23 Nov 2005
Altered states of being…
Eileen Reppenhagen, QuickBooks ProAdvisor
Transition from one personal state to another requires individuals to stop, take stock and start over. There are tax consequences that must be determined.
Disposition of controlling interest in a Corporation results in a deemed year end;
Adding or deleting partners to partnerships results in the formation of a new partnership;
Together to single, separation, divorced, or what I like to call “NST” (not so together); and
Alive to “Not So Alive” (“NSA” is definitely preferable to Dead).
Transitions often result in deemed dispositions and sometimes those deemed dispositions are avoidable with elections to roll assets at cost to spouses who are still alive, both in the case of separation and death.
This article is not about calculating tax consequences. In this article I will discuss some strategies for arranging and marketing your services to prepare clients for personal transitions.
If a client is separating from a spouse or partner, a statement of assets and liabilities is drawn up in order to ascertain how the net worth will be divided and what support is necessary. This accounting for the net worth and the subsequent split in net worth is normally undertaken by lawyers with their clients. Lawyers might contract this work out to an accountant to contemplate tax consequences and possible elections for tax free roll over of assets. The end result is usually a legal contract that sets out who gets what and who pays for what. There are often choices to be made about the most beneficial means of handling this transition in terms of tax credits and claims for dependents.
A final tax return and possibly several other returns are required to be filed at date of death. A list of assets and liabilities is drawn up for the Probate by lawyers in order to ascertain the probate fees. Then there is a deemed disposition at fair market value of all assets including principal residence at date of death. There are provisions to roll assets tax free in certain circumstances. Income is calculated to date of death. Any subsequent income is accounted for in the estate.
Clients tend to bypass accountants and go straight to the lawyer for this step. What if they were to visit you first because you had done the preliminary work and your client knew to come to you for assistance with the list of assets and liabilities to take to the lawyer for Probate? What are the steps?
Subsequent to the date of death, an estate or trust is established by the will. The executor of an estate or the trustee of a trust is required to account for all of the assets and liabilities up to the distribution of the estate or trust to beneficiaries. This process could take a few months or a few years or in the case of a trust, 21 years.
The executor of an estate or trust prepares financial records and files a tax return called a T3 each year. In order to file the T3, the accountant prepares a financial statement from date of death for each period until the estate is wound up. The estate is wound up when the remaining assets are disbursed to the beneficiaries of the estate. In the interim, assets might be sold, for which there are tax consequences, and liabilities might be paid from the proceeds. For example, the principal residence might be sold and there could be tax consequences between the date of death and the date of sale. Sometimes these consequences can be applied back to pre-death tax returns.
Recommended reading Canada Revenue Agency Guide T4013, T3-Trust Guide 2005 and the latest News Release from the Auditor General, Sheila Fraser on Verifying Income Tax Returns of Individuals and Trusts.
We, as accountants, should be much more pro-active about setting our clients up for transitions. Lawyers complain that accountants do legal work. I believe lawyers in some cases, are doing accounting work. It might cost your client thousands of dollars for a lawyer to prepare a list of assets and liabilities for someone in transition. Lists of assets and liabilities are accounting work. How is it that lawyers have taken on accounting work and we let them do it without even a whimper? I am not suggesting that lawyers are doing anything illegal, but I am suggesting that we as accountants might not be doing what we should have been doing right from the moment our client walked in the door.
It could be that lawyers do not know we do this kind of work. It’s surprising that lawyers even take on the challenge, because it can be extremely tedious and time consuming.
If an accountant had done the work in advance, the cost of legal preparation for a transition can be significantly reduced. Accountants should advise lawyers we are available to do this type of work, or at the very least, advertise it to our clients.
At the initial interview stage for new clients and right now for your existing clients. The next time you’re scheduled to see them is probably during tax time. You will not have time to do transition work then. What are you doing today? Start by reviewing your client list for likely transition candidates.
You might find your clients are much more amenable than you thought toward your transition readiness proposal. From first hand experience I know that women fear they will end up a bag lady; men, well, who knows exactly what they fear - I can’t speak for them as I am not one, but I am sure they have fears about transition too.
Organizational assistance is the solution.
Let’s be clear that this is not taking over a financial planner’s job, though many will offer this service, but not for the same reasons you are. Because transition is about tax consequences, you’ll want to team up with someone who has tax expertise, if you don’t have it yourself, and make this a joint effort as the rewards could be significant.
Assist with the organization of the client’s financial affairs as follows:
List assets and liabilities and identify critical documentation:
- Establish permanent files for each asset;
- Establish permanent files for each investment and RRSP account;
- Establish permanent files for insurance; and
- Establish permanent files for each liability.
Record assets and liabilities in a general ledger.
Record investments at cost, adjusted for any cost base adjustment. For example:
- Reinvested dividends on mutual funds;
- Return of capital; and
- Note: Next year’s T3 and T5 forms will show you a cost base adjustment box.
Identify cost basis for tax and contemplate documentation required in the event of a disposition of each asset.
Estimate tax consequences of disposition at current fair market value
Review net worth and establish awareness about planning for growth…this is where you send them to a financial planner if you are not in that business.
Review liabilities, including terms, interest rates and establish plan for reduction, restructuring or bankruptcy (last resort).
Have a To Do file at the front of the client’s account info box.
Make up separate files with the most current information on top for each of the following:
- Taxpayers tax returns by year;
- Bank or credit card account(s);
- Investment accounts for all years since inception including the contract to open the account;
- RRSP or RRIF accounts for all years since inception including the contract and beneficiary designations;
- Assets, for example, each rental property, principal residence, cottage, boat, car, antiques, artwork, collections, race cards, jewellery, RV’s…including acquisition cost information, purchase dates, appraisals, repairs; and
- Liabilities, for example, each mortgage, car loan, RRSP loan, business loans, including contracts, statements, and/or refinancing documents.
If you run out of room in one box, put the bank and credit card statements for each year and tax return files by year in another box. Don’t throw them out as you might need them, especially if your client gives a percentage of their estate to a charity or other beneficiary. Most clients will fit in a box or two unless they are self-employed, in which case, it might be a box or two per year, plus a permanent file box for assets and liabilities.
In times of transition, be it separation or death, oops, “NST” or “NSA” there is always stress. When we transition, we often grieve, and I read somewhere that grieving has a physical component causing the logic centre in our brain to swell. We are not at our best in terms of logic during times of transition. The last thing we want to be contemplating is a mess of papers in the days, weeks or months after a transition.
Most of your clients will love a neatly organized box of records, with each asset and liability documented and identified. It will provide them with a sense of control over their documentation. You will need to explain to them:
How the box is organized (see above);
That the records in the box should stay in the box, not be re-distributed back into their filing system;
New records should be added to the appropriate file; and
That the box should be returned each year with their tax return.
Beneficiaries, including family and especially charities are interested in maximizing their take from an estate and will actively pursue executors to ensure that past years’ tax returns were filed correctly and that their interests are protected.
The Canadian Association of Gift Planners has produced a guide for charities called Estate Administration Communications Package (Gifts of Residue to Charities). This guide explains how to protect the interests of the charity when collecting on a percentage of an estate. It is available from their website: CAGP.
The tax department also has an interest, so as executor you should always obtain a Clearance Certificate prior to distribution of the estate assets in order to protect yourself from further tax liability
My article in the April 2005 edition of ProConnection, entitled: “Shoe Box Clients” might give you more ideas about organizing, if your client has a business.
The end result is a client who is ready for a transition. Your clients will have:
- A list of assets and liabilities; and
- Organized documentation required to effect tax calculations, should the need arise to dispose of assets prior to a transition.
Should your client “check out,” as a 95-year old client of mine put it yesterday, they will not be leaving a mess behind for their executor to sort through. That doesn’t mean that you as the executor, won’t still have the pleasure of sorting through the possessions to find a love letter from 1930 in the underwear drawer. Your tears will not be about the documentation. After all it is the people, not the work that inspires us to do what we do.
Eileen Reppenhagen is a member of the: Disability Advisory Committee and the Minister of National Revenue, 2005 Committee.
Eileen is the originator and contributing author of Section 800 of the CGA Canada Public Practice Manual "Future Oriented Financial Information" (1999), and a participant in CGA Canada's Video: Taking Care of Business (2000). She may be contacted by telephone: 1 604 943-7414.