As clients get older, some want to make estate matters as simple and convenient as possible, including adding a child’s name to their account. Clients may be motivated to do this as they believe it would simplify things upon their passing because their children would automatically take over the account. In addition, bypassing the estate also enables one to avoid probate fees, hence saving both time and money.

While this is true, clients may fail to consider other potential consequences when adding a child’s name to an account. For investment accounts, new names are not simply “added” to an account. Instead, financial institutions must close the existing account and then transfer the assets to a newly opened account under the names of all parties. Hence, with the requirement to close the account and transfer assets, this is considered a tax triggering event. Below is a scenario and question that I was able to help answer with the assistance of our FAST team.

Question:

If parents decide to add the name of their daughter to their joint account, will there be a taxable deemed disposition for the parents? The existing joint account is under Mr. Smith and Mrs. Smith. However, they are considering opening a new joint account under Mr. Smith, Mrs. Smith, and Miss Smith.

Answer:

From an income tax perspective, it depends on whether the clients give their daughter a ‘beneficial ownership’ or just gift a ‘right of survivorship’. The difference is that “ownership” provides control and possession today, whereas survivorship is intends to pass ownership and control after the owners are deceased. If they are giving her beneficial ownership, each parent would have a disposition related to their share of the account at the fair market value (FMV), triggering any unrealized gains/losses on that share. Hence, the daughter would acquire 1/3 of the account at FMV, and this would also become her adjusted cost base (ACB). Going forward, the parents and daughter would each pick up 1/3 of the income and gains earned in the account (assuming no spousal attribution rules are violated). If one parent were to pass away, there would be a disposition of their 1/3 share of the account so that the surviving spouse receives 1/6 and the child receives 1/6.  The portion that goes to the daughter would be deemed disposed of at FMV, which triggers taxes on any net gains. The portion that goes to the surviving spouse can be rolled over at cost with no tax consequences. By adding the child to the account, the parents negated the ability to benefit from a tax-free rollover of the entire account to the surviving spouse.

If the parent intends only to give the child right of survivorship, then the daughter won’t receive beneficial ownership until both spouses have passed away. In that case, there is no deemed disposition when adding her to the account. Instead, the parents continue to report all of the income and gains earned in the account. There would be a disposition of 100% of the account at FMV on the second spouse’s death, and any gains/losses realized would be taxable on that spouse’s terminal tax return. The daughter would acquire the securities at FMV, which would become her new ACB. Going forward, she would pick up the income/gains earned on the funds in the account.

The planning mentioned above may lead to some additional work to ensure all reporting is done properly. Financial institutions like ours will treat regular joint accounts as true ‘joint tenancies’ which means each party has equal legal and beneficial ownership of the assets. This means transferring assets into a new joint account will lead to a full disposition of the securities. Upon tax time, it would be up to the clients and their accountant to ensure the disposition is reported properly. For those gifting beneficial ownership, only 1/3 of the account should be deemed disposed of. For those gifting the right of survivorship, none of the assets should be disposed of. It may take some time to review to ensure all ACBs are reflected properly.

If the clients intended to gift the right of survivorship, they would need to document this somewhere. Please note that RBC DS does not look at side agreements. However, in my next blog, I will present an alternative turn-key solution that will solve the inconvenience of side agreements and the problem of closing a joint account that leads to automatic disposition reporting.  Please stay tuned!

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The content in this article is for information purposes only and does not constitute tax or legal advice. It is imperative that you obtain professional advice from qualified tax and legal advisors before acting on any of the information in this article. This will ensure that your own circumstances are properly considered and that action is taken based on the most current legislation