Here is an interesting case study I wanted to share regarding potential tax issues during estate planning.
Mr. A owned all of the shares of ACO prior to his death. ACO owned valuable real estate. Mr. A’s will provided that his shares of ACO were to be held in a testamentary spouse trust which would benefit Mrs. A during her lifetime and their children after her death. The children were the trustees of the testamentary spouse trust.
The real estate appreciated in value before Mr. A’s death. It appreciated even more between Mr. A’s death and Mrs. A’s death. On Mrs. A’s death, the Income tax Act deems the testamentary spouse trust to dispose of the shares of ACO for proceeds of disposition equal to the fair market value of those shares immediately prior to her death. As the appreciation in the value of the real estate is reflected in the value of the ACO shares, the testamentary spouse trust is effectively taxed on the economic gain arising from the appreciation in the value of the real estate. However, the cost of the real estate to ACO for tax purposes remains unchanged. Accordingly, the same economic gain is taxed again when ACO sells the real estate.
There are tax planning steps which in some cases prevent the double taxation. However, these are not available, with respect to the appreciation in the value of the real estate after Mr. A’s death, when the children are the trustees of the testamentary spouse trust. It is preferable to avoid this double tax issue when drafting the will so that the children are not the trustees of the testamentary spouse trust. Fortunately, the problem can be dealt with if it is identified during the lifetime of Mrs. A. Unfortunately, the double tax problem cannot be fixed after the death of Mrs. A.
It is important to obtain the advice of a tax lawyer in relation to spouse trusts.
These comments are of a general nature and not intended to provide legal advice as individual situations will differ and should be discussed with a lawyer.