will be paid upon your death.
Making this requirement abundantly clear for your executor will help smooth the execution of your wishes and avoid conflict. Without your guidance, the estate may experience delays, extra costs, and disharmony.
Suppose, for example, the situation for a successful entrepreneur whereby her real estate and RRSP portfolio worth $5 million has been bequeathed to her oldest daughter while her estate with an equal residuary value of $5 million in stock and other liquid assets are to pass to her younger daughter.
However, the apportionment clause in her will guides all estate taxes to be paid out of the residuary estate. By way of this plan, the mother has pushed the tax burden of the entire estate onto the portion of the estate going to her younger daughter, including the payment of the taxes attributable to the RRSP portfolio being given to the older daughter. The reduction in the younger daughter's inheritance would create unequal treatment of the two sisters. Apportioning the responsibility for paying taxes proportionately to each asset would help prevent this uneven result.
That being said, assigning proportionate responsibility for taxes due could result in different problems. For example, if a beneficiary receiving a fixed asset such as real estate does not have sufficient cash liquidity to pay their proportionate tax liability, they would be forced to sell or mortgage that fixed asset(s) in order to pay the estate taxes due.
When fixed assets form part of one's estate, adding a permanent Legato life insurance strategy can create sufficient liquidity in the estate. Most importantly, the death benefit payout of the Legato plan would time perfectly with the residuary estate's need for liquidity to cover the taxes due thereby preventing unwanted asset sales.
Getting To Plan
List the various assets of your estate as well as those assets and investments that will pass outside of your estate to a joint owner or named beneficiary. Best to list both the current market value and, where applicable, the purchase price of each asset.
Then, determine the projected estate income and taxable capital gains that will come due upon your passing. In the case of a couple, an elected spousal rollover will push those taxes due to the period after the passing of the surviving spouse.
Finally, determine how the various estate taxes will be funded and paid.
Often, the responsibility for paying taxes gets defined in one of two ways:
Pay all of the taxes from the estate assets controlled by the will. In this situation, the beneficiaries and joint owners receiving assets outside the will, such as RRSPs, retirement plans or life insurance proceeds will not bear any of the associated tax burdens for their inheritance. The estate will hold all liability for the final taxes due.
Or, apportion the taxes proportionately to each asset, including those assets passing outside the will, such as discussed in the example above.
There’s no one right way to define the responsibility to pay final and estate taxes. One thing's clear: taxes will be due! Understanding how an apportionment clause could impact your wealth intentions should form a key part of your decision process when creating and updating your will.
Without an apportionment clause.
The estate is liable for all of the taxes of the deceased and their estate, including taxes on their assets that pass outside the estate as a consequence of their death. Should the estate hold insufficient assets to pay those taxes, CRA will go after the beneficiary of those assets instead. For example – if there’s a large RRIF going to a designated beneficiary and the estate has no assets, CRA can go after the designated beneficiary to collect those taxes in place of the estate.
Talk to your professional advisors
If issues like the equal treatment of your children and succession of key assets such as real estate form part of your planning process, make sure to consult with your estate lawyer and chartered life insurance professional for further guidance and solutions.
Your ultimate goals should include a legacy of family harmony and a smooth transition of your estate.
Making this requirement abundantly clear for your executor will help smooth the execution of your wishes and avoid conflict. Without your guidance, the estate may experience delays, extra costs, and disharmony.
Suppose, for example, the situation for a successful entrepreneur whereby her real estate and RRSP portfolio worth $5 million has been bequeathed to her oldest daughter while her estate with an equal residuary value of $5 million in stock and other liquid assets are to pass to her younger daughter.
However, the apportionment clause in her will guides all estate taxes to be paid out of the residuary estate. By way of this plan, the mother has pushed the tax burden of the entire estate onto the portion of the estate going to her younger daughter, including the payment of the taxes attributable to the RRSP portfolio being given to the older daughter. The reduction in the younger daughter's inheritance would create unequal treatment of the two sisters. Apportioning the responsibility for paying taxes proportionately to each asset would help prevent this uneven result.
That being said, assigning proportionate responsibility for taxes due could result in different problems. For example, if a beneficiary receiving a fixed asset such as real estate does not have sufficient cash liquidity to pay their proportionate tax liability, they would be forced to sell or mortgage that fixed asset(s) in order to pay the estate taxes due.
When fixed assets form part of one's estate, adding a permanent Legato life insurance strategy can create sufficient liquidity in the estate. Most importantly, the death benefit payout of the Legato plan would time perfectly with the residuary estate's need for liquidity to cover the taxes due thereby preventing unwanted asset sales.
Getting To Plan
List the various assets of your estate as well as those assets and investments that will pass outside of your estate to a joint owner or named beneficiary. Best to list both the current market value and, where applicable, the purchase price of each asset.
Then, determine the projected estate income and taxable capital gains that will come due upon your passing. In the case of a couple, an elected spousal rollover will push those taxes due to the period after the passing of the surviving spouse.
Finally, determine how the various estate taxes will be funded and paid.
Often, the responsibility for paying taxes gets defined in one of two ways:
Pay all of the taxes from the estate assets controlled by the will. In this situation, the beneficiaries and joint owners receiving assets outside the will, such as RRSPs, retirement plans or life insurance proceeds will not bear any of the associated tax burdens for their inheritance. The estate will hold all liability for the final taxes due.
Or, apportion the taxes proportionately to each asset, including those assets passing outside the will, such as discussed in the example above.
There’s no one right way to define the responsibility to pay final and estate taxes. One thing's clear: taxes will be due! Understanding how an apportionment clause could impact your wealth intentions should form a key part of your decision process when creating and updating your will.
Without an apportionment clause.
The estate is liable for all of the taxes of the deceased and their estate, including taxes on their assets that pass outside the estate as a consequence of their death. Should the estate hold insufficient assets to pay those taxes, CRA will go after the beneficiary of those assets instead. For example – if there’s a large RRIF going to a designated beneficiary and the estate has no assets, CRA can go after the designated beneficiary to collect those taxes in place of the estate.
Talk to your professional advisors
If issues like the equal treatment of your children and succession of key assets such as real estate form part of your planning process, make sure to consult with your estate lawyer and chartered life insurance professional for further guidance and solutions.
Your ultimate goals should include a legacy of family harmony and a smooth transition of your estate.
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Don Anderson
Legato
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