By Mac Killoran, Fruitman Kates
Clients often have a whole new set of issues after selling their business. Several considerations require attention prior to deploying the new, generally liquid capital. These include fewer boundaries to foreign jurisdictions, residency, foreign tax rules, and estate planning for each class of assets. Business owners should review their desires and longer-term intentions for the wealth created. This would include estate intentions, planned distribution of assets upon death, philanthropy, and personal needs. The level of planning for each individual or family will be different, as there is no “cookie cutter” solution to fit everyone’s needs.
Once taxpayers understand the values and availability of assets and their planned deployment, we can look at options, integrated tax rates, compliance filings, and ownership structures. This chapter discusses estate planning strategies for selling different types of assets.
Asset Classes and Considerations
Typical asset classes include:
- Real estate
- Cars, boats, planes, and jewelry
For various asset classes, individuals can use domestic corporations, foreign corporations, partnerships, foreign partnerships, trusts, and foreign trusts (as well as personal ownership) to own the assets and potentially mitigate the taxes. However, each approach comes with complexity, incurs various filing costs, and requires accurate and timely recordkeeping. They must determine how much complexity they want in their lives and whether the added tax savings are worth the complexity and compliance costs.
As asset ownership and tax rules expand globally and countries look to increase tax revenues to cover deficits and government spending, governments will look to increase their tax revenues and increase the compliance, reporting, and scrutiny of their tax base.
General Strategies for Mitigating Taxes
Gift assets to the next generation or charities:
- Income and capital accrue to next generation.
- Capital is in the next generation’s name. You can’t take it back or control how it’s used. Consider outright gift or settlement of a family trust. Make gifts in the year of sale.
- Consider using charitable foundations or private foundations to carve out a portion of capital for future annual gifting. Schedule a future large donation you don’t have time to plan for in the year of sale.
Plan to match assets to be donated to maximize tax benefits:
- Donations are limited to 75% of taxable income prior to death and 100% in year of death.
- Confirm tax treatment of foreign donations.
- Public securities and ecological and cultural property have beneficial rules to being donated whereby gains are not taxable and the full amount of the gains are added to capital dividend accounts.
- Graduate rate estates (GREs) can carry back donations from a will to any taxation year of the GRE or estate, or the decided individual’s last two tax returns if made in the GRE within 60 months of death.
Max out RRSP, TFSA, RESP, 401K, and IRA accounts:
- Consider individual pension plans (IPPs) and additional health and welfare trust planning that maybe available.
- Bare trusts support the ability to separate legal and beneficial ownership. Tax follows beneficial ownership.
- They enable you to mitigate probate tax and provide for voting agreements.
- Bare trusts require annual compliance filings in 2022 and beyond. There are also significant penalties for late filing and failure to file.
- Have future capital accrue to the next generation to mitigate or avoid death tax.
- Canadian corporations provides current year deferral compared to personal taxes but often come with higher overall tax and higher compliance costs.
- Use trusts to gift assets or loan capital at the prescribed rates to family trust. Trusts enable you to multiply capital gains exemptions. Considerations to for taxing split income include:
- Private corporations
- Private mortgages to Canadian residents
- There are tax considerations to attribution and tax on split income (TOSI):
- Inability to freeze for income splitting with spouses
- Ability to freeze and income split with adult children (attribution at age 18, TOSI at age 24)
- Foreign corporations support both active and passive income. You must consider foreign accrual property income (FAPI) requirements and fill out form T1134 for foreign asset reporting.
Probate and U.S. estate tax planning:
- Using Canadian corporations to hold assets can mitigate provincial probate and eliminate U.S. estate taxes. However, they can cause higher integrated income tax rates.
- Canadian trusts can be used to mitigate probate and U.S. estate tax.
- Alter-ego trusts save probate tax in most provinces and provide for extended time frame for estate optimization from one year versus three years in loss carry back planning.
- There is less ability to leverage or get financing for sole purposes assets.
- There are also additional filing compliance requirements.
- In general, there is a 21-year ownership window. It does not apply to alter-ego trusts but you must be 65 years old to qualify for a tax-free rollover to an alter-ego trust.
Once taxpayers layer in the family residency, complexity of estate planning for non-residents, and deployment planning, you can look at each asset class from the estate and income tax implication requirements, as well as the benefits and disadvantages of various ownership options. As rules change and evolve, taxpayers, their executors, and trustees must stay current with tax legislation and reporting obligations to ensure they will achieve their intentions or pivot if their intentions change down the road.
As governments continue to collect and analyze data, increase their algorithms, and expand their budgets, taxpayers will face increased scrutiny from tax collection agencies and more complex compliance reporting obligations. There is not much the government can’t access if they want the data, including brokerage accounts, bank account data, credit cards, merchant accounts, utility and property tax bills, foreign tax agencies, Amazon, Shopify, PayPal, Coinbase, and other Canadian regulated crypto brokerages. You must also consider information leaks (e.g., HSBC, Panama, Paradise, Pandora) and future data leaks. Taxpayers who think their data is encrypted and secure should think twice. With increased reporting (reportable, notifiable, and GAAR rules are expanding), smart banking, blockchain, and digital currencies (i.e., crypto and government-backed coins), taxpayers’ digital footprints will be stored, making it only a matter of time before tax agencies find ways to access and use the data.
Business owners must balance complexity, tax savings, and compliance costs to maximize their estate value. It’s important to not end up in a position where “tax is wagging the dog’s tail” in estate planning. An ideal estate plan is efficient and understandable, and puts the taxpayer in the best position to continue maximizing value.