Avoiding double taxation on death
Tuesday, February 22, 2011 at 10:06AM Why post mortem planning is a must
by: Harris Kligman, C.A. and Armando Iannuzzi, C.A.
Post mortem planning is a misnomer. It’s really pre-mortem planning for post mortem implementation.
Decisions you make today, will affect your family’s future.
You have spent a lifetime accumulating wealth and without proper planning, a portion of that wealth could be subject to double tax on death.
Deemed dispositions arising on death generally give rise to tax.
When a taxpayer dies owning shares of a private corporation, including corporations that hold real estate, marketable securities, other investment assets and shares of business corporations, there is a potential for double taxation.
Double taxation is best illustrated by way of an example. Take Mr. Smith, who recently died owning shares of a private corporation with a fair market value at the time of his death equal to $1,000,000. The value of the corporation was attributable to real estate it owned with a fair market value of $1,000,000. The corporation originally acquired the real estate for $100,000 several years ago.
Upon his passing, for Canadian tax purposes, he was deemed to have disposed of his shares of his corporation for proceeds equal to the fair market value of those shares immediately prior to his death, or $1,000,000.
As the original owner of the shares, Mr. Smith had only paid a nominal amount of money to acquire them. As a result, he realized a gain on his terminal tax return of approximately $1,000,000. The gain gave rise to tax of approximately $230,000 (assuming top marginal tax rates in Ontario).
Mr. Smith was not married and had one child, Bob, who was a beneficiary under his will. As the beneficiary, Bob became the owner of Mr. Smith’s shares.
For Canadian tax purposes, Bob was deemed to have acquired Mr. Smith’s shares for proceeds equal to the fair market value of the shares at the time of Mr. Smith’s death, or $1,000,000. What this means is that Bob could sell the shares without realizing a gain as the tax cost of his shares is equal to the fair market value of the shares.
Shortly after acquiring the corporation’s shares, Bob decided to have the corporation sell the real estate it owned. As the real estate was worth $1,000,000 and only had a cost base to the corporation of $100,000, the corporation realized a gain on the sale of the real estate of $900,000. The gain gave rise to tax in the corporation of approximately $211,500.
At this point, Mr. Smith had paid tax in his terminal tax return of approximately $230,000 as a result of the capital gain he realized on the deemed disposition of his shares. In addition to that, the corporation had paid tax of approximately $211,500 on the capital gain it realized on the sale of the real estate.
Overall, on a $1,000,000 capital gain, the Smith family paid (directly and through the corporation) a total of approximately $441,500, or 44 per cent, in tax when they should have only paid approximately $230,000, or 23 per cent.
This is double tax, and is generally the result when no action is taken in order to mitigate this exposure!
For owners of private company shares, double taxation is one of the most relevant tax risks inherent on death.
The good news is, however, that there are a number of opportunities available in the estate planning context that can be applied in order to mitigate the exposure to this potential risk. These possibilities, however, need to be anticipated and provided for during a taxpayer’s lifetime.
Whether you are bequeathing a business or other assets, a proper estate plan is the only way to ensure an effective transition of your wealth.
As with any tax planning, be wary of potential traps and pitfalls, and be sure to consult your tax professional for proper advice.
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(Harris Kligman, C.A. is Tax Partner and Armando Ianuzzi is a Tax Manager with KRP (Kestenberg Rabinowicz Partners LLP) Chartered Accountants in Markham, ON. www.krp.ca <http://www.krp.ca/> ).
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