This blog was written by: Craig Coulson, Senior Trust Officer
Many professional estate administrators emphasize the emotional toll and time-consuming steps that are reduced or eliminated when a corporate executor is named in one’s will. Sometimes, beneficiaries may be unhappy with corporate executor fees, perhaps thinking if only they were appointed, they would save the estate the cost of administration. What is not frequently mentioned, is how the appointment of a professional executor may save the estate money in the long run by utilizing their professional expertise with respect to an estate’s biggest cost, tax!
When the testator passes away with a controlling interest in a private corporation, it is vital to engage a tax professional to reduce the potential of double, or even triple taxation arising on the value of the same assets. I will provide a simplistic example to illustrate the two most common wind- up strategies, the loss carryback strategy, and the pipeline planning.
How can the same assets be taxed twice? I will use an example of John, who has a will, with an estate holding a controlling interest in a holding company which owns a portfolio of investments. His Will leaves everything to his adult daughter Jane. Jane wishes to simply have the executor wind up the corporation, pay the wind-up proceeds to the estate and receive her distribution.
Upon death all capital property, including the shares of a private corporation are deemed to have been disposed of for proceeds equal to their fair market value. Any capital gain that arises from this deemed disposition is reported on the testator’s terminal T1 and taxed accordingly. Immediately following death, the deceased’s estate is considered to have acquired the shares at that fair market value, (FMV), and that FMV becomes the shares’ adjusted cost base, (ACB). Using our example of John, if the adjusted cost base of his corporate shares at death is $1, and the FMV is $100, then we have a $99 capital gain (CG). Currently, 50% of CG are included in taxable income, so $99 is taxable at a personal tax rate on taxable gains of 26.76% (50% of the 53.52% top tax rate). The tax on John’s terminal T1 would be about $26.49 and his estate would now have an adjusted cost base in his shares of $100.1
Jane has advised the executor she wants the corporation wound up, so the executor decides to liquidate the investments within the holding company, and thereafter, a wind- up dividend is paid to the estate which is taxed at the dividend tax rate. Assuming the corporation has no tax credits or notional tax accounts (refundable dividend tax on hand or capital dividend account for example) and the ordinary dividend tax rate is 47.74%, the estate has now paid tax on that $100 of 74.5%! (Capital gains tax of 26.76% and dividend tax of 47.74%). So how do we mitigate this tax exposure?
The Loss Carryback strategy utilizes s.164(6) of the Income Tax Act which allows a capital loss incurred within the first taxation year of the estate to be carried back and applied against capital gains reported on the terminal return.
How is the loss in the estate’s return created?
Once the corporate assets are liquidated and the wind-up dividend is paid, the corporation has no assets and therefore, its share value will decrease to $0. The corporation is wound up, and the shares have a FMV of $0, but an adjusted cost base of $100 to use our example. This results in a $100 capital loss, which can be carried back to the terminal return and the capital gain that arose on death is eliminated. This strategy can only be utilized in the estate’s first taxation year, so time is of the essence! With this strategy, the only tax paid is on the wind-up dividend. One should consider that the tax rate on dividends is higher than the tax rate on capital gains, so Jane will end up with about $50 when the corporation is wound up and the capital loss carryback strategy is fully implemented. A tax accountant should be consulted as complex tax credits and notional tax accounts within the corporation can reduce the impact of the dividend tax.
To summarize, the loss carryback strategy is one effective defense against the potential double taxation that can occur on death if post mortem tax planning is not undertaken. Although there is always a tax liability, one is only left with a wind-up dividend tax, rather than a capital gain and a wind-up dividend tax.
In my next post, I will discuss another, more complex tax strategy, pipeline planning.
Assuming Ontario personal tax rates
 Income Tax Act s.84(2)