Tax Strategies for Private Corporations at Death: What Canadian Financial Advisors Need to Know

As financial advisors, you often work with clients who are business owners and have built significant value inside private corporations. When these individuals pass away, the estate may face a harsh tax reality—double or even triple taxation—without proper planning. This article provides an overview of what happens on death from a tax perspective and outlines key post-mortem planning strategies you should be aware of when speaking to your business owner clients and families. In addition, we’ll explore why permanent life insurance can enhance any strategy, regardless of which one is implemented.

The Double (or Triple) Taxation Problem

Upon the death of a private corporation shareholder, Canadian tax rules trigger a deemed disposition of their shares at fair market value (FMV), resulting in a capital gain on their terminal return. However, this is only the first layer of tax. Let’s explore this first layer in more detail, followed by an additional two layers of tax exposure that can occur:

1. Tax at Death (Capital Gains Tax)

• The deceased is deemed to have sold their shares at FMV.

• If FMV > Adjusted Cost Base (ACB), a capital gain is reported on the terminal return.

• 50% of that gain is taxable.

2. Tax on Extracting Corporate Value (Deemed Dividend)

• To pass value to heirs, shares are typically redeemed, or the company is wound up.

• Proceeds to the estate are often treated as deemed dividends, taxed at higher rates.

3. Corporate-Level Tax (Asset Liquidation)

• If the company sells appreciated assets to generate cash, this triggers a third layer of tax inside the corporation.

  
  

Combined, these taxes can erode 74–80% of corporate value, depending on the province—leaving significantly less wealth for the estate.

Post-Mortem Planning Solutions

Effective post-mortem planning can reduce the overall tax burden to a single layer of taxation. Below are the three primary strategies used in practice:

1. Loss Carryback Strategy

How It Works:

• When shares are redeemed, the estate may realize a capital loss.

• This loss can be carried back to offset the capital gain reported on the terminal return.

Key Benefits:

• Clear basis in tax law, providing certainty.

• Can utilize tax pools (CDA, RDTOH) to reduce tax on deemed dividends.

Limitations:

• Must be executed within 12 months of death.

• Subject to stop-loss rules, especially where corporate-owned life insurance is involved.

Strategic Enhancements:

• “50% solution” or hybrid strategies can mitigate stop-loss restrictions and maximize use of CDA balances.

2. Pipeline Strategy

How It Works:

• The estate transfers shares to a new corporation (Newco) for a promissory note equal to FMV.

• Newco and the original operating company (Opco) merge.

• The company repays the note to the estate over time—this is not taxable, as it’s treated as a loan repayment.

Key Benefits:

• Avoids dividend taxation; only the capital gains tax at death applies.

• No hard deadline like the loss carryback.

Considerations:

• CRA expects a waiting period (1 year) and gradual repayment (3–5 years) following death.

• Business activity must continue; loss of tax pools (CDA, RDTOH) is possible.

• More complex and costly to implement.

• Subject to CRA administrative positions and potential future legislative changes.

3. Bump Strategy

How It Works:

• In combination with the Pipeline, a "bump" increases the ACB of certain corporate assets to FMV.

• Reduces corporate-level tax if assets must be sold post-mortem.

Limitations:

• Only applies to non-depreciable capital property.

• Does not affect the capital gains tax on the deceased’s final return.

Choosing the Best Strategy:

There's no single "best" plan; it depends on the specific situation.... Factors to consider include:

• What tax accounts (like CDA, RDTOH) does the company have?

• What kind of assets are inside the company?

• What do the beneficiaries need or want? (e.g., quick access to cash?)

• How much time is available? (Remember the Loss Carryback deadline).

• The costs and complexity of each strategy.

Talking to tax and legal experts is crucial to figure out the right strategy to implement.

Integrating Corporate-Owned Life Insurance

Permanent life insurance is a powerful tool in post-mortem planning. Regardless of which post-mortem strategy is implemented, corporate-owned permanent life insurance will enhance the outcome.

Key benefits:

• Tax-exempt growth within the policy.

• Tax-free death benefit paid to the corporation.

• Proceeds (less ACB) create a Capital Dividend Account (CDA) credit.

• Enables tax-free capital dividend distributions to the estate or heirs.

Insurance can also:

• Fund the tax liability from the deemed disposition created in the pipeline strategy.

• Enhance CDA planning in a loss carryback strategy.

Conclusion

Post-mortem tax planning for private corporations is complex, but essential. As a financial advisor, your role is critical in assembling the right team of tax professionals and legal advisors. This will help ensure that your clients’ estates are protected from avoidable tax erosion.