Succession, Will, Estate, and Tax Planning

Posted on by Tax Partners
01
Jan

Introduction

Succession, estate, and tax planning play a crucial role in preserving wealth and ensuring a smooth transfer of assets across generations. In Ontario, effective planning can significantly reduce tax liabilities upon death while safeguarding the interests of your beneficiaries. 

This guide explores key aspects of succession and estate planning, including taxation, methods for deferring taxes, and strategies to address challenges related to family businesses.

Taxation on Death or Transfer of Assets

In Ontario, there is no federal or provincial succession duty, estate tax, or gift tax. However, under the Income Tax Act (the Act), individuals are deemed to have disposed of all their capital property at its fair market value (FMV) immediately before their death.

Key Considerations:

  1. Spousal Transfers and Trusts: Transfers to a spouse or a spousal trust are exceptions to this rule. These transactions generally occur on a tax-deferred basis, deferring capital gains tax until the death of the surviving spouse.
  2. Non-Arm’s Length Transactions: Transfers of assets to non-arm’s length individuals or through inter vivos gifts trigger a deemed disposition at FMV, resulting in capital gains tax.

For entrepreneurs, inherent capital gains on shares of a family business can pose significant tax challenges. Planning for how these tax liabilities will be financed often motivates the development of succession and estate plans.

Estate Planning Strategies

1. Gift to a Spouse or Spousal Trust

Transferring a family business to a spouse or a spousal trust is a common way to defer capital gains tax. However, this strategy only postpones the tax liability until the death of the surviving spouse.

  • Election Option: The Act allows for transfers to occur at FMV instead of a rollover basis. This option can absorb capital losses at the time of the transfer.
  • Spousal Trust Benefits:
    • Ensures the business ultimately passes to the next generation.
    • Defers the tax liability until the death of the spouse.

However, spousal trusts may not always align with family dynamics, particularly in second marriages or cases where children are actively involved in the family business. Balancing the needs of the surviving spouse with those of the next generation requires careful planning.

2. Estate Freeze

An estate freeze is a powerful tool for transferring future growth in a business’s value to the next generation while locking in the current value for tax purposes.

  • How It Works:
    • Common shares are converted into fixed-value preference shares equal to the FMV of the business at the time of the freeze.
    • New common shares with nominal value are issued to the next generation or to a family trust.
    • Future growth in the business’s value is attributed to these new shares.
  • Benefits:
    • Defers capital gains tax until the parent’s death.
    • Allows gradual redemption of preference shares to provide income for the parent.

Estate freezes can be executed through a section 86 reorganization or a section 85 transfer, depending on the business structure. Partial freezes are also an option, allowing parents to retain a share of future growth to ensure financial security.

3. Inter Vivos Trusts

Property transfers to an inter vivos trust (other than a spousal trust) trigger a deemed disposition at FMV, resulting in immediate tax consequences.

  • Benefits of Trusts:
    • Flexibility to delay decisions about ultimate ownership.
    • Shares can be held for minor children or unborn beneficiaries.
    • Provides operational control and oversight by trustees.

However, income earned within an inter vivos trust is taxed at the top marginal rate, making it less tax-efficient compared to testamentary trusts.

Property in the United States

Owning property in the U.S. can introduce additional estate tax complexities. U.S. estate tax applies to Canadian-owned assets considered U.S. property, such as:

  • Real estate (e.g., vacation homes).
  • Shares in U.S. corporations.
  • U.S. Government Savings Bonds.

Planning strategies, such as holding U.S. property through Canadian corporations or trusts, can help minimize estate tax exposure.

Managing Control and Income

Transferring a family business requires balancing operational control, legal control, and income needs.

  1. Operational Control:
    Transitioning day-to-day management to the next generation ensures continuity. Defined roles for parents and children during this period help facilitate a smooth transition.
  2. Legal Control:
    Voting shares can be structured to retain legal control with the parents, while non-voting shares are passed to the next generation. Unanimous shareholder agreements can also be employed to govern decision-making and management.
  3. Income Considerations:
    Ensuring sufficient income for the parents post-transition is critical. This can be achieved through:

    • Employment income for ongoing contributions.
    • Redemption of preference shares.
    • Bonuses or dividends, provided they are reasonable and deductible for the business.

FAQs

  1. What happens if I die without a will?
    Without a will, your estate will be distributed according to Ontario’s intestacy laws, which may not align with your wishes. This can lead to higher taxes and disputes among heirs.
  2. Can I have a will without naming an executor?
    No, an executor is essential to administer your estate and ensure that your wishes are carried out.
  3. What is included in an estate plan?
    An estate plan includes a will, powers of attorney, trusts, and strategies for minimizing taxes and ensuring financial security for beneficiaries.
  4. When should I consider estate planning?
    It’s best to start estate planning as early as possible, especially if you own significant assets or a family business.

Conclusion

Succession, will, estate, and tax planning are essential for protecting your wealth and ensuring a seamless transition to the next generation. Strategies such as spousal trusts, estate freezes, and inter vivos trusts offer tax-efficient solutions tailored to unique family dynamics and business needs.

If you need guidance with estate planning or managing tax implications in Ontario, our experienced team is here to help. Contact us today to develop a customized plan that aligns with your goals and secures your family’s financial future.

This article is written for educational purposes.

Should you have any inquiries, please do not hesitate to contact us at (905) 836-8755, via email at [email protected], or by visiting our website at www.taxpartners.ca.

Tax Partners has been operational since 1981 and is recognized as one of the leading tax and accounting firms in North America. Contact us today for a FREE initial consultation appointment.

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