What happens to your assets when you pass away?
Rick is a retired Physician. He and his wife Janet are both Canadian and they have three children. He is incorporated and has built up savings of $3,000,000 in his corporation which includes the cash value of his life insurance. They have RSPs of $2,000,000 and they own their home which is worth $2,500,000 and have no debt. Their children are grown up and they have five grandchildren. Their Wills and Power of Attorney are up to date and Rick has a secondary Will for his corporate assets. Rick owns permanent whole life insurance on his and Janet’s life and at the time of death, the value is $2,000,000. Assuming they live off income during retirement, they want to know how will things be taxed when they pass away.
Without proper planning, taxes may consume a substantial portion of your estate and on your corporate assets; over 70% will be lost unless you plan accordingly.
- At the time of death, you may owe tax on the income earned that year, capital gains tax on capital property (i.e. your investments and the value of the shares of your corporation), registered assets (RSPs/RRIFs) are taxed as income, and if you own US property, are a US citizen/resident or have a green card you may owe tax in the United States. As an incorporated doctor, there are issues you may not be aware of with your medicine professional corporation.
- Corporations do not die when a business owner dies. Corporate bylaws or a shareholders’ agreement dictate what happens with a deceased shareholder’s shares. If there is no shareholder agreement, the shares pass according to your estate plan. Generally, when the owner 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, there are several areas of taxation that apply.
- Capital gain on the disposition of shares of the corporation. The corporation was setup with a share value of $1. The deemed value of the corporation at the time of death is at least the fair market value of these investments. This value will be taxed as a capital gain as the shares are deemed to have been disposed.
- Capital gains on the sale of investments owned by the corporation. This is where you are looking at the gains on the investments. This gain will be taxed only when the investments are sold. If the investments are not sold, there is no tax.
- Dividend tax on distribution of assets to the next generation. When the investments are sold and assets distributed, the distribution of these assets to the next generation will done so as a taxable dividend.
Assuming Rick and Janet live off their income when they retire, they want to understand the tax implications when they pass away. Below is a synopsis for discussion purposes. Upon the second death, all other things being equal, the assets are taxed as follows:
- House – Gains on the principle residences is not subject to tax.
- RSPs/RRIFs are taxed as income (53%) on the second death. Tax $1,034,859.
- Shares of the Medicine Professional Corporation. This requires your attention!
- The corporation was setup with a share value of $1. The deemed value of the corporation at the time of death is at least the fair market value of these investments plus cash value of the life insurance as this is a corporate asset.Tax $803,700.
- The life insurance is a corporate asset. Upon Rick and Janet’s death, the insurer provides $2,000,000 tax-free to the corporation. The corporation receives a capital dividend equal to the death benefit less the policies adjusted cost base ($0) of $2,000,000. This allows the life insurance to flow through the corporation tax efficiently.
- Additional issues for consideration are what the children do with the investments in the corporation. As in most cases, the children liquidate the investments, pay tax on the gains (taxed at 50.17%) and distribute these assets as a taxable dividend (46% tax). The net result is up to 70% is lost to tax.
Without proper planning up to 70% of your corporate assets will be lost to tax. Rick and Janet were good planners and recognized that life insurance as an estate asset was a prudent way to reduce overall tax to the estate. In their case we helped reduce the tax on the corporate assets from 71% to less than 24% when we and their tax accountants combined the life insurance with the Redemption and Loss carry back planning (section 164-4 of the income tax act) and/or Pipeline Planning.
Often Physicians do not realize that the shares of their corporation are taxable as the shares themselves are an asset. The amount of tax ultimately payable based on the corporate assets will depend on the type of post-mortem planning that is done - for example, loss carry back planning or pipeline planning or a combination of both.
Elliott Levine is the President of Levine Financial Group in Toronto
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 in their practice should consult with experienced corporate law, tax and financial planning advisors to discuss their specific needs and circumstances. E&OE.