Estate Planning for a Business Owner with Unequal Bequests
Elena, 78, is a widow and owns all shares of a CCPC, Elmwood Tooling Ltd., with a fair market value of $4 million and a nominal ACB. She has a $600,000 RRIF, a $1.2 million principal residence, a $500,000 cottage, and $200,000 cash. Her will leaves the Elmwood shares to her son, who works in the business, and the residue to her daughter, who is not involved. Elena has no spouse or common-law partner. She has never used her lifetime capital gains exemption. Her adviser mentions an estate freeze, a secondary will, and life insurance. Elena wants to minimize tax at death and treat her children fairly, but she is concerned about probate fees and the cost of insurance. She is in good health and expects to live another 10 years. Elmwood is an active business and has been a CCPC since incorporation.
1. Identify the main tax consequences at Elena's death if she dies with the current will and no planning. Consider the shares, RRIF, residence, cottage, and lifetime capital gains exemption.
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On death, Elena is deemed to dispose of her capital property at fair market value. The Elmwood shares have a $4 million gain. If the shares are qualified small business corporation shares, Elena can claim the lifetime capital gains exemption up to the indexed limit, leaving the excess taxable at a 50% inclusion rate. The shares must meet the QSBC tests at death and throughout the prior 24 months, including the 50% active-business asset test. The shares are left to her son, not a spouse, so there is no spousal rollover.
The RRIF is deemed to be received at fair market value on death, so $600,000 is included in income unless a spouse or common-law partner is the beneficiary. Elena has no spouse, so the full amount is taxable. The principal residence can be sheltered by the principal residence exemption, assuming Elena has owned and ordinarily inhabited it and has not used the exemption on the cottage. The cottage is a capital property with an assumed gain of $400,000 if its ACB is $100,000; only one property can be designated as the principal residence for each year, so the cottage gain may be partly unprotected. The cash is not taxable. Probate fees will apply to the value of the estate passing under the will, including the shares and other assets, unless a secondary will or beneficiary designations are used.
2. Explain how an estate freeze, a secondary will, and life insurance could reduce tax, probate fees, and fairness concerns. Include the trade-offs Elena should weigh.
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An estate freeze would fix the value of Elena's interest in Elmwood at $4 million, likely through preferred shares with a redemption amount equal to the current value, and issue common shares to her son. Future growth would accrue to the son and would not be taxed in Elena's estate. The freeze reduces future deemed disposition tax and gives the son the upside, but it also transfers future value to him and may worsen the equalization problem with the daughter. The freeze should be implemented with a section 85 rollover and a valuation, and Elena should retain control and sufficient income.
A secondary will can deal with private company shares and other assets that do not require probate, while the primary will deals with assets that do require probate. In Ontario, using multiple wills can reduce probate fees because only the primary will is submitted for probate. The secondary will must be properly drafted and the assets must not be commingled with probate assets. Life insurance can provide tax-free cash outside the estate, avoiding probate, and can be used to fund the tax liability or to equalize the daughter's inheritance. The trade-off is the cost of premiums and the loss of current cash flow. Elena should consider a last-to-die or joint policy only if there is a spouse; here, a single policy on her life, owned by the estate or a trust, could be used. Beneficiary designations for the RRIF and insurance can bypass the estate and probate, but they must be coordinated with the will.