Success Tax- What is it?

How much is the Success Tax going to cost you?

All of your life you have been paying taxes: income tax, property tax, sales tax, GST, etc. You have probably paid more taxes than you care to remember. But despite all of the taxes that you have paid you have still managed to do a little investing. Perhaps you have put away some money in RRSPs, or you have invested in some real estate. Maybe you purchased a recreational property, such as a cottage. Whatever your situation, you've probably overcome the odds and set aside a little extra for your family's future. In other words, you have had some success with your financial affairs.

So what will be the reward for this success? The biggest tax bill you have ever had to pay! On the day you or your spouse die, the Canada Customs and Revenue Agency (CCRA) will collect taxes on the assets that you have worked so hard over the years to accumulate. This tax bill will make all the other taxes you have paid throughout your lifetime seem minuscule by comparison. The success tax, the penalty you will eventually pay for investing in your financial future, could leave your estate with a huge tax burden.

There are two things in life that are unavoidable: "Death and Taxes." Each is bad enough on its own, but when you combine the two, look out. This success tax could cost up to 51% of your estate, leaving only 49% to go to your heirs. The success tax that I'm referring to occurs when your estate files your final tax return, and you no longer have a spouse. This success tax does not come into effect when the first spouse dies because capital assets and tax-sheltered plans can pass tax-free to the surviving spouse. A word of caution: tax-sheltered plans will only pass tax-free if the spouse is the named beneficiary on these plans.

On your final tax return, your estate will have to include the fair market value of all of your capital assets, minus the adjusted cost base. (NOTE: You can give away, gift or sell assets below their FMV (fair market value), but you are still taxed as if those assets had been sold at their FMV) These assets along with the current value of all of your RRSPs and/or RRIFs will often put your estate into the top marginal tax bracket. Capital assets such as stocks, mutual funds, and the family cottage used to get a break through the $100,000 lifetime capital gains exemption. This is no longer the case. The $100,000 exemption was removed on February 22, 1994.

This "Success Tax" will have to be paid before your estate can be divided up and passed on to your heirs. It is very difficult to avoid the success tax, but with proper planning and funding you can reduce it, defer it, or even pay it with deeply discounted dollars. You need to take steps today to find out what your approximate tax liability will be.

Once you know your tax liability you may wish to put an estate preservation plan into place. This can help reduce the effect of this success tax on your estate. Knowing where your liability lies will help you take steps now that will minimize the success tax in the future.

Should you spend it?

Many seniors today don't like to take money out of their RRSPs or RRIFs because they will have to pay 30 or 40% tax on this money. This means that a large portion of this money usually stays in the tax-sheltered plans until the day that they die. When this happens the government will step in and most likely take 50% right off the top. So if you're not happy paying 40% in taxes why give the government 50%? Even if there is no need for the extra funds now, many seniors might be better off to take the money out of their tax-sheltered plans and invest it elsewhere.

This not only happens to tax-sheltered plans but also to second properties such as the family cottage. Any capital assets that you have when you die is deemed to have been sold at the fair market value. The fair market value of these assets minus your adjusted cost base (the price you paid for it) is added to your final tax return. This can produce a tax liability with no source of funds to pay the taxes due. This could force the person or persons who inherited the asset to sell the asset just to pay the tax. That is part of the reason we see so many estate sales on cottages. The owners may have wanted to keep the cottage in the family, but they overlooked the tax liability that existed on it.

The best way to reduce this final tax grab is to have a proper estate preservation plan in place. You should talk over your current situation with your financial planner or accountant to see how you can keep this tax liability to a minimum.