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Benjamin Franklin famously said, ‘Nothing is certain except death and taxes’, and when you pass away this statement rings even more true than while you are still alive. The three main taxes that are applicable when you pass away are Estate Duty, Capital Gains Tax and Income Tax. This topic can be extremely technical, and it is advised that you seek professional help when doing your estate planning. The goal of this article is to give you the background and a framework to understand where they all fit in.
In layman’s terms this is often referred to as “inheritance tax”, and is considered a wealth tax as it is largely aimed at addressing inequality. This tax is payable by individuals who reside in South Africa at the time of their death as well as South Africans living abroad. The first R30 million of the dutiable estate is taxed at a rate of 20% and 25% on anything above R30 million. The dutiable estate comprises all the deceased’s assets and liabilities after allowed deductions were made. Allowable deductions include debts, funeral and death-bed expenses, administration costs, property transferred to a surviving spouse as well as attorney and accountant fees to name but a few.
A very important deduction to also consider is so called “Section 4q deductions” which are any assets or property that will be inherited by a surviving spouse, either via a will or via the Intestate Succession Act. A simple example is where the surviving spouse inherits her late husband’s unit trust to the value of R10,000, in which case the full R10,000 will be a 4q deduction from the deceased spouse’s dutiable estate since it is inherited by a surviving spouse. In addition to these dedications the first R3.5 million of the value of the estate is not subject to Estate Duty and is known as the Section 4A rebate. Any of the Section 4A rebate that was not used in the deceased estate may be carried over as a deduction in the estate of a living spouse should they pass away. The dutiable estate does not include retirement funds or living annuities that had nominated beneficiaries elected on them.
Life policies and estates can however be a bit more complicated, but it is important to address this since life policies play an important part in holistic estate planning. Any life policy on the life of the deceased will form part of the dutiable estate, but there are exemptions to this rule, as explained below:
- Life policies owned and premiums paid for by a third party will form part of the estate, but the value of the policy in the estate will be reduced by the total premiums paid by the third party compounded at 6% per annum. The estate duty payable on the portion of these life policies owned by third parties, can be claimed from them by the executor of the estate.
- A life policy registered under an antenuptial or postnuptial contract, where the spouse and/or children are nominated as the beneficiaries, will not form part of the deceased’s dutiable estate at all.
- Any life policy that had the surviving spouse as the nominated beneficiary will also be considered deductible from the dutiable estate in accordance with the Section 4q deduction as discussed above.
- Buy and sell policies owned and paid for by the business partner of a deceased will also not form part of their estate. These policies are owned by the business partner of the deceased with the goal to buy the deceased’s shareholding in the business.
- If we consider endowment policies owned by the deceased that will not be paid out at the death of the deceased, the policy’s surrender value will form part of the deceased’s dutiable estate.
- In a situation where the life policy has the estate nominated as the beneficiary (with the goal of providing the estate with liquidity to pay expenses and not have to sell property to do so) the policy will form part of the dutiable estate. Life policies with no nominated beneficiary will also be paid out to the estate and form part of the dutiable estate.
Capital gains tax and Income tax
Every South African earning an income pays Income Tax based on their income earned during the tax year (1 March to 28 February). This tax is calculated using sliding scales by considering the amount of the taxable income earned during that year, which may include rental income, salaries, business income and investment income. When someone passes away their final Income tax needs to be calculated, which will be based on any income earned/received during the tax year that they passed away in. In their final tax return submitted to SARS they are able to utilise the annual interest exemption of R23,800 (R34,500 if older than 65) against all interest income earned. They are further granted use of the primary, secondary and tertiary tax rebates, depending on their age.
Capital Gains Tax (CGT) is payable when someone disposes of an asset and profits were made during this disposal. CGT is not a separate tax but forms part of Income tax by adding 40% of the profit made to your annual taxable income that will be taxed according to the relevant Income Tax sliding scales. The first R40,000 worth of profit made by an individual during the tax year will however be excluded from the profits used to calculate the 40% inclusion in taxable income. This exclusion is known as your annual exclusion. A simple example of this is when you buy shares at R100,000 and sell it a year later at R350,000 making a profit of R250,000. Assuming no other profits were made during this tax year, R40,000 will be deducted from the R250,000 as your annual CGT exclusion, leaving you with R210,000 taxable capital gains. But as mentioned above, only 40% of these gains (or profits) is included in your taxable income meaning R84,000 (R210,000 x 40%) forms part of this individual’s taxable income that will be taxed according to the income tax bracket within which he or she falls. Personal use items, such as a car, the furniture in your home etc, will not be considered assets for the purpose of CGT.
When someone passes away it is considered a deemed disposal of their assets to their estate which means a CGT event is triggered. The “selling” price of the asset is the market value of the asset on the day of their death. One difference is that the annual exclusion for an estate is R300,000 as opposed to the R40,000 for individuals. There is also another CGT exclusion at death where the gain of up to R2 million of the deceased’s primary residence is excluded from the capital gains when calculating the CGT payable on such a property at death. Another exemption is that any asset that is inherited by the surviving spouse will not be included in the CGT calculation at all. Such an exclusion is known as a “roll-over” since the CGT on this asset will be rolled over and be taxable when the surviving spouse eventually passes away. Important to note is that the surviving spouse inherits this asset with the same base cost (a.k.a. the same price the deceased spouse originally bought the asset at) and not the market value of the asset on the day the first spouse passed away as is the case with all the other assets.
Any assets that the executor needs to sell in the estate as part of the process of winding up the estate will also be subject to CGT, but it is important to understand that this CGT is paid by the estate, whereas the CGT discussed above is payable by the deceased as part of their final tax return before the assets were moved into the estate. CGT paid by the estate will however only be allowed the R40,000 exclusion and all the exclusions as discussed being part of the deceased’s final tax return will not be available for the estate to take advantage of.
Even though this article has only touched on the broader concepts relating to some of the taxes that become relevant when we pass away, it is clear that there is a lot to consider. It is especially important to plan for these taxes and costs when you have loved ones that are financially dependent on you that may be left vulnerable when you pass away, since they may be left with considerably less once these taxes and costs are paid as part of winding up the estate. Being married in community of property, owning your own business or having assets in a trust may also add a layer of complexity and it is therefore always a good idea to seek professional help when doing your estate planning.