Since COVID started, clients have been looking at their investments, insurance, tax and estate plan. With this in mind, we wanted to take a client scenario and help you understand exactly what happens to your assets when you and your spouse pass away.
Upon death, a taxpayer is deemed under paragraph 70(5)(a) of the Income Tax Act to have disposed of all capital property, subject to certain exceptions, for proceeds equal to their fair market value at the time of death. Resulting capital gains must be reported in the taxpayer’s tax return for the year of death (terminal return). Included in income at death is the net capital gain recognized under the deemed disposition rules. The deemed disposition rules treat capital property owned by the deceased as if it was sold immediately prior to death. Thus, all unrecognized capital gains and losses are triggered at that point with the net capital gain (gains less losses) included in income and tax is due.
The Income Tax Act contains provisions to defer the tax owing under the deemed disposition rules if the asset is left to a surviving spouse or to a special trust for a spouse (spousal trust) created by the deceased’s Will. This provision allows the spouse or the spousal trust to take ownership of the asset at the deceased’s original adjusted cost base. Hence, no tax is payable until either the spouse or the spousal trust sells the asset or until the surviving spouse dies and the assets flow to your heirs or to whoever is specified in the trust documentation.
In general, here is how assets are taxed as of 2021
- Registered assets (RRSP/RRIF) – The value of the RRSP/RRIF is taxed as income. The highest marginal tax rate is 53.53%
- Non-Registered Investments – Gains are subject to capital gains tax of 26.76%
- Vacation property/cottage – Gains are subject to capital gains tax of 26.76%
- Tax free savings account – The value flows tax free.
- Primary residence – The family home flows tax free.
What about my Corporation (i.e. Medicine Professional Corporation or Holding Company)?
Generally, when the shareholder of the corporation dies (you) and is survived by their spouse, the shares can be transferred to a spouse or spousal trust tax-free. When you and your spouse both pass and the assets are distributed to your heirs, there are up to 3 levels of taxation that may occur.
For simplicity, lets assume you have $3,000,000 in corporate investments with a cost base of $2,000,000 when you and your spouse pass away. Here is how this is taxed.
- TAX ON YOUR CORPORATE SHARES
The corporation was setup with a value of $1. The deemed value of the corporation’s shares at the time of death is the fair market value of the corporate investments (less the $1 adjusted cost base for the shares) which will be taxed as a capital gain. The shares are worth $3,000,000 and will result in a capital gain tax of $805,680.
- TAX ON THE CORPORATIONS’ INVESTMENT GAINS
Once the investments owned by the corporation (stocks, bonds, mutual funds) are sold, there is capital gains tax on these investments. Assuming the cost base of the corporation’s investments is $2,000,000, there will be a capital gain of $1,000,000. Passive investment income for Canadian Private Corporations is taxed at 50.17% which results in corporate tax on the investment gains of $251,703
- TAX ON THE ASSET DISTRIBUTION TO YOUR HEIRS
When the investments are sold and assets are ultimately distributed to your heirs (i.e. your children), the distribution of these assets will likely be done at least in-part as a taxable dividend at the heirs’ personal tax rate on dividend income. If so, the payment of taxable dividends will trigger a dividend refund from the Corporation’s RDTOH account. The highest tax rate on personal dividend income is 47.74% which would result in tax of approximately $1,147,607.
From the $3,000,000 in corporate investments, your estate will pay $2,204,990 in tax and your children will only net $795,010.
|Less capital gain tax on corporate shares||$ 805,680|
|Less corporate capital gain tax||$ 251,703|
|Less heirs personal tax on dividends:||$1,147,607|
|Equals total tax paid||$2,204,990|
|Net after tax for your children||$ 795,010|
|% Estate lost to tax||73%|
Physicians often do not realize that the shares of their corporation are taxable and the distribution of the assets to their heirs is also taxed.
Our suggestion for this client (age 64) was to convert some of his term insurance to permanent life insurance. He could have a joint plan with his spouse or an individual plan on him. He choose an joint plan on him and his wife (age 58) to provide for the tax liability when they are gone. This accomplishes two goals. First, it reallocates a small amount of income from the corporate investments to insurance which reduces the overall estate. Second, life insurance flows through the corporation tax free. There are two options for permanent insurance; universal life and participating whole life. A universal life plan has a level death benefit and minimal cash value. A whole life plan has an increasing death benefit and cash value. In this case, they converted $1,000,000 of their term insurance to a joint last to die universal life plan at a rate of $15,885/year paid by the income from his corporate investments.
Assuming life expectancy of age 85 on the spouse (29 years), the life insurance will pay out $1,000,000 to the estate tax free. If they had invested these dollars in their corporate investments, he would have to earn a guaranteed pretax equivalent annual rate of return of 11.85% thereby showing the life insurance has excellent value.
The amount of tax ultimately payable will depend on the type of post-mortem planning that is done and whether or not there are planning tools available at the time you and your spouse pass away. For example, loss carry back planning, pipeline planning, a transfer of shares and then liquidation of assets or a combination of these strategies may be useful if they are available at the time you and your spouse pass away.
One asset that your corporation can own that is guaranteed and not subject to tax is permanent life insurance.
If you want to revisit your insurance click here, call Elliott or Efe at 416-222-1311 or email email@example.com
Elliott Levine, MBA, CFP is the President of Levine Financial Group in Toronto
We Save Physicians Money on their Insurance
416-222-1311 I firstname.lastname@example.org
The above is an overview of incorporation and is not to be relied upon for definitive legal, tax or financial planning advice. Professionals interested in exploring the opportunities of incorporation of their practice should consult with experienced corporate law, tax and financial planning advisors to discuss their specific needs and circumstances. E&OE.