6 Reasons to Transfer Money During Your Lifetime
There are numerous ways to transfer assets to others. The challenge is to make those transfers in the right way at the right time so that you remain financially secure, take into consideration the circumstances of the recipients, and minimize taxes. Here are six suggestions for developing an estate plan whereby you dispose of your assets as you intend.
You might want to transfer property during your lifetime for one or more of the following reasons:
- You want to provide financial assistance to the recipient.
- You would like to reduce estate assets that would be subject to probate fees.
- You are concerned about possible challenges to your will.
- You would like to have your money taxed at a lower rate.
Income Attribution Rules
The income attribution rules are designed to block attempts to shift income to a person who is subject to a lower tax rate than the transferor’s. They accomplish this by attributing the income back to the transferor. For instance, if you transfer assets to a spouse, any income earned on those assets will be attributed back to you. Likewise, if you transfer assets to a minor child, or to a trust established for the benefit of a minor child, the income will be attributed back to you.
The attribution rules do not apply to outright gifts to a child over the age of 18. However, they do apply to loans made to adult children, if one of the main reasons for the loan is to achieve gift splitting and reduce taxes. For example, it you make an in interest-free loan to an adult child, and the child invests the money, the interest and dividends earned on the investment will be taxed to you. This will not be the case if the loan bears interest at or above the minimum rate prescribed by the Canadian Revenue Agency (“CRA”) and the interest is actually paid. It will also not be the case if the loan is for a non-investment purpose, such as payment of university tuition, because no income is earned on the loaned amount.
If you make an interest-bearing loan to your spouse, and your spouse invests the loaned money in stocks and bonds, you will be taxed on the interest your spouse pays you but not on the income she earns from the investment of what was borrowed. As with loans to adult children, the interest must be no less than the CRA prescribed rate. There should also be a loan agreement, and the interest must actually be paid and recorded. Because the prescribed minimum rate is now lower than the return that can probably be earned on the money, a spousal loan could be a way to reduce income tax.
Taxation of Capital Gain
When you transfer appreciated assets, you are generally deemed to have sold them at market value even if no sale actually takes place. This means that the includible portion of capital gain (currently 50 percent) will be added to your taxable income. Suppose, for example, that you transfer to an adult daughter stock now worth $100,000 for which you paid $40,000, and your combined federal and provincial tax rate is 46.4 percent. The transaction would cost you $13,920 (the includible gain of $30,000 x 46.4 percent). The good news is that your daughter’s new cost base is $100,000, and she will be taxed on gain only if she subsequently sells the stock for more than $100,000.
If you had transferred the stock to your spouse, you would not be taxed on any of the gain at the time of the transfer. However, if your spouse holds the stock for a while and then sells it for $110,000, the taxable portion of the gain ($70,000 x 50% = $35,000) would be attributed to you. Likewise, any dividends earned on the stock would be attributed to you.
If you transferred the stock to a trust established for the benefit of your spouse, you would also be taxed on dividends earned on the stock and capital gains if the stock is sold, provided that the dividends and capital gain are distributable to your spouse. However, if they are to be retained in the trust, the trust, rather than you, would be liable for tax on them, and the maximum tax rate would apply.
Alter Ego and Joint Partners Trust
Ordinarily, when you transfer property to a trust, you are deemed to have disposed of the property, and the includible portion of the capital gain is taxed to you at the time of the transfer. This is not the case for a spousal trust (discussed above) and for an alter ego or joint partners trust. An alter ego trust could make sense if you would like to provide for expert management of assets, remove them from your probate estate, and assure privacy. In order to establish such a trust, you must be age 65 or older, and no one except you can receive the trust income and have access to trust principal. The gain in the property would not be taxed until it is sold by the trustee or at your death if it remained in the trust. You could name individuals or charities as remainder beneficiaries of the trust.
In the case of a joint partnership trust, the income would be paid only to the person who establishes the trust and his or her spouse, and no one except the spouses could access principal. Taxation on gain would be deferred until the property is sold by the trustee, the death of the surviving spouse, or at the end of a specified period applicable to trusts. Again, the remainder could be paid to individuals or charitable institutions.
Closely Held Stock, Partnership Interests, and Limited Liability Company (“LLC”) Shares
If you own a family business, or have created a partnership or LLC to hold real estate investments, you may transfer shares or units to family members during your lifetime. These assets would need to be appraised, and the rules pertaining to attribution of income and taxation of capital gain discussed above would apply. There are many options for transferring these various business interests to family members, and you will want to consider not only ways to minimize gift taxes but also which family members you want to hold or control particular assets. Be sure to consult your lawyer and perhaps also someone who specializes in business succession planning.
Most of your charitable gifts will probably be outright, which means that you retain no economic interest in the asset you contribute, and the charity is free to use it immediately. Outright charitable gifts are emotionally satisfying because you can see what they are accomplishing. However, you may hesitate to make large outright gifts because you would lose the income from the asset you contribute. If that is a concern, you might consider a gift arrangement where you and/or another person, such as a spouse, receive income.
One such arrangement is called a charitable remainder trust. You transfer property – cash, securities, or real estate – to a trust, which pays you the net income for life of for a term of years. In addition to income, you receive a donation receipt which enables you to claim a tax credit on your income tax return. As with all receipted gifts, the maximum portion of the receipt creditable in any one year is 75 percent of your net income, but the unused portion can be carried forward for up to five years. You have the year of the contribution plus up to five carryover years to claim the credit. When you establish the trust you will be taxed on 50 percent of the gain in the contributed property, but in most cases, the tax credit will exceed the tax on the gain, resulting in net tax savings. Often, the trustee is able to sell the asset you contribute and reinvest in something that pays you more income than you have been receiving.
Another option is a gift annuity, which is offered by The Winnipeg Symphony Orchestra and certain other charities. In exchange for a contribution of cash or securities, you, or you and/or another person receive fixed payments for life, the size of which depends on your age when you establish the annuity. As with the charitable remainder trust, you receive a donation receipt. Another benefit is the fact that a significant portion of your payments will be tax-free. The Winnipeg Symphony Orchestra will use a portion of your contribution to secure an annuity from a highly-rated insurance company in order to assure your payments. The remaining portion of your contribution will be used for the purpose you designate.
Suggestions for Assuring your Intentions with Lifetime Gifts
The following are suggestions for avoiding blunders and achieving desired results when making lifetime gifts:
- Be sure that you retain sufficient assets under your personal control to sustain a desired quality of life and meet contingencies, such as family emergencies and long-term care costs. Sometimes, in the interest of simplifying their estate, parents transfer to children more than is prudent and then become dependent on them.
- If you want to equalize gifts to children, remember that gifts you make to certain children during life must be integrated with provisions you make for them at the end of life. For example, if you make a large gift to a child during life – perhaps to enable that child to start a business or purchase a home – and your will or trust divides all of your property equally among your children, the total distribution will have been unequal.
- If a significant portion of your estate could be consumed by taxes due on your final income tax return, act now to implement plans that will reduce those taxes.
- Note that certain charitable gifts can make sense from an estate and financial planning perspective. They can reduce your current and future taxes, and they can increase your cash flow. Thus, put them on the table for discussion with your attorney or accountant, and contact our office for information that could be a basis for that discussion.