Halifax Estate Planning Council

Halifax Estate Planning Council

February 2007 Case Study


The Case Study FactsThe Client: Dad (age 58)

Immigrated to Canada in his twenties from GreeceOwner of development (“Constructco”) and real estate holding companies (“Realco”) Actively involved in the businessesSecond marriageOne son (28) from first marriage who is actively involved in the businessSecond wife (45) and daughter (16) who Mom wants to be involved in the businessElderly Grandmother (83) who Dad has brought over from Greece


The Client’s Personal Assets- Initial Meeting

Jointly owns home with second wife FMV $800,000 ACB $600,000RRSPs $600,000Owns 100% of Realco and ConstructcoPersonally owns first rental property purchased4 unit building personally owned FMV $500,000 ACB $50,000


The Client’s Corporate Assets

Constructco $500,000 Term insurance convertible to Universal Life

FMV $1,000,000 – land, work in progress, equipment

RealcoFMV $4,000,000 net of financingACB/UCC $800,000Debt $1,000,000 operating line


The Client’s FamilySecond Wife (age 45)

Not employed, has a non-registered portfolio of $350,000 from inheritanceHome is jointly owned with client

Son (age 28)No significant assets, employed in Dad’s development business and works under a General Manager who reports to Dad

Daughter (age 16)From Dad’s second marriage


The Client’s FamilyGrandma (age 83)

Immigrated to Canada 5 years ago, lives in basement in-law suite of client’s home but desires her own condominiumLife savings is a $750,000 non-registered portfolio

Aunt (age 51)Second Wife’s sisterResident of NSLukewarm relationship with Client’s family;


Dad 58 2nd Wife 45

Grandma 83

Son 28 Daughter 16

Real Co

Dad 100%

Constructo Co

Dad 100%

First Property

Dad 100%GM 45

HEPC 2006 CASE STUDY


The PlanSuccession plan for businessesRetirement plan for Dad and WifeBusiness/financial plan for SonEstate plan for family

Constructco and Constructo2

FT

CONSTRUCTCO INVESTCO2

LEASECO CONSTRUCTCO2

Value Pref Shares$1,000,000

Shareholders’ Agreement of Constructco• Contractually obligates life insurance proceeds to fund purchase of Preferred Shares

(drafted to provide flexibility of a redemption or dividend)

Shareholders’ Agreement of Constructco2 • Provides shareholder exit mechanisms to ensure central control of company by a key

group of people (avoiding third-party sales, bequeathing shares and involvement by a trustee in bankruptcy)

DD2 shares - Son

SonDaughter

FatherSpouse

Son

GM

DD1 Shares

100% 60%25%

15%

Lease

100 Common100 Common

REALCO INVESTCO

FT

DADDAD$2,000,000Pref. Shares

$2,000,000Pref. Shares

85% Common 100% Common

(GM over time)

15% Common

Realco

Shareholders’ Agreement of Realco • Son has option to acquire up to 75% of common shares over a period of time if certain business milestones are met•GM has option to receive shares from the Trustees of the Family Trust over time


Dad’s Planning to DatePurchased a $1,000,000 Joint Last-to-die insurance policy naming the Estate as beneficiary

Purchased $500,000 additional life insurance in Constructco$1,000,000 total insurance

Froze his interest in Constructco to a discretionary family trust (Trust 1)

Issued preferred Freeze shares

Preferred “super-voting” shares

Froze Realtyco to a different discretionary trust (Trust 2)

Changed beneficiary designation on his RRSP’s to Second Wife and his mother as contingent beneficiary


Grandma 84

Dad 59 2nd Wife 46

Son 29

Real CoComms: D. Trust #2

Prefs: Dad “Freeze”

Supervoting

Constructo CoComms: Trust#1

Prefs: Dad “Freeze”

Supervoting

First Property

Dad 100%

$1,000,000 Insurance

Trust #1 Trust #2

Aunt 51

January 1, 2007

Daughter 17


The Client’s Personal Assets- Date of Death

Jointly owns home with second wife FMV $800,000 ACB $600,000RRSPs $600,000 (Beneficiary: Wife; Contingent: Grandma)Owns Preferred shares

Realco – “Freeze shares”: $3,300,000Constructco – “Freeze shares”: $1,000,000Plus nominally valued “super-voting” shares of each;

Joint last to die policy: $1,000,000


Current FactsDad & Second Wife died in a car crash on January 1, 2007

CSI crew cannot determine who died first

Daughter, now 17, has a new boyfriend, who is a drug dealer


Distribution of Dad’s Estate

Dad was older than Second Wife and is therefore presumed to have predeceased Second Wife under the Survivorship Act, R.S.N.S. 1989, c. 454

“3(1) Where two or more persons die at the same time or in circumstances rendering it uncertain which of them survived the other or others, such deaths are, … for all purposes affecting the title of property, presumed to have occurred in the order of seniority, and accordingly the younger is deemed to have survived the older.”


Distribution of Dad’s Estate (Cont’d)

Significant implications to the distribution of Dad’s assetsSecond Wife acquires 100% interest in house as the surviving joint tenantDad’s RRSP – does it pass to Second Wife as the designated beneficiary or does it pass to Grandma as contingent designated beneficiary?



Beneficiaries Designation Act, R.S.N.S. 1989, c.36 permits designation of a beneficiary for a registered plan (section 9) Since Second Wife survived Dad, Dad’s RRSP payable to her However, Act does not apply to designations made pursuant to the Insurance Act, R.S.N.S. 1989, c. 231 (as amended)



Section 218 provides as follows:“Unless a contract or a declaration otherwise provides, where the person whose life is insured and a beneficiary die at the same time or in circumstances rendering it uncertain which of them survived the other, the insurance money is payable in accordance with subsection (1) of Section 196 as if the beneficiary had predeceased the person whose life is insured.”



Accordingly, if the RRSP was held by an insurer in insurance products and a declaration pursuant to the Insurance Act had been made, Second Wife would have been treated as predeceasing Dad and the contingent designation to Grandma appliesTax would have been payable by Dad’s estateAssumption: RRSP not an insurance contract



The remainder of Dad’s assets pass under the Intestate Succession Act, R.S.N.S. 1989, c. 236 (as amended) as follows:

$50,000 to Second Wife as her preferred share (ss.4(2)) – equal to Dad’s bank accountRest of the estate (comprised of freeze preferred shares of Constructco and Realtyco, voting preferred shares of Constructco and Realtyco and four unit rental property) are divided one-third to Second Wife and one-third to each of Dads’ two children, Son and Daughter (ss. 4(5))



Common shares of Constructco and Realtyco held by Family Trust 1 and Family Trust 2 pass the same way (one-third/ one-third/ one-third)


Distribution of SecondWife’s Estate

Second Wife is deemed to have died immediately after Dad Second Wife has no spouse at the time of her death but has one child, DaughterUnder Intestate Succession Act, Daughter inherits 100% of Second Wife’s estate (ss. 4(7))


Distribution of SecondWife’s Estate (Cont’d)

Second Wife’s estate comprises:Matrimonial home Second Wife’s own non-registered portfolio100% of Second Wife’s interest in Dad’s estateProceeds of joint last to die insurance policy – More on this later


Beneficial Ownership ofAssets After Both Deaths

(Before Probate or Income Tax)

Assets Fair Market Value Ownership

House $ 800,000.00 Daughter

Dad’s RRSP $ 600,000.00 Grandma

Constructco Freeze Preferred Shares $1,000,000.00 2/3 Daughter, 1/3 Son

Realtyco Freeze Preferred Shares $3,300,000.00 2/3 Daughter, 1/3 Son

Constructco Voting Preferred Shares $ 10.00 2/3 Daughter, 1/3 Son

Realtyco Voting Preferred Shares $ 10.00 2/3 Daughter, 1/3 Son

Constructco Common Shares $ 10.00 2/3 Daughter, 1/3 Son

Realtyco Common Shares $ 10.00 2/3 Daughter, 1/3 Son

Four Unit Rental Property $ 500,000.00 2/3 Daughter, 1/3 Son

Second Wife’s Non-Registered Portfolio

$ 350,000.00 Daughter

Grandma’s Non-Registered Portfolio $ 750,000.00 Grandma

Joint Last to Die Insurance Proceeds $1,000,000.00 Daughter


Administration IssuesSon to act as administrator of Dad’s estate pursuant to the Probate Act, S.N.S. 2000, c. 31, paragraph. 32(1)(a)Son will require an administrator’s bond equal to 1.5 times the total value of Dad’s estate – extremely expensivePublic Trustee is administrator of Second Wife’s estate, notwithstanding Aunt wishes to be appointed – Probate Act paragraph 32(1)(c)


Administration Issues(Cont’d)

Public Trustee could be asked to renounce in favor of Aunt, but unlikely to do so given the value of the estate and the fact that sole beneficiary is a minor child While Daughter is a minor, she also needs guardian of the person and a guardian of the property under the Guardianship Act, S.N.S. 2002, c. 8 (as amended)



Because there is no guardianship appointment by Dad and Second Wife, Aunt must apply to Supreme Court to be appointed guardian of Daughter’s person - Grandma fights this but loses Public Trustee is authorized to receive Daughter’s interest in Dad’s estate and, if required, Second Wife’s Estate (section 14)



Daughter becomes adult at age 19 pursuant to the Age of Majority Act, R.S.N.S. 1989, c. 4, section 2, notwithstanding that she will be an adult for purposes of the Income Tax Act at age 18Public Trustee cannot resist transferring all the assets to Daughter at age 19



Public Trustee does not need a bond


Can Post-Mortem Tax Planning Occur?

Very difficult proposition given role of Public TrusteeSome limited scope to effect tax planning that benefits DaughterPublic Trustee will always act in best interest of DaughterIf tax planning saves Daughter significant tax, may support it



Court application will be required Son, as administrator, must act in best interest of Dad’s estate and cannot pursue actions that favor him over DaughterPrinciples in BC cases O’Hagan v. O’Hagan, [2000] B.C.J. No. 204 (CA) and British Columbia (Public Trustee) v. Bradley Estate [2000] B.C.J. No. 205 (CA) would be applied



Very unclear whether otherwise appropriate post-mortem planning could occur


What if Dad and Second Wife

Had Planned Properly?Dad’s will would have appointed an alternate executor avoiding bonding costs for Son as administrator of Dad’s estate Second Wife’s will would have appointed an alternate executor and trustee for Daughter avoiding involvement of Public Trustee



Had Planned Properly? (Cont’d)

Wills would have contemplated joint death and provided an alternative distribution equalizing estate between Son and Daughter Both wills would have provided trust for Daughter until age 25 (or later) for estate planning purposes with Aunt as trusteeWills would have provided for testamentary trust for Son immediately and for Daughter after age 25 (or later) purely for tax planning/income-splitting




Aunt would have been named guardian of the Daughter’s person by guardian appointment, avoiding court applicationThe general manager of Constructco would have been properly addressed – not addressed at all without a will and/or shareholders’ agreement/earn-in agreement




Wills could have provided sufficient powers to the executors to implement post-mortem tax planning that benefited estate as a wholeProfessional fees to deal with this mess and the administration bonding costs greatly outweigh costs to implement the plan recommended to Dad in 2006!


Income Tax IssuesTax on deathFunding of liabilityPost mortem planning for corporationsRRSP


Husband’s asset distribution

Value Son Daughter Wife

RRSP 600,000 600,000 Constructco shares Special voting 100 33 33 33 Freeze preferred 1,000,000 333,333 333,333 333,333 Realtyco shares Special voting 100 33 33 33 Freeze preferred 3,300,000 1,100,000 1,100,000 1,100,000 Rental Property 500,000 166,667 166,667 166,667

Husband's Estate


Wife’s asset distribution Value Daughter

RRSP 600,000 600,000 Constructco shares Special voting 33 33 Freeze preferred 333,333 333,333 Realtyco shares Special voting 33 33 Freeze preferred 1,100,000 1,100,000 Rental Property 166,667 166,667 Home 800,000 800,000 Wife's portfolio 350,000 350,000 Life insurance 1,000,000 1,000,000 Total 4,350,067 4,350,067


Total distributionsSon Daughter

RRSP - 600,000 Constructco shares Special voting 33 67 Freeze preferred 333,333 666,667 Realtyco shares Special voting 33 67 Freeze preferred 1,100,000 2,200,000 Rental Property 166,667 333,333 Home - 800,000 Wife's portfolio - 350,000 Life insurance - 1,000,000 Total 1,600,067 5,950,133


Husband’s TaxFacts and Assumptions:

RRSP goes to wife’s estateCapital cost for recapture on rental property assumed to be $30,000Husband used capital gains deduction on Constructo estate freeze, therefore ACB of 2/3 of the shares is $333,333. All income taxed at highest tax rateRealco shares worth $3,300,000


Husband’s assets subject to tax

Value Taxable Tax Constructo

Voting p/s $ 67 $ 0 0 Freeze p/s $ 666,667 $ 166,667 $ 80,417Realco Voting p/s $ 67 $ 0 0 Freeze p/s $2,200,000 $1,100,000 $530,750Rental ppty $ 333,333 $ 150,000 $ 72,375 Recapture $ 20,000 $ 9,650

$4,800,200 $3,200,133 $693,192Probate tax $ 65,918Total tax liability $759,110


Wife’s TaxFacts and Assumptions:

Principal residence exemption used on homeCapital cost for recapture on rental property assumed to be $30,000 – 1/3 owned by wife’s estateWife is able to use capital gains deduction on her 1/3 interest in ConstructcoAll income taxed at highest tax rate


Wife’s taxValue Taxable Tax

Constructo Voting p/s $ 33 $ 33 0 Freeze p/s $ 333,333 $ 0 0Realco Voting p/s $ 33 $ 33 0 Freeze p/s $1,100,000 $ 550,000 $265,375Rental ppty $ 166,667 $ 75,000 $ 36,188

Recapture $ 10,000 $ 4,825Portfolio $ 350,000 $ 37,500 $ 18,094RRSP $ 600,000 $ 600,000 $289,500Probate tax $ 59,683Total taxes $673,665


Post Mortem planningConstructco:

Use life insurance to redeem freeze sharesLoss on redemption can be used to offset ½ of capital gain on death

Tax savings in Husband’s estate: $40,200

Provides liquidity in estates


Post Mortem planningRealco:

Double tax issue if no post mortem planningConsider wind-up and 164(6) electionConsider 88(1)(d) bump planning


Realco Post Mortem Tax Planning

Shareholders' Equity as at February 2007 (200,000) Unrealized gains

FMV 5,000,000 NBV (800,000) 4,200,000

Corporate tax on liquidation (1,092,000) RDTOH 400,000 Cash available for distribution 3,308,000

Rounded 3,300,000 Distributed as:Paid Up Capital - Capital dividend 2,100,000 Taxable dividend 1,200,000

3,300,000

Personal tax on dividends @ 33% 396,000


Realco Post Mortem Tax Planning

Tax in Husband’s estate $530,750Tax in Wife’s estate 265,375Total taxes paid by estates 796,125Corporate tax on wind-up 1,092,000RDTOH recovered (400,000)Personal tax on wind-up 396,000Total taxes if no planning 1,884,125


Realco - 164(6) electionConsider winding up within Estates’ first taxation yearEstates will realize a loss on Realco shares on wind-upLoss can be used to offset gain on final tax returns of Husband and Wife

164(6) election

In this scenario, the full loss cannot be carried back – stop loss rules apply

Most tax on death can be offsetCorporate tax paidTax on wind-up dividend paid


Realco Post Mortem 88(1)(d) bump

Facts and Assumptions:FMV Land and buildings = $5,000,000

FMV of land = $2,000,000FMV of building = $3,000,000

ACB Land and buildings = $800,000No recapture as ACB = UCC



Both Estates would transfer Realco shares to Newco in exchange for shares of Newco having PUC = Estates’ ACB ($3,300,000)

Realco wound up into NewcoIncrease ACB of land using 88(1)(d) bump88(1)(d) bump not available on depreciable property (building)



Newco sells assets and pays tax on capital gain on buildingWind-up Newco and distribute cash as return of capital to Estates



Shareholders' Equity as at February 2007 (200,000) 88(1)(d) bump:

FMV Land 2,000,000 ACB land 320,000 1,680,000

FMV of land and building 5,000,000 Original ACB (800,000) 88(1)(d) bump (1,680,000) Capital gain realized on liquidation 2,520,000

Corporate tax on liquidation (655,200) Cash available for distribution 3,344,800

Rounded 3,300,000

Distributed as Paid Up Capital 3,300,000


Realco Post Mortem planning

Do nothing 164(6) 88(1)(d)

Tax on death 796,125 108,563 796,125

Tax on wind-up of RealcoCorporate tax 1,092,000 1,092,000 655,200 Recovery of RDTOH (400,000) (400,000) - Personal tax on distributions from Realco 396,000 396,000

1,088,000 1,088,000 655,200

Total taxes paid 1,884,125 1,196,563 1,451,325


RRSPLeft to minor daughter through Wife’s estateAdministrator and daughter’s guardian (Public Trustee is both) can jointly elect to transfer to daughter on a tax deferred basisMust buy an annuity payable until daughter is 18Annuity taxed in daughter’s hands


RRSPVery little tax deferral, given that daughter is 17Could use daughter’s marginal tax brackets for two yearsAdministratively, an insurance company not likely to sell a 2 year annuity


Life Insurance Considerations

After last year’s meetings …Additional coverage on Dad in Constructco to fund buy-out by son.Joint Life, Last-to-die coverage on Dad and Second Wife, to fund overall estate tax liabilityEstate Equalization issues discussed, but no action taken


(1) Constructco buy-out

Dad wants his son to ultimately take over the business.

Son is interested – but no assets

Life insurance increased to $1 million to finance the buy-out. Term insurance used as the need is not permanent.


(2) Estate Tax Liability

With proper planning, the estate tax liability can reduce over time, but right

now it’s significant.

The choice is whether to pay the tax using 100-cent dollars, or shift the burden to an

insurance company.

Insurance makes sense …


Life insurance – Dollars at a Discount

1/2 cent on the dollar each year1/2 cent on the dollar each year, , at our clients’ blended age, if approved at our clients’ blended age, if approved

medically.medically.

$5,000 yearly insurance cost = $1 million tax-$5,000 yearly insurance cost = $1 million tax-free.free.

Insurance costInsurance cost

Male 58 + Female 45 Male 58 + Female 45 = Joint 39= Joint 39


What type of insurance?

The tax liability may be around for 20 years or more. It’s a long-term issue.

Typical considerations would be Term to 100 or Universal Life.


Term to 100 vs Universal Life

For clients where assets or cash flow are modest, Term 100 coverage provide a

very effective means of creating or conserving an estate.

Dollars at a discount.

Using Universal Life, more affluent clients can sometimes cut the insurance cost in

half.


Term to 100 vs Universal Life

The cost of Term 100 is paid with after-tax dollars.A $5,000 yearly premium may actually cost $10,000

pre-tax.

Using Universal Life, our clients - in just 2 years - can create a tax-sheltered investment where pre-tax

investment earnings can pay the yearly insurance cost.


Aggressively-funded Universal Life

Investment earnings can pay the insurance cost each year, with the fund returned tax-free at death.

The death benefit option is called “Face Amount + Fund”.

High levels of funding can qualify the client for substantial cost discounts and/or investment bonuses.

Many ULs allow clients to use brand-name mutual funds as the underlying investments in their contracts – at

no additional management fee.


Joint Last – Beneficiary Provisions

Contract wording – one major insurer:

Simultaneous deaths. Unless the beneficiary designation specifies otherwise or prohibited by law, if two or more Lives Insured under the policy:

• die at the same time or in circumstances in which it is uncertain in what order they died, and

• if the sequence of those deaths affects the determination of a Designated Life Insured and/or the calculation of a death benefit payable

we will use the following criteria to determine and pay the death benefit(s) resulting from those deaths:

• if the sequence of the deaths would otherwise determine which of the Lives Insured is a Designated Life Insured for a coverage, the death benefit otherwise payable with respect to that coverage will be divided into equal portions and each of those Lives Insured will be deemed to be a Designated Life Insured and to have survived the other(s) to determine each beneficiary's entitlement to each portion of the divided death benefit


(3) Estate Equalization issues

Dad and Second Wife never got “a round tuit”,

but life insurance – especially at ½ cent on the dollar – is a very effective way of

equalizing inheritances for family members where some children will

remain outside the business


(4) Estate Multiplication

Worthy of mention is the idea of using life insurance to multiply an estate for the

beneficiaries …


$1 Million - $5,000/year

If $5,000 is invested yearly, how long will it take the investment to reach $1 million?

At 6% growth 43 yearsAt 8% growth 36 yearsAt 10% growth 31 yearsAt 12% growth 27 years

These are after-tax growth rates!


Estate Multiplication

Policies originally placed to fund immediate tax liabilities can become “estate

multipliers” when clients live long enough to enjoy the tax minimization

recommendations they’ve actioned.


Concluding RemarksRole of Trust Company – Executor/Trustee and agent for executorComplex planning should be presented and phased in gradual steps to ensure client understanding and acceptanceBegins and ends with the WillVarious elements and needs should be coordinated during each stage of implementation

Halifax Estate Planning Council

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