Individual & Family Income Tax Planning
The desire to reduce the tax burden which will be incurred on death is the main motivating factor behind income tax succession and estate planning.
Taxation on Death or Transfer of Assets
While succession duty, estate tax and gift tax are not currently imposed by the Federal or Ontario governments, an individual is deemed by the Act to have disposed of all of his capital property immediately before death for its fair market value at that time. There is an exception for property that is transferred to the taxpayer’s spouse or a trust for the taxpayer’s spouse as discussed below.
The Act provides that where a taxpayer disposes of anything to a non-arm’s length person for proceeds less than fair market value; or to any person by inter vivos gift, the taxpayer is deemed to have received proceeds of disposition equal to fair market value. An entrepreneur who owns shares in a family business with inherent capital gains will realize those gains on death or when he transfers the shares of the business for less than the fair market value to a child.
It is the inherent capital gains tax on the increase in value of the family business which often motivates an entrepreneur to consider how the family business can finance the transfer from one generation to the next.
Estate Planning Methods
Gift to a Spouse or Spousal Trust
One of the simplest ways for an individual to defer capital gains tax on death is to transfer the family business to a spouse or to a trust for the spouse. This, However, does not defer the tax on the accrued value of the business when transferred to the next generation, which tax will occur on death of the surviving spouse.
An election can be made under the Act so that a transfer to a spouse or to a spousal trust will occur at fair market value rather than on a rollover basis. This enables the personal representatives of the deceased entrepreneur to elect to realize sufficient gains to absorb any capital losses owing on death.
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business cannot fund the tax liability arising on death, the parent can transfer the property to a spousal trust. This allows capital gains tax to be deferred until the death of the spouse, but ensures that the family business is eventually transferred to the next generation. This approval also defers the problem of funding the tax liability to the children.
A spousal trust will, however, not be appropriate in all circumstances. Vesting of the family business in the children will be delayed until the death of the spouse. The desire of the children to increase the value of the business by reinvesting income to allow for expansion may be at odds with the surviving spouse’s need for income. Perhaps most likely to cause problems is the transfer of a family business to a spousal trust for a second spouse where the children are actively involved in the family business and the relationship between the spouse and the children is not good. In such a case, the potential for disruption of the operation of the family business may be sufficiently serious to forego the tax deferral and to make instead a direct transfer of the family business to the next generation. However, in Ontario, a spouse’s right to elect to take an equalization of net family property rather than what is provided under the will must also be considered.
Property in the U.S
If you own property in the U.S., your estate may have to pay U.S. estate tax on the property after your death. The U.S. imposes its estate tax on all assets owned by Canadians that it considers to be U.S. property, which includes real property such as vacation homes and may include other items such as furniture. In addition, shares in U.S. corporations and U.S. Government Savings Bonds are considered U.S. property even if the certificates are kept in Canada.
Where there are significant assets outside the family business, some thought should be given to establishing both a spousal trust and a family trust under a will, so that assets with an inherent capital gain can be transferred to the spousal trust and the tax deferral obtained and other assets with little or no inherent capital gains can be available for the children.