1. Plan to fund the deemed disposition tax that will arise on your death and defer the tax with a spousal rollover
Subject to certain limited exceptions, an individual is deemed to dispose of all assets for fair market value proceeds upon death:
- Capital gains and losses will be triggered and tax will be payable on the net capital gains – top tax rate ranges from a low of 19.5 per cent in Alberta to a high of 25 per cent in Nova Scotia.
- Your estate can make an election to pay the tax over 10 years–but interest will be charged at the prescribed rate + 4 per cent, which is not tax deductible
- Without proper planning to fund the tax, your family may need to sell your business to pay the tax
If your shares have a value of $10-million and a nominal cost, the deemed disposition tax could be as much as $2.5-million. If you have a spouse or a common law partner who survives you, the tax can be deferred if your will transfers your assets:
- to your spouse or partner directly, or
- to a “spousal trust” for the benefit of your spouse or partner
The tax is deferred until the earlier of the assets being sold or the death of your spouse or partner.
If you use a spousal trust:
- your spouse or partner must be entitled to receive all income earned by the trust, and
- no one else can receive or obtain the use of any income or capital of the trust while your spouse or partner is alive
- avoid the traps that can taint the spousal trust!
2. Consider a flexible estate freeze to prevent tax liability from increasing
The deemed disposition tax arising on your private company shares will increase as the value of your business increases–so the tax could be as much as:
- $2.5-million if the capital gain on your shares is $10-million
- $5-million if the capital gain doubles to $20-million before your death
An estate freeze of your company can prevent your tax from increasing over time. It generally involves an individual exchanging their common shares for preferred shares that have a fair market value equal to the value of the common shares and requires a valuation. But the structure can be very flexible:
- You can control your company after the freeze
- The new common shares can be owned by a trust for the benefit of you and your family members for almost 21 years
- You can be one of the trustees of the trust
- You can potentially share in the future growth after the freeze
The estate freeze structure can facilitate income splitting with adult children and possibly your spouse if they have nominal income. Once the value of the company is determined for the estate freeze, you can plan to fund the deemed disposition tax, which should not increase if you do not share in future growth.
3. Consider a redemption strategy after the freeze to reduce tax on death
A flexible estate freeze can prevent the death tax from increasing. The deemed disposition tax can be reduced and possibly eliminated by redeeming a portion of your preferred shares after the estate freeze as you require funds, instead of paying bonuses or dividends. For example, assume you freeze your company at a value of $20-million – your tax on death will be as much as $5-million:
- if you receive an annual dividend of $500,000 on your preferred shares, you will pay tax on the dividend and your death taxes will not be reduced
- if instead $500,000 of your preferred shares are bought back by your company, you pay the same tax–but your death tax will be reduced by up to $125,000 – and by $1.25-million after 10 years
4. Plan to use your capital gains exemption and to use exemptions of family members
The use of your lifetime capital gains exemption (“LCGE”) of $750,000 can reduce tax payable:
- on a sale of your shares, or
- when your shares are subject to the deemed disposition on death by up to $187,500 if your shares qualify
An estate freeze may allow you to multiply the use of the LCGE: