Succession and estate planning

At a time when many baby-boomers are planning their retirement, the preservation and eventual transfer of your family assets are becoming a major concern. Estate planning aims to minimize the income tax consequences of meeting these objectives.

You will likely own capital property at the time of your death and, in most cases, there will be a tax liability associated with this property. Although you want your estate to be transferred in accordance with your wishes, you also want to pay as little income tax as possible. Therefore, planning has to be done during your lifetime. The main steps in the process include

  • financial planning;
  • estate freeze;
  • life insurance;
  • shareholders’ agreement, if any;
  • powers of attorney in the event of incapacity;
  • planned charitable giving, and
  • will planning.

Succession planning

The family business brings together a number of players, including shareholders, family members and employees. The survival of a business will depend on the development and implementation of a succession plan. This involves the consideration of a number of issues:

  • continuation of the business
  • development of children’s talents
  • preparation of succession
  • choice of successor
  • transfer of ownership, leadership and control of
    the business
  • adequate retirement income
  • reduction of income taxes

If you can determine your objectives in advance and start the succession process early, you have a better chance of succeeding.

Estate freeze/refreeze

You are deemed to dispose of all of your capital property at FMV immediately prior to death. This can produce a significant income tax liability in the year of death. While this deemed disposition can be deferred when assets are left to a spouse or a spousal trust, this is only a temporary solution to the problem and doesn’t solve the issue of eventual transfer to your children.

An estate freeze is a popular method of limiting death taxes. It consists primarily of transferring to a younger generation the growth potential of assets such as real estate or shares of corporations. By doing so, the asset value to the transferor is frozen at its value at the date of transfer. Accordingly, the amount of potential capital gain on death is also frozen. This will allow you to estimate your potential tax liability on death and better plan for the payment of income taxes.

You can usually accomplish an estate freeze through a transfer of assets to a corporation or an internal reorganization of capital. The mechanics can vary, but the transfer must be professionally planned to avoid the many punitive provisions of the Income Tax Act.

But what if the value of the frozen assets actually decreases after the date of the freeze? For example, assume you have an investment company that was frozen several years ago while businesses and markets were still in bull mode, but now, due to the 2008-2009 market turmoil, the value of the company is still less than it was on the date of the estate freeze. This presents an excellent tax-planning opportunity. The previously frozen assets can be “refrozen” at the lower current value, and the future increase in value can accrue to other (generally younger) family members. If you have already undertaken an estate freeze, you should consider if now is the time to do a refreeze.

When new shareholders are brought in as part of an estate freeze, a shareholders’ agreement should be prepared. At the minimum, this agreement should ensure that there are provisions for the disposal of the company’s shares, either by means of a purchase, redemption or transfer. The financing for such transactions should also be considered.

Life insurance

Life insurance is a fundamental estate planning tool. If your estate has enough liquid assets, the payment of income taxes may not be much of a problem. But if a major portion of your estate consists of shares of private companies or real estate, it may not be possible to satisfy your tax bill on death without selling off the assets.

Funding potential income taxes through the purchase of life insurance can be an effective estate-planning tool. If sufficient insurance proceeds are available and the policies are properly structured, any income tax arising on the deemed dispositions of assets on your death can be paid without resorting to the sale of your assets. As insurance needs are constantly evolving, it’s important to review your coverage on a regular basis.

As a cautionary note, the government is always looking at ways to close “loopholes” and has recently put a stop to certain more aggressive planning strategies using life insurance. As changes can be announced at any time, it’s best to consult with your tax adviser before getting involved with any planning arrangement involving life insurance.

Tax tip: If you decide to acquire life insurance to fund any income taxes owing on the deemed disposition of your private company shares, plan carefully to determine whether you or your company should own the policy. Both options have different advantages. Consultation with your tax and insurance adviser is a must.

Asset transfers

If you have decided that you have more assets than you need, you can reduce your estate probate and executor fees, and possibly income taxes upon death, if you transfer assets during your lifetime. If these assets have increased in value since acquisition, however, the transfer could cause an income tax liability. You should carefully assess which assets to transfer, to whom, and how to avoid triggering a tax liability. Complicated rules apply to income and capital gains on gifts to spouses or common-law partners and children under 18 (see topic 109).

Alter-ego and joint-partner trusts

To avoid probate fees, will substitutes—such as inter vivos trusts—have been used to transfer assets to the beneficiaries. However, a gift of assets to a non-spousal trust that names other persons as beneficiaries usually results in a disposition of those assets at fair market value for income tax purposes. This can result in the payment of significant tax at the time of the transfer.

If you’re 65 years of age or older, alter-ego and joint- partner trusts can be used to avoid having to dispose of the assets at fair market value. One of the advantages of these types of trusts is that assets can be transferred to them on a tax-deferred basis, thereby avoiding triggering any tax on accrued gains. However, there will be a deemed disposition of all property in the trust on the day you or (where applicable) your spouse or common-law partner dies, whichever is later. New rules taking effect in 2016 may adversely impact some of the more common estate planning strategies associated with these types of trusts. As these rules can be quite complex, it is recommended that you consult with your tax adviser regarding the effect that these new rules may have.

Another advantage of these trusts is that they can avoid the application of wills variation legislation in those provinces that have this legislation.

If you establish an alter-ego or joint-partner trust, you (or you and your spouse or common-law partner) must be entitled to receive all of the trust’s income prior to death, and no other person can obtain the use of any of the trust’s income or capital before your death (or that of your surviving spouse or common-law partner in the case of a joint-partner trust).

Tax tip: If you own assets with an accrued gain and live in a jurisdiction with high probate rates, talk to your financial adviser about the advisability of setting up an alter-ego or joint-partner trust.

Planned giving

The value of your estate—and, as a consequence, income taxes and estate administration fees—can be reduced by making charitable donations during your lifetime (see topic 81). The added benefit is that you also earn income tax credits during your life rather than on your death. Other benefits may include the reduction of probate fees and other estate costs.

Planned giving can take many forms. It can involve gifts of life insurance or the establishment of a private foundation, or can be as simple as reviewing your charitable objectives with a view to accelerating your intended donations now to maximize tax savings.

Since many of the planned-giving strategies involve the disposition of capital, you may also have to report income or a capital gain as the result of making a gift. As the name suggests, planned giving consists of planning and giving. “Planning” refers to a careful consideration of estate planning, financial planning and tax planning as part of making the gift. Your tax adviser can help you develop a planned-giving strategy that is most appropriate to your individual situation.

Tax tip: Planning to make significant charitable donations in your will? It may not be your best option. If you make them during your lifetime, you’ll reduce the value of your estate for probate purposes, reduce your executor fees and realize tax savings earlier.

Will planning

Both you and your spouse or common-law partner should have wills. This is probably one of the most critical elements of your estate-planning strategy, as dying intestate (without a will) can defeat almost all the estate-planning arrangements you have put into place. If you die intestate, your assets will be distributed to your spouse, children and parents in accordance with the laws of the province where you resided. This may produce quite different results from what you would have wanted.

An up-to-date will sets down the parameters of your estate plan, indicating in particular the manner in which assets are to be distributed to your heirs and ensures that your wishes are respected. A will also makes it possible to minimize the taxes payable by your estate and your beneficiaries through the use of various provisions in the tax legislation such as testamentary trusts. Since amendments to the tax laws and changes in your personal situation might change your objectives, your will should be reviewed on a periodic basis.

Tax tip: A periodic review of your will is part of prudent estate planning. It should ensure that your assets will be dealt with in accordance with your wishes in the most tax- effective manner and that your will complies with current laws, such as provincial family law acts.