The two certainties: death and taxes

There are two unfortunate certainties in life; death and taxes. And, unfortunately, tax cannot be avoided (legitimately) even by dying.

Australia is one of the very few countries in the world that has no death taxes. However, although there is no tax levied on the property of a deceased person, there may be tax consequences flowing from the dealings with the deceased assets.

This blog outlines some of the key considerations you must address.

The deceased estate

When a person dies, an executor or administrator takes control of their assets. The executor named under the (valid) Will is known as the legal representative. An administrator is appointed by the probate court when a will does not exist.

A deceased estate is not a separate legal entity but a relationship between the executor/administrator and the beneficiaries – much like a trust. The deceased estate would comprise of all assets owned by the deceased as at the date of death – except for any assets owned as joint tenants, superannuation and any assets held in a discretionary trust.

A Will covers matters such as how the assets should be shared amongst family members and other beneficiaries, trusts to be established subsequent to death, bequests to charities and institutions and funeral instructions.

A Will is a legal document and therefore should be drafted by a lawyer preferably one who practices in the area of Wills and Probate and has tax knowledge – or at least a lawyer who would work in conjunction with an accountant who is familiar with the tax treatment of such estates.

What if you don’t have a will?

If you die intestate, the Supreme Court will decide who will be your administered and who will benefit from your estate. Dying intestate creates a lot more work, cost and stress for the people you leave behind. It also might result in people benefiting from your estate who you don’t want to benefit. Therefore, for the sake of a relatively small cost and to ease some of the stress on your family, it is always best to have a valid and up-to-date will.

If you’re a single and have little assets and no special beneficiaries, a cheap will kit will probably sufficive. However, if you have any significant assets or liability, children, a spouse and so on, you really need personalised legal advice.

Taxation of assets received from a deceased estate

Death is generally not a trigger point for taxation. Assets owned by the deceased are passed onto beneficiaries without any immediate capital gains tax consequences. When an asset passes to a beneficiary, the beneficiary becomes the owner of the asset and generally inherits the same cost base and tax treatment of the deceased.

For example, if you were to inherit the main residence of the deceased, you would be eligible for the main residence CGT exemption, if the property is sold within 2 years. If you were to inherit an investment property held by the deceased, and sell it at a later stage, your cost base would be the purchase price (plus costs) initially paid by the deceased person.

Controlling assets from the grave

Often people wish to regulate the time/age their beneficiaries obtain control of the estate. For example, it is best to avoid a situation where a beneficiary inherits a substantial amount of money when they are not mature enough to make prudent financial decisions, may be under the influence of an addiction (such as gambling or drugs) or at risk of a relationship breakdown. The best way to accommodate these risks is to provide your executor with clear instructions and enough flexibility to execute those instructions effectively.

Typically, the best vehicle to facilitate this is a Testamentary Trust. A testamentary trust (usually a type of a discretionary trust), is a trust established under the terms of a Will. In this situation, some or all of the assets from the deceased estate are transferred into the Trust, and the trustee can distribute income and/or capital to any named beneficiaries. The definition of a beneficiary can be as wide as you would like to make it. You may permit the executor to establish a different testamentary trust for each beneficiary.

There are three main benefits of including a testamentary trust in your will:

Asset protection

Your will can dictate that all your assets be transferred into a testamentary trust. This will protect your estate and any “at-risk” beneficiaries. An at-risk beneficiary is someone that has a high risk of a relationship/marital breakdown or has certain self-employed or occupational risks (see this recent blog about asset protection).

Tax savings

Unlike other trusts, distributions to minors (people under the age of 18) from Testamentary Trusts are not subject to the special minors’ tax rates – meaning each minor has access to the tax-free threshold which is currently $18,200. This is advantageous if you have any children or grandchildren that are under 18 years if age. Essentially, the executor can spread the estates income across multiple minors and possible avoid paying any tax. This should also assist with minimising any future capital gains tax.

Practical benefits

Quite often beneficiaries will be at different stages from a financial strength perspective. Therefore, it is possible that one beneficiary wants to liquidate assets whereas another may want to retain assets. This can be difficult when assets will have different values e.g. property. A testamentary provides a good solution. It allows the executor to sell some assets and retain the rest in a tax effective environment.

How to minimise the risk of your will being contested

Virtually anyone can contest your will and the estate (your money) must pay for the contester’s legal costs. However, there are a few things that you can do to minimise this risk.

Firstly, be as transparent as possible with everyone that expects or doesn’t expect to benefit from your estate. If you are going to purposely give less or exclude someone, have that (sometimes difficult) conversation whilst you are alive.

Secondly, move existing or acquire future assets in entities like family trusts or own assets jointly (not tenants-in-common) with others. This minimises the pool of assets that ends up in your estate. So, if you have no or very few assets, there’s little to fight over.

Finally, make sure your will is up-to-date. It is best to review it annually to ensure the way it is structured is still correct, executors are still appropriate and so on. It’s unlikely you will need to redo your wills often but its important to consider them periodically.

Power of attorneys

A power of attorney is a document that permits someone (called your attorney) to make decisions for you and those decisions will have the same legal force as if you had made them. Practically, this is most useful in situations where you travel and are unable to sign documents and/or for individuals where their capacity is impaired due to age or illness.

Normally it is advisable to have a separate medical power of attorney. This document sets out the people that can make decisions about your medical treatment on your behalf.

Super death benefit nomination

Superannuation does not form part of your estate. Instead, the trustee of a super fund must decide where to pay your super. However, most super funds allow you to complete a binding or non-binding death benefit nomination which directs where your super is to be paid. These must be updated every 3 years. Typically, it is advisable to nominate a financial dependent (such as your children and/or spouse) to avoid the benefit being taxed.

Estate planning is crucial

The last thing you want to happen is that you work hard throughout your whole career, invest successfully and then lose a large amount of your wealth you intended for your beneficiaries to unexpected tax bills, unintended beneficiaries or avoidable legal fees and costs.

There are many factors that need to be considered in your estate planning process, from tax, asset pool distribution, wills, cash flow distributions and investment strategy. By having a well-rounded network of trusted and independent advisors, you will avoid the unnecessary complexity of estate planning whilst ensuring the intent for your wealth is seen through, well after your death. If you need help don’t hesitate to reach out to us.