Imagine you have an interest in a privately held corporation, which corporation’s underlying assets include a valuable art collection. Perhaps on your death you would like the art collection, or certain pieces, to be given to your closest friend, with the remaining assets (represented by the shares in the corporation) being given to your family. From an estate planning perspective, you have to consider whether the art collection can be stripped out (i.e. extracted) from the corporation and if so, how.
This blog reflects on some high level considerations to make when clients wish to extract certain underlying assets out of corporations on their death. (The term “trustees” used throughout this blog refers to the executors and trustees of an estate).
This discussion may be relevant to clients’ planning because in some circumstances, clients have complex corporate structures in place, however, when they think about distributions on their death and who they want to receive what assets, they speak about the corporations underlying assets.
There are a number of corporately-owned assets, other than an art collection, that a client may wish to have distributed to a beneficiary of their estate. For example, perhaps a client wants certain real estate to be distributed to a certain beneficiary. Another asset to be stripped out may be a corporate-owned life insurance policy. Perhaps a client’s estate planning involves distributing such policy’s proceeds to a given beneficiary or ensuring that such proceeds are used to satisfy tax liabilities arising on death.
For the purposes of this discussion, I refer to any assets that are to be extracted from a corporation after a client’s death as “Stripped Assets.”
When an estate planning discussion involves the possibility of stripping assets out of a corporation, you may wish to consider the following:
A) What are the tax consequences?
Stripping assets out of a corporation raises a host of issues, including tax and corporate issues. For example, will tax be triggered and if so where – within the corporation or the estate? If tax is triggered, who bears the burden of the tax consequences? In addition, how is the tax liability going to be funded? Are the answers to these questions fair to the beneficiaries affected, meaning that they result in an outcome consistent with the client’s intentions? For example, will a certain beneficiary ultimately bear the tax consequences while the client’s true intention was for the tax consequences to be borne by another beneficiary’s interest in their estate?
B) What’s the purpose of extracting the Stripped Assets?
The client may intend to ensure that Beneficiary A is able to use the Stripped Assets during their lifetime while Beneficiary B ultimately receives the shares of the associated corporation. In such a circumstance, you may wish to consider the following:
- Is it possible and appropriate to establish a trust that holds the corporate shares for the benefit of Beneficiary A during their lifetime, with a direction to permit Beneficiary A’s use of the Stripped Assets during their lifetime, while not permitting any capital distributions to Beneficiary A? Does this achieve the testator’s intentions? If the answer is ‘yes’, consider other details, such as to whom is the income going to be distributed, who would the trustees of such trust be, are there any shareholder benefit issues or tax consequences triggered?
- Would Beneficiary A want use of the Stripped Assets?
- Is there a circumstance where Beneficiary A may wish to have the value of the Stripped Assets as opposed to use of the Stripped Assets? In this scenario, drafting broad discretionary powers for the trustees into the Will may be helpful. If discretion is going to be provided to the trustees to extract the Stripped Assets for Beneficiary A, consider who the beneficiaries of Beneficiary A’s estate would be – if they would be different than your client’s, is Beneficiary A going to pressure the trustees to extract the Stripped Assets in order for Beneficiary A to have legal and beneficial ownership, enabling the Stripped Assets ultimately to be distributed according to Beneficiary A’s testamentary intentions? Is the client aware of the risks? Again, consider the client’s intentions.
Another purpose may be to ensure that Beneficiary A receives the Stripped Assets while Beneficiary B receives the remaining value of the corporation represented by shares. In addition to considerations noted above, you may wish to consider:
- What is the most tax efficient and appropriate way of accomplishing this purpose?
- Is it better to fully extract the assets or leave them in the corporation?
- Is it preferable to leave the Stripped Assets in the corporation, but establish a different class of shares representative only of such Assets to be owned by Beneficiary A? Is this possible and appropriate?
- Are there other shareholders of the corporation? If the answer is ‘yes’, what are the implications? For example, do voting rights attach to the client’s shares? If the answer is ‘no’, how may you achieve your client’s objective?
- What would the cost be of any necessary transactions to achieve this purpose? Who is bearing such cost?
C) What drafting considerations may be made?
Among other considerations, including those noted above, you may wish to consider:
- Should the Will include a direction for the trustees to take whatever steps necessary to affect the transactions involving the Stripped Assets?
- Should the Will direct that the trustees elect themselves as directors and officers of the corporation which owns the Stripped Assets?
- If the Stripped Assets are proceeds from a life insurance policy that was purchased for a specific purpose, such as satisfying tax liabilities on death, should the trustees be made aware of this? Should there be a direction that the policy’s proceeds be used for this purpose?
- If the Stripped Assets are proceeds from a life insurance policy, should the trustees be directed as to how to strip such Assets from the corporation on a tax efficient basis?
- Should the Will include directions for the trustees to obtain tax and/or other professional advice?
- Should any “direction” be rephrased as a wish and desire in order to be precatory rather than legally binding?
As demonstrated above, stripping assets from a corporation requires several considerations that may lead to more complex drafting and planning, in addition to possibly requiring assistance from professionals in complementary fields to estate planning.