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Most business owners are familiar with the taxes associated with business operations. However, they may not be as familiar with the taxes associated with the administration of an estate. When a business owner passes away, their estate becomes subject to various tax implications that can affect the distribution of assets and the financial well-being of their heirs or beneficiaries. Understanding estate taxation rules allows business owners to plan and implement effective estate strategies. This helps ensure a smoother business transition to heirs or partners, avoiding disruptions in operations or forced liquidation. It is also essential to understand how the business owner’s shares will be transferred or disposed of in the event of their passing. Shareholder agreements will often contemplate these events.

This blog will focus on the key “need-to-knows” for business owners in order to effectively minimize the tax burden on their estate and business and understand the implications of estate planning on their shareholdings.

The Consequences of a Deemed Realization

In Canada, a “deemed realization” occurs when an asset is considered sold or disposed of, regardless of whether a sale occurred. Per the Income Tax Act, death triggers a deemed realization for assets such as non-depreciable and depreciable capital properties. The realization can significantly impact a business and an estate, as the business or its shareholders may be liable for a large tax liability as a result of the deemed realization.

As a result, depending on the business’s liquidity, shareholders may need to liquidate assets to cover the tax liabilities of the business, which could affect short-term operations and the business’s long-term goals. Succession planning may also be impacted as the realization could lead to an unequal distribution of assets amongst family members, which, in turn, can change the business’s management, despite the business owner’s intentions. Further, the deemed realization is stipulated to occur at fair market value. However, evaluating a business’s assets and shares can often be complex. Without professional help, the deemed realization could result in tax liabilities that are greater than is required under the law, which is a particularly important factor when considering capital losses.

It is important for business owners to carefully plan for the consequences of a deemed realization, as it could affect not only the business, but also the heirs and beneficiaries of their estate.

Income Sprinkling

In 2018, the Canadian Revenue Agency adopted new rules regarding “income sprinkling.” They are designed to limit the ability of owners of businesses to pay dividends or distribute business income to family members that are disproportionate to that family member’s contribution to the business. The new rules operate to tax the dividends distributed to family members under the age of 18 years old at the top marginal tax rate. These are known as the “tax on splitting income” (“TOSI”) rules.

These new rules are also relevant to estate planning, as they may affect the taxation rate of inheriting property and passive income received through a private corporation. However, these rules do not apply in every circumstance, and income or dividends can still be distributed to family members if specific exclusions apply. In any event, the TOSI rules must be considered when planning for the succession of the family business.

Involuntary Transfers of Shares

Shareholders’ agreements contemplate various circumstances concerning the shareholding of a shareholder, one of which is their death. Depending on the agreement’s specifics, the business or corporation typically can acquire or dispose of the deceased shareholder’s shares, otherwise known as an involuntary transfer.

A business owner subject to such a shareholder agreement must carefully consider its provisions to understand what will happen to their shares upon their passing. Generally, the corporation may have several options, for example:

  • The other shareholders may be able to buy the shares from the deceased shareholder’s estate at fair market value or a predetermined price. This could have significant implications for the business, as the other shareholders could cede more control of the business, and the estate could have higher tax liabilities,
  • The corporation may have the right to redeem the deceased shareholder’s shares, again for fair market value or a predetermined price, triggering tax liabilities, or
  • Even if the shareholder’s agreement does not restrict the transfer of shares to an estate, the corporation could require the transfer to occur subject to various legal restrictions. For instance, the shareholder’s agreement could require that the beneficiaries enter into a voting trust agreement, restricting the voting rights associated with the transferred shares. It may need the estate or its beneficiaries to vote on the shares in a particular manner, or grant voting control to specific individuals or a trustee.

Contact Bader Law in Mississauga for Experienced Advice on Estate Planning and Business Matters

Bader Law provides clients with trusted guidance on the estate planning process and corporate matters. Our experienced wills and estate lawyers guide clients on best practices in both simple and complex estate matters to ensure they have a sufficient plan in place to protect their interests and minimize their estate tax obligations. Our business team also regularly advises clients on matters involving corporate transactions, shareholder agreements and disputes, and business organizations.

Our firm represents individuals, families, and business owners in Mississauga and the Greater Toronto Area. To book a consultation with one of our lawyers, call us at 289-652-9092 or contact us online.