Read the audio transcript below:
Dr. Luisa Schuldt (LS): Hello everyone! Welcome to the latest edition of Brush Up, presented by Oral Health Group: The Dental Podcast where we speak with industry experts to discuss a variety of topics such as technology, finance and practice management. I’m your host, Dr. Luisa Schuldt, a dual certified periodontist and prosthodontist based in Font Hill, Ontario. Today we’re discussing estate planning with Paul Jacobson. Welcome, Paul. Thank you so much for joining us.
Paul Jacobson (PJ): Thank you very much for having me.
LS: Paul Jacobson is a senior member of the Alberta Bar with a referral-only Calgary practice, concentrating on “bespoke preservation planning.™” And I noticed a trademark in that bio. I hope we’re going to get to that soon. For now, would you like to just give us an intro on what is estate planning?
PJ: So thank you very much for having me. Estate planning is a buzzword. I like to call it a buzzword that a lot of lawyers and financial planners – to some extent accountants – like to use when you’re looking at reviewing the financial situation of a family and preparing the documents around that financial situation to manage incapacitation and death. So those documents would be things like powers of attorney and will, etc. So normally it starts with a review of the assets and liabilities of the family and some cash flow projections. You kind of see that a lot with the private banking groups out there. They do cash flow protections. They look at your retirement, they look at your budgets, they do a tax analysis. They prepare a balance sheet and from all of that they then look at putting together those documentations. That documentation might be for tax planning purposes while they’re still alive and for the documentation on incapacitation and death. So that’s really what an estate plan is all about.
LS: So you’re mentioning a little bit about the first few steps and documents that will be part of this estate plan. What would the key documents or the most important ones be that are required?
PJ: It’s pretty standard across Canada. The terminology may be a little different for some of them, but I can speak from an Alberta point of view. So on incapacitation. So you’re still alive, but you have a mental incapacity. You’re looking at things like an enduring power of attorney and a personal directive. That’s what we call them in Alberta. Now other provinces might have different terminology, but the documents are the same across Canada. So, for example, the enduring power of attorney – a power of attorney is where you grant someone the power to do a specific or general act on your behalf. But generally speaking, a power of attorney comes to an end when you have a mental incapacity. So what the laws across Canada have done is said, OK, well, we want powers of attorney to endure beyond mental incapacity, so they’re a special version of a power of attorney. They endure mental incapacity. The second one is the personal directive on mental incapacity, and that’s the person in Alberta that you appoint as an agent to manage your day-to-day affairs, your accommodation, your healthcare, who you get to see, those kind of things. So those are the two documents that come in on mental incapacity, generally speaking across Canada. And then on death, obviously the will, so the will comes into play on death. So those are the three documents that lawyers concentrate on.
LS: You’ve tied together a couple of really important things already, which is the tax purpose and accounting aspects of this and the law related ones and I have heard about and read about family trusts. Should I consider one or who should consider a family trust?
PJ: That’s a question I often get, because that’s my practice, obviously. My practice is tax planning and trust law and estates, so I’m a real fan of trusts. So what I do when I speak about trust, I go back to the basics so people understand them. A trust is basically a relationship between three people, three groups of people. The person who set it up, known as the settler, the people who manage the property within the trust, known as trustees, and the people who benefit from those trust properties, being the beneficiaries. So it’s just a relationship. The settler is the person that starts it all. They set up a trust and they put trust property in it. That trust property could be an estate, for example, and they give that property to the trustees. And the trustees manage it under the terms of the trust document for the benefit of the beneficiaries. So that’s essentially what a trust is. It’s the relationship. It’s not like a company where you go and incorporate it and have to, you know, file a name search etcetera, etcetera. This is very much just a relationship scenario. There’s two types of trusts that I tell people to consider. The first one is a Latin word I guess, inter vivos, meaning during your life. So you set up a trust during your life. Those are common. The buzzword is discretionary family trusts that people set up during their lifetime. The second one is the testamentary trust. The testamentary trust is set up in the will itself, so it doesn’t come into play until you die. And it’s usually in the form of a spousal trust or trust for younger children, so children don’t get all of the estate until they’re 18, for example, they get a blended estate over time. So that’s a testamentary trust. So those are the two types of trusts that I talk about. And I really stress the point that it’s about relationships more than anything. Then, when you get into the tax side of things, it gets quite a bit different and quite a bit interesting. And I’m going to go with the testamentary trust first on the tax side, if you don’t mind. All trusts are taxpayers. And so when you die and you have a testament you trust, it’s a taxpayer. It’s a new taxpayer. You’ve created a taxpayer for the benefit of the beneficiary and the person managing it. The trustee will pay taxes on the growth of, or the income, sorry, of the trust, but the trust is taxed with marginal tax rates, like an individual for the first 36 months after death. However, the inter vivos is quite a bit different. Its tax rate is the top marginal tax rate, so it’s not that great from a tax point of view. And in fact, if you put an asset into a trust, say some shares of your private company, you’re going to report a capital gain when you put those shares in. So there’s a tax when you go in, there’s a top marginal tax rate on an inter vivos family trust, and every 21 years the trust is deemed to sell and reacquire its asset. Which means they have to pay if there’s gains, capital gains tax again. So from a tax point of view, it doesn’t sound very appetizing. Let me put it that way. But it is appetizing in my practice, and that’s because the federal government has allowed taxpayers who are 65 and older to use what they call alter ego trust. So inter vivos alter ego trusts. And they can roll. They can transfer their assets into that trust at cost, not fair market value. So there’s no capital gain on the way in and there’s no 21 year rule. It does not apply because the government is assuming that if you add 21 years to 65, you’re at 86, you’re probably dead. They don’t really worry about it too much, right. If you live to 95, then they’ve got 10 years of further deferral. But the tax rate, the marginal tax rate and the trust is still the top marginal tax rate. So that’s the two types of trust that I use. But I really am a big, big fan of the alter ego trust for anyone 65 and older.
LS: When you’re talking about these taxes and the trusts and you mentioned the beneficiaries, it brings to mind, you know, passing away and passing this property or this estate or trust onto family members, whether that’s children, a partner, what taxes would we have to be aware of as far as inheritance tax or a probate tax?
PJ: OK. So in in Canada, I get that question quite a bit because people are concerned about what they owe to the government on death. In Canada, we do not have an inheritance tax or a gift tax regime like the US, for example, and most of the European countries. What we have is when mom and dad die and they pass their estate on to the next generation, their children, there is a capital gains tax to be paid. So there’s no capital gains tax between spouses or partners, common law partners. But when they pass the estate down to the next generation, you have to think about capital gains tax. If you are American as well, and there are, especially in Calgary, a lot of Americans up here. We often get into this issue of do we have to consider US inheritance tax because the Americans are taxed not on where they reside, but because of citizenship, so they always have to worry about inheritance tax as well. And so that would be kind of a first question I ask people is are you American? So that we know if we have to deal with the IRS as well. But the probate side of things, the probate tax is your other question, depends where you are in Canada. We have the – you’ve heard the terminology Alberta Advantage before. We don’t have probate tax, our top probate tax rate is a flat $450, but other provinces have a percentage of the asset value. So for example, in British Columbia, where we have a lot of clients with recreational properties in the Okanogan, that property is subject to British Columbia probate tax. That particular property, not the Alberta property, but that particular asset and it’s a percentage and it can get quite high actually. So one of the ways to try and mitigate probate is actually to sell your asset before you die, obviously. But if you can’t do that and you want to keep it in the family then that’s where the family trust comes into play again. You put it in the family trust or you try to look at ways of putting it into the family trust. So those are the kind of taxes that you look for. You look for the capital gains tax passing on to the next generation, potentially probate tax across Canada other than Alberta, and if there’s Americans involved, then there’s definitely an inheritance tax issue to consider.
LS: We’ve given us already really great information about how property or assets might play into this. What about life insurance? Is that part of an estate plan as well?
PJ: I love life insurance. I really do. And I actually think that we should rename it. It shouldn’t be called life insurance because people don’t like talking about it because it means that I’m going to die kind of concept. I call it a liquidity contract. So it’s a contract that provides liquidity on an event and that event just happens to be death. But think of it as a liquidity contract. And what does that mean? Well, that means that it will provide a cash injection to the estate for a number of things. It could be buying out a business partner. It could be paying CRA debt, capital gains tax debt. It could be an equalization. Maybe you preferred to give the business to the one child and the other child you have to equalize and the best way to do that is through life insurance. And then you can also use it just to enhance the retirement of the surviving. So those are kind of the big things that I look at and I really think it’s a great tool and, in fact, a lot of professionals and who run their practices through professional corporations, tend to have life insurance called permanent life insurance in their company. And it’s a really good investment in my opinion and it’s a necessity to the family. The government feels that it’s a super asset of the family. They have policies to protect it around that concept. And just a wonderful tool that people, when they get older, realize that it is going to be pretty beneficial. When you’re younger, when you’re in your 30s doesn’t mean much. But when you’re my age, it starts to.
LS: Sometimes you don’t think about it until further down the line, but I really love the way you view life insurance. It doesn’t sound as, you know, as sad as it might if you think of it as a as an investment or injection of capital for those you care about. As far as estate planning, this is a dental webcast, is there anything specific to dental that is different than the usual estate planning?
PJ: I think it’s more to do with how the dentist is going to divest themselves of the practice. Meaning – so it’s part of their retirement planning as opposed to the estate at the end of the day. And from that point of view, I look at it and say, OK, your practice has matured, you’re now going to retire. How are we going to liquidate that business? How are we going to sell it? And there’s two options, and it’s not particular to dentists per se, but the two options are to sell the assets of the business or the shares of the company. And it’s pretty hard to sell the shares of your company if all of your retained earnings from all those years, all those savings in your company, are trapped in the company. Because people want to sell the shares of the company to get a thing called the Capital gains exemption, which is currently almost $1,000,000 per taxpayer. But you just don’t automatically get it when you sell shares; they have to be an active company, not a passive company. And generally speaking, professional corporations overtime become passive companies because they have so many investments within the company. So it’s more likely that the dentist will sell the assets of the company and the company will be converted. The name will be changed from a professional corporation, it’s just a family company, and it will be a company that has a bunch of assets in it that will be part of the retirement regime. So to answer your question, I think the dentists have to consider the asset sale versus the share sale. What does it mean to them? What do I have to do to clean my company up to get the share sale? Is it really worth it, etcetera, etcetera. So that’s pretty much the biggest thing that dentists can look at. They also are, as you know, really restricted on who they can sell to. It’s only to dentists, right. It’s not to to Paul Jacobson and so and it’s the same with me, with law. So their market is a quite a bit smaller than a normal business. But having said that, it’s pretty much similar to any other business – share sales, capital gains, exemptions, asset sale. If we do an asset sale and then what? That’s where I come in usually to do talks about preservation planning and how to preserve that asset, cause really what it is that company has become a super RSP for.
LS: Well, you mentioned already that some practices hold other assets within that corporation. Not all dental practices are equal, whether it’s just looking at the value of it or the size of it. How does this impact the planning process if at?
PJ: Well it goes back to the fact that the dentist is going to want to divest themselves with the practice, and I honestly believe that most practices will be asset sale practices because of the different investments within the PC. There might be life insurance. So for example, if there were life insurance and it was very valuable life insurance, to move it out of the company and to the dentist, it is a taxable event to the company and a taxable benefit to the dentist. So you’re paying a huge amount of tax just to get that out of the company. Similarly, if you have lots of investments in the company – mutual funds, stocks, bonds, things of that nature – those would all Have to be taken out and you’d have to pay, I don’t know, depending on where you are, but probably 40 percent tax on that, and there’s still a disposition within the company to clean it up. Now there are some provisions in the Income Tax Act to allow you to, what they call, butterfly those assets into a holding company, but from an Alberta point of view, that’s a pretty risky venture, potentially risky venture, because we in Alberta cannot have share ownership, voting shares can only be with the practice, the person practicing, and they can’t be with family members. They can’t have a holding company. All that kind of things. Now some provinces are different. I think British Columbia, you can have a holding company. So it really depends on what province. But there are concepts about butterflying those assets out and then just selling the dental business and using your capital gains exemption. So yeah, when you have a lot of investments in there, you’re probably going to keep them because they’re probably your super assets for your RSP. Kind of like your RSP.
LS: That’s a lot of information. I think we all really need to put into practical use, and I’m guessing it’s never too soon, and it’s never too late to start thinking about this. Thank you so much Paul for sharing all this knowledge with us. I really appreciate it. Thank you so much to our listeners as well. Is there any other little tidbit or bit of advice you can share with us.
PJ: I would love to. I would love to because my practice, you asked me, we spoke preservation planning. What that means to me is it’s a supercharged estate plan in the sense that it looks at how we protect the family assets throughout their retirement, into mental incapacity, and then onto death. Estate plans really look at mental incapacity and death. I like to think about the 25 years before that. And so what we’re doing or what I am recommending is these family trusts. They’re known as alter ego trust. If you’re 65 or older, you gotta remember that: alter ego trust. Do I need one?
LS: Thank you so much, Paul. I really appreciate the information. Thank you to our listeners as well. Be sure to subscribe on Spotify and follow us on social media to be notified every time we post a new episode. Keep brushing up!