As a business owner, why should you care about estate planning? Well, if you're like most business owners, the majority of your wealth is tied to your business. And a big chunk of that wealth could be gobbled up by the tax man upon your death.
For Canadian tax purposes, you are deemed to dispose of all of your assets at their fair market value upon your death, including your business.
In order to minimize the tax consequences upon death, there are a few tax strategies that you can employ. Two of the most common being life insurance and an estate freeze.
Life Insurance:
Let's assume that the fair market value of your business is $4 million upon your death. Let's further assume that when you started your business, the value of your shares was very small - say $100.
Based on these two numbers, you are potentially exposed to tax on the accrued gain of $3,999,900 on your shares (i.e. $4,000,000 - $100). That equates to $919,000 of tax that will be due to the tax man upon your death. (This is based on a 46% marginal tax rate and does not account for the capital gains exemption).
Unless you have $919,000 in your piggy bank, you should arrange for life insurance, which has a death benefit of at least $919,000. Life insurance proceeds are tax free and can be used to pay for the estate taxes upon your death.
Estate Freeze:
Another option to minimize the $919,000 of tax is to use a tax strategy called an estate freeze.
An estate freeze will lock-in (or freeze) the value of your shares to their present fair market value. Any future growth above their frozen value will be attributed to your beneficiaries, which could include your spouse or children.
For example, assume that at the time the estate freeze is implemented, the fair market value of your shares is $1 million. Further assume, that your shares are expected to increase in value to $4 million by the time of your death.
When you pass away, only the gain on the shares up to their frozen amount, which is $999,900 (i.e. $1,000,000 - $100) will be taxed. This results in $230,000 of tax owing to the tax man ($999,900 x 23% tax rate on capital gains).
This represents a tax savings of $689,000 (i.e. $919,000 - $230,000)!
You can also compliment this strategy, an estate freeze, by buying $230,000 of life insurance. As previously indicated, life insurance proceeds are tax free.
You should consult your Chartered Accountant before undertaking any of the above mentioned strategies.