Double taxation is a significant concern for the shareholders of an owner managed business. The problem arises from the deemed disposition of all an individual’s assets on death – this includes the value of the shares of the business. If the business is valued at say $2,000,000 (and the lifetime capital gains exemption is either not available or the business does not qualify), the capital gains tax on the shares would amount to approximately $480,000. If the business were to then liquidate its assets or pay out a dividend in the amount of the $2,000,000 to the estate, an additional dividend tax would range from $634,200 to $824,800 (depending on the dividend being eligible or other than eligible). This double taxation would result in an overall tax burden of up to 65.24% or $1,304,800 on the $2,000,000 leaving just $695,200 for the estate.
To mitigate this, an estate plan should be put in place and there are a few avenues a CPA could guide you through to minimize the tax due. It is important to note that waiting until after death may be too late for proper post mortem tax planning and as such, a plan should be put in place in concert with the shareholder’s will. These plans are strategies a tax specialist would be familiar with such as 164(6) planning, pipelines, bumps or a hybrid of these. Additional considerations include the use of trusts such as alter ego or joint spousal trusts.
An example of how one of these plans would work can be seen in the 164(6) plan – named as such after the section of the income tax act it relates to. This section was updated on January 1, 2016 and now available only to newly defined “graduated rate estates” (GRE).
The GRE allows the estate to carry back losses to the terminal personal return of the estate (likely by filing an amended return). To create the capital loss (to offset the deemed capital gain on death), the estate would pay a dividend equivalent to the fair market value of the shares to the estate. The dividend payment would extract cash (or result in a payable) from the company and as such devalue the shares by the same. The share, now being valued at $Nil would result in a capital loss that can be carried back to the date of death. This would eliminate the capital gains tax on the deemed disposition, leaving only the dividend tax for the estate to pay.
It is important to note for this plan, executors must make the proper election with CRA and to do so must have the authority in the deceased’s will to do so. Shares would also have not been distributed to the beneficiaries and timing is also important – with planning executed in the estates first taxation year.
In our example above, only the dividend tax rate would apply to the estate – resulting in a maximum of $824,800 in taxes payable or 41.24% – however this may be lowered significantly where preferable tax pools are available such as capital dividend accounts, eligible dividends or RDTOH balances.
Estate planning is an important tool for business owners and those with considerable estates and should be implemented with the consultation of a tax professional. It would be important to ensure your estate plan qualifies for a GRE by not going offside of the testamentary trust rules. A well purposed estate plan prepared by a tax specialist should go hand in hand with a will.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action.