How spouses provide an advantage in post-mortem tax planning

In my previous article, I discussed the advantage of having a spouse when it comes to post-mortem tax planning for capital property. The two main advantages are the spousal rollover—the deemed disposition of capital property at the deceased’s adjusted cost base (ACB) when ownership is transferred to the surviving spouse—and the ability to elect out of this rollover on a property-by-property basis.

Read: Capital gains and losses at death: the spousal advantage

The latter opens the door to further planning. Options include using capital loss carryforwards, unused lifetime capital gains exemption (LCGE) amounts and triggering capital losses to reduce taxes using either Method A or B. Now it’s time to see this in action.

The case of two (fictional) brothers

Gilbert and Michael, B.C. residents in their 70s, have identical financial situations:

• Annual incomes of $150,000
• Net capital gains of $5,000 (2016) and $6,000 (2017)
• Non-registered portfolios with a fair market value (FMV) of $1.2 million and an ACB of $1 million
• Three securities within their portfolios with unrealized net capital losses totalling $60,000.

The only difference between the brothers is their marital status. Gilbert is married to Aura; Michael is single. Both brothers died at the end of 2018.

Michael’s tax breakdown at death

There is a deemed disposition of Michael’s assets upon his death that results in a $200,000 capital gain ($100,000 of which is taxable). This is added to his 2018 income of $150,000. His tax results are as follows:

Based on Michael’s profile, his tax situation is straightforward. His taxes payable are $91,227 , leaving his net income in his year of death at $158,773.

Remember that Michael had taxable capital gains of $5,000 in 2016 and $6,000 in 2017. His taxes payable in those years was $46,537 and $46,646, respectively. For the three-year period from 2016 to 2018, Michael’s total taxes payable was $184,410.

There may be little Michael can do to change this tax result. Gilbert, on the other hand, has options.

Gilbert’s tax breakdown at death

Gilbert’s tax breakdown is not nearly as simple as his brother’s because of Aura, his surviving spouse. This complexity is a good thing from a tax planning perspective.

First, Gilbert’s estate representative could elect to have the entire portfolio transferred to Aura at FMV, but that would result in a $91,227 tax bill. Can the estate representative do better and lower this tax bill?

Absolutely. Here’s how:

a) A 100% rollover of the non-registered portfolio at Gilbert’s ACB to Aura

The tax results for this option are as follows:

This option would leave Gilbert’s 2016 and 2017 taxable income and taxes payable unchanged, for a total three-year tax liability of $136,844.

b) A partial spousal rollover of the securities not in a loss position in Gilbert’s non-registered portfolio to Aura at Gilbert’s ACB

Elect to transfer the three securities with losses to Aura at FMV, realizing a net capital loss of $60,000. Apply those capital losses to Gilbert’s taxes using Method A, which allows the capital losses to be carried back up to three years and applied against net capital gains.

Any remaining loss can be applied against other income in the year of death and/or the year before death. The results are:

When Gilbert’s estate representative uses a partial spousal rollover in combination with Method A, Gilbert’s three-year total tax liability is $112,161.

c) Take the same approach as (b) above but use Method B instead of Method A

Recall that Method B allows the capital losses to be applied against other income in the year of death and/or the year before death, skipping the three-year carryback. For simplicity, the full $60,000 net capital loss will be applied to income in the year of death. The results are:

When Gilbert’s estate representative uses a partial spousal rollover in combination with Method B, Gilbert’s three-year total tax liability is $112,952.

The table below summarizes the tax results for Michael and Gilbert:

As you can see, regardless of the option that Gilbert’s estate representative picks, he ends up paying less tax than his brother at death. How much less will depend on the option chosen.

There may even be other combinations applicable to Gilbert, such as splitting the losses between the year of death and before death to reduce other income. One thing remains constant: a surviving spouse increases your tax planning options and can reduce your taxes at death.

Curtis Davis

Tax & Estate

Curtis Davis, FCSI, CFP, TEP, is director for tax, retirement and estate planning services, retail markets at Manulife Investment Management.