PREVENT YOUR ESTATE FROM BEING LEFT UNPREPARED

DEATH TAX AND INHERITANCE TAX

PREVENT YOUR ESTATE FROM BEING LEFT UNPREPARED

Tailored estate planning to meet your needs and circumstances is essential to avoid unpleasant surprises and headaches for shareholders and their heirs. Without proper planning, the estate of the deceased entrepreneur may face a hefty tax bill and little to no liquidity to cover it.

In Canada, the Income Tax Act creates a legal fiction whereby, upon death, the deceased is deemed to have disposed of all their assets, and the estate is deemed to acquire them at the same ‘price’ at the same moment. Consequently, the deceased must report the proceeds of the ‘sale’ of these assets in their final tax return. However, as the deceased is only presumed to have divested themselves of their assets, there may not necessarily be an actual sale generating capital. Settling the taxes owed, which can be a significant amount, can therefore jeopardize the financial stability of the estate.

Fortunately, there are strategies that can substantially reduce the amounts owed to the tax authorities. Although it is possible to implement some of these strategies at the time of death, the most advantageous planning is done before death as it allows for customized solutions.

Planning to save

Through thoughtful planning, it may be possible to avoid ‘double taxation’ of shares held by the deceased, meaning first taxation on capital gains, followed by a second tax on a deemed dividend. Here are some scenarios to consider with your legal advisor and tax specialist:

• Subscribe to life insurance: This allows the company to cash in the policy and obtain the necessary liquidity to buy back the shares held by the deceased before their death. The cashing of the policy increases the balance of the capital dividend account, which, in turn, allows for the payment of a non-taxable dividend to the estate that has become a shareholder, up to the balance. It is strongly recommended to periodically review the value of the contract to adjust it as needed, ensuring that the proceeds from the policy will be sufficient to buy back all shares held by the deceased shareholder, if applicable. It is also possible to include the obligation for the company to take out such life insurance in a shareholders’ agreement.

• Use choices provided by the law: Although, in general, it may not be possible to use a capital loss generated as a result of the deemed disposition of the deceased’s shares, there is an exception to the rule when certain conditions and formalities are met. The estate could, therefore, have every advantage in availing itself of this option.

• Allow or limit the “rollover”: Upon death, it is possible to transfer the shares of the deceased to the surviving spouse without a tax impact (“rollover”). However, to benefit from this option, the shares must have been irrevocably bequeathed. If there is a shareholders’ agreement granting surviving shareholders and/or the company an option to acquire the shares of the deceased, this “irrevocable bequest” no longer holds, and the option granted to the company can impede the rollover. There is, therefore, a trade-off between the desire of surviving shareholders to have a say in who can join the company and the possibility of implementing advantageous tax planning strategies for their respective estates.

• Pipeline technique: This strategy allows the estate, through the incorporation of a new company, to cash in on sums that would otherwise have been considered taxable deemed dividends without a tax impact. There are specific conditions that must be met to allow this planning to achieve its objectives, so the advice of a tax specialist is essential.

WARNING: The information contained in this article, while of a legal nature, does not constitute legal advice. It is recommended to consult with a professional for advice that will address your specific situation.