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Succession Planning for the Business Owner - the “Estate Freeze”

Let’s start with the law

Subsection 70(5) of the Income Tax Act provides that individuals are deemed to have sold all capital property (like a house, or shares in a company) at fair market value immediately preceding death. This is called “deemed disposition”.

Now, I’ll go off on a tangent for a moment.

For a house, if it was the deceased person’s principal residence, then the “principal residence exemption” applies so that federal tax does not have to be paid on the increase in value of the house (“capital gains”) from the date of purchase till the date of death.

However, at death, it is assumed that the deemed disposition referred to above was to the estate of the deceased, which conveniently for the government, is a separate legal entity for tax purposes. So, capital gains tax would be payable - by the estate - from the date of death till the date the house is sold. The exception is if the house is given to an adult child who has no principal residence, so that it continues as someone’s principal residence in an unbroken chain.

That is the end of my tangent. Now, what if we are looking at company shares?

Well, for shares, there is no “principal residence exemption” of course, but if we are talking about the shares of a small business, there is the “lifetime capital gains exemption” - which as of 2019 stands at around $850,000.

Say you started a business from the ground up, and back then you took $100 in shares, and the business is now worth a tidy $3,000,100, you’d have three million dollars in capital gains. Instead of being taxed on that amount at the time you sell the business, the lifetime capital gains exemption would let you reduce that amount by about $850,000.

You would still have to face paying capital gains tax on $2,150,000 however. Of course, you are still working at your business, so its value will keep increasing. One day, it might well be double what it is today. Well, the lifetime capital gains exemption won’t double just because the value of your shares in your small business have. As a result, your capital gains tax exposure will be higher still!

For small business owners, this can mean an outsized tax burden at some point in the future. An estate freeze is a handy way to halt this “taxation creep”, at least as it applies to you. It also has the added benefit of transferring control of the business to the next generation while you are still alive and can mentor them. Thirdly, it provides a way to fund your retirement by ensuring you can “cash out” of the business at some point.

So, what exactly is an estate freeze?

An estate freeze is an estate planning technique that locks in the current value and tax liability of capital property, like company shares, and attributes the value of future growth to another individual or trust. The current owner can still have some say in how the business is run, but the beneficiaries of the freeze - usually the children but possibly a family trust - can take active control, as well as reap the benefits of future growth from, and pay future taxes on, the capital property following the date of the freeze.

So, remember your small business corporation’s shares? They keep increasing in value as your business is successful year after year, right? And that keeps increasing the capital gains tax you’ll have to pay one day, right? Well, swap those “value-increasing” shares (typically called common shares) for “fixed value shares” (typically called preferred shares) in the same corporation, and presto, you’ve locked in what you’ll take out of the company and the next generation can take over the “value-increasing” shares.

The handing over of control that this process entails means that it can only happen once the “next generation”, for the purposes of the business, have been identified and are ready to take the helm.

An estate freeze doesn’t mean you sell the “fixed value shares” right away. It just means they won’t increase in value. By keeping them, you can still participate in dividend distributions. At some point however, you may want to sell them, and the corporation will then pay you out of the accumulated liquidity it has available. If you do sell, you’d owe capital gains tax at that point.

Secondly, assuming you don’t sell the shares, an estate freeze gives you the added benefit of knowing, with great certainty, what your estate’s tax liability will be at the time you pass on. This is great for estate planning, since it means you aren’t thinking of how your estate might write a cheque to the “Receiver General of Canada” for a moving figure.

Thirdly, an estate freeze gets the next generation started at little cost, and ensures they don’t have to worry about capital gains tax themselves until they are ready to sell, or until much after they put an estate freeze in place themselves.

Some Caution

It is important to know that once implemented, it is very difficult to undo an estate freeze. With that in perspective, it must be seen as bringing together retirement planning and estate planning for owners of small businesses.

Also, an estate freeze can be tricky. It must be done right. There are trip-wire Income Tax Act rules that would need to be avoided.

If you feel as though an estate freeze may be a good option to include in your estate plan, and you are resident in Ontario, we can readily assist as estate planning lawyers. We have offices in Ottawa and Toronto, and can provide services in most other parts of Ontario. We can be reached by phone at 1-888-59-WILLS.

Someone left you a house? Why you should transfer the title from the estate to yourself.

Losing a family member can be sad, stressful, and difficult.

To add to it all, the process of settling the estate of the deceased can be frustrating and complicated, and can place a strain on familial relationships. This is even more so if real estate is in the mix of the assets of the deceased.


Deemed Disposition of a Non-Principal Residence

Well, when a person dies, the government considers that the person disposed of (as in sold) all of his or her capital assets immediately before death. It’s called “deemed disposition”. Capital assets are significant pieces of property - the ones that tend to appreciate in value. The assets are all still there, but since the government considers they have been sold, capital gains tax is triggered, covering the period from the purchase to the deemed disposition of the asset. The sole exception is the principal residence of the deceased.

Capital gains tax are the taxes owed on the increase in value of capital assets. For example, for a house bought for $300,000 and sold for $700,000, capital gains tax would be due on $400,000.

Since the assets are all still there, deemed disposition can lead to a cash headache. The inheritors might have to sell a property just to pay off the government.

That, however, is just the half of it.

Deemed Disposition of a Principal Residence

Let’s say, as will be the case for many people, the capital asset was the home of the deceased. Well, that starts out as a good thing - the capital gains tax would not apply. However, the home is still transferred from the deceased to his or her estate, so, it has a new owner.

A new owner you ask? Well, the estate is seen at law as being a “legal person”, separate from the deceased and separate from the inheritors.

What does that mean? You guessed it! It restarts the clock on the capital gains tax! If the inheritors have the estate hold on to the home for years, the estate will eventually owe capital gains tax at the time it transfers or sells the home. In the case of a transfer, that of course can lead to that same cash headache. The property may have to be sold or mortgaged, just because it wasn’t transferred in a timely fashion.

When the time of transfer comes, there are a number off steps to be followed.

Probate, Transmission and Transfer

First, probate must be done. That is the step, in court, through which the Will is "approved", and the executor is empowered to act.

Second, transmission must take place. That is, a transfer from the deceased person to the executor of the deceased person, in trust. (That is, not personally.) To undertake transmission, the executor must complete a Sam completes a "Declaration of Transmission" and files it at the Land Titles Office, along with some supporting documents. Once processed, the executor takes title, in trust, and is responsible for keeping the property insured, and taking care of the ongoing house bills.

Third, a transfer must occur. That is, the house must be given to the person the deceased intended should have it. To undertake a transfer, the executor must complete a "Transfer of Land", which must also be accompanied by some other documents, and filed with the Land Titles Office. A Transfer of Land can also be used to sell the house to someone who isn't an estate inheritor, such that the resulting money is distributed to inheritors instead.

Capital gains? Transmissions before transfers? The impact of delays by the executor?

It is all proof positive that on matters concerning Wills and Estates law in Ontario, and in most other places for that matter, a terrain that appears serene can actually be full of unknown trip wires. To avoid stumbling, it is best to consult a professional. With offices in Toronto and Ottawa, and the ability to provide legal assistance in all parts of Ontario, we can readily assist with estate administration concerns. We can be reached by phone at 1-888-59-WILLS. You can also set up a consultation right on our website.

Friends forever? Estate planning and social media or digital accounts.

Access to an internet connection can provide us with plenty of opportunities - from global networks of hobbyists to platforms for sharing thoughts and pictures to marketplaces with goods you can’t find locally. Participation on these platforms can be rewarding and fun, but what happens to our online presence when we pass away?

It is evident that we can’t upload a new post to Instagram or browse for a rare pair of sneakers from the great beyond. However, many of our accounts will remain active, and any assets left on the web, like rewards points, gift cards, and alternate currencies will be stuck in limbo. Furthermore, monthly subscriptions may continue to be charged to the credit card.

In addition to the wealth that can be contained in accounts on websites such as PayPal or in cryptocurrency wallets, collections of online games, music, or films, the sentimental value of memories locked into photographs and other social media posts can be substantial. For this reason, it is crucial to include details of what you wish to happen to these assets and accounts in your Will.

Know Them and Categorize Them

The first step in properly addressing the question of what happens to digital assets after a person passes on is to have the person comprehensively list every “internet access asset” she or he has. Let’s think of “internet access assets” as every account you have online. That could be anything from Facebook to your online banking access details.

Then, categorize them. The truth is, they aren’t all the same. Which ones concern money? Which ones are all social and fun? Which ones are for work or for running a business? Which ones relate to travel? They’ll all have rules that will be similar based on the industry or concern they relate to. For example, for rewards points at certain companies, the value would not be transferable to another person, and may be reclaimed by the company when a person passes away. For online banking access, it may not be in keeping with the banking agreement to simply have the executor of the deceased person take over the username and password in order to get things done for the purposes of the estate.

Still, the first step in providing an executor with the tools to do her or his job is the inclusion of account access details - usernames and passwords - within the categorized list. This, of course, underscores a related point a Wills and Estates lawyer would readily reiterate to every client - estate documents should be kept in ironclad form. Leaving a Will in a drawer, along with account details for every internet access asset, would not be very wise. A safety deposit box or a lawyer’s office would be much more ideal.

What Gets Shuts Down? What Lives On In Digital Valhalla?

Having categorized your internet access assets, the ideal step would be to separate the items in each category into two - the accounts you wish to have shut down, and the ones you wish to have live forever in digital nirvana … or digital valhalla.

For accounts to be shut down, clear instructions can be added to your Will, and their very presence in your Will would be useful to the companies or institutions that maintain the websites at issue. In many instances, and for obvious reasons, email accounts would be on the shut-down list. Part of shutting an account down might include the prior transfer of assets with monetary value or with emotional value. The process might also include the prior purchase of physical goods that would belong to the estate and be available for distribution to beneficiaries, using points, or the payment of the debts of the deceased, using points.

Know What You Want To Give Away

The sad truth is that not much thought has been put into estate planning for the digital world. So, there aren’t really a lot of digital-world-specific rules in place. Some of the bigger players are starting to “get with the program”. For example, Facebook, through Legacy Contact, allows an account holder to designate a person who would have access after death. Google, through Inactive Account Manager, allows much the same thing, and extends the access to cases of incapacity.

That said, the majority of companies and institutions are still grappling with the issue, or perhaps just ignoring it. A recent University of London study found that 85% of cloud services providers don’t have terms in place to deal with incapacity or death. So, what to do? Well, the rules of the non-digital world can in many cases apply to digital assets. That includes, with some contractual and other limitations, the ability to give an asset away as a gift. The larger and more valuable the asset, the more likely time can be put into designing a custom legal solution to have it dealt with exactly as you’d like.

Beneficiaries can be named as recipients of some digital assets, much in the same way that beneficiaries can be left a house, a dog, or a collection of antique spoons. For example, after the tragic passing of Anthony Bourdain, the probate of his Will revealed that he left his frequent flyer miles to his estranged wife. As a travel writer and TV show host, there is wild speculation about the quantity of miles she was bequeathed. Whatever the total may be, Bourdain was right to recognize the value in these digital assets and to pass them on to someone who could make good use of them.

The opposite case on point is that of Gerry Cotten, the founder of Quadriga - Canada’s largest cryptocurrency exchange. He died suddenly at the age of 30, leaving behind unaccessible cryptocurrency worth about $250 million. No plan, no accessible details.

The real life and real death examples of both Bourdain and Cotten go to show that with “internet access assets”, the estate planning stakes are only becoming higher. Even for those without $250 million lying around on a computer, getting it right for those digital things of value - however little or much they may be worth emotionally and financially - is critical. At AFOLABI, our lawyers are able to include a comprehensive digital estate strategy within your overall plan. With offices in Toronto and Ottawa, and the ability to provide legal assistance in all parts of Ontario, we can readily assist. We can be reached by phone at 1-888-59-WILLS. You can also set up a consultation right on our website.

What is the Passing of Accounts?

What is an estate trustee? Or rather, who?

An estate trustee is the person given the responsibility of executing a Will by the person who crafted the Will. Typically, the estate trustee would be a known person, like a family member or a friend.

Is the estate trustee always an accountant or a lawyer?

Funny question, eh? The answer of course is “no”. That aside though, it is the question itself that is instructive.

There is a legal obligation on an estate trustee to keep a complete and accurate set of accounts detailing the assets of the deceased. The “passing of accounts” is the process through which a court approves those accounts. Think of it as a double-check on the work of the estate trustee. Needless to say, since the estate trustee is typically not a professional, the process of passing accounts typically includes professional advice and assistance.

Interestingly, not all accounts must be passed. For example, the beneficiaries could consent to an informal summary and release the estate trustee. Some instances in which accounts must be passed include the existence of minor, unascertained, contingent, or incapable beneficiaries, as well as when a beneficiary challenges the handling of the estate accounts.

The Process

If an estate trustee wishes to or must pass an account, there are a number of important considerations to take into account.

An estate trustee must file a series of documents with the Superior Court of Justice. They include the accounts in the proper court format; Form 74.43 - the Affidavit of the Estate Trustee Verifying Estate Accounts; Form 74.44 - The Notice of Application to Pass Accounts; and the certificate of appointment as estate trustee.

A filing fee of $322 made payable to the Minister of Finance is also required. The trustee may also be required to attend a hearing, or have an estate litigator attend as representative.

The fully detailed process for passing of accounts can be found in Ontario’s Rules of Civil Procedure. Rule 74.17 contains the form for the passing of accounts, which requires accurate records of the assets and transactions in the estate. Rule 74.18 details the process for submitting the application and the requirements for sending notice to involved parties.

If one of the beneficiaries is a minor, the Trustee or the Office of the Children’s Lawyer must be notified and involved in the process. The same is true for the Public Guardian if a beneficiary is deemed to have a disability.

If there are any objections to the accounts, the process for submitting a Notice of Objection can also be found under Rule 74.18. In order to avoid a lengthy court process, it is best for estate trustees to ensure they have a detailed and accurate account of transactions in the estate, as well as justifications for purchases.

Needless to say, with court rules and legal documents flying left, right and centre, it can be a convoluted process. So, as stated earlier, it is best for the estate trustee to seek the help of a Wills and Estates lawyer involved in estate administration matters.

Keep This in Mind

It is important for beneficiaries to note that there must be sufficient justification for raising an objection regarding an account. The temptation to turn the estate administration process into a battleground for past grievances must be resisted. Why? Let’s take a look at the 2017 Pochopsky Estate case.

In that case, four sibling beneficiaries legally compelled their estate trustee to initiate a passing of accounts in an attempt to obtain assets shared by their deceased father and his sister. All of the assets of the deceased had been settled outside of his estate, so their request was largely baseless - they were no assets for them to pursue in reality. Nevertheless, they persisted, despite repeated warnings from the estate trustee. The presiding judge ruled that the beneficiaries themselves would be liable for the $17, 445 in costs that the trustee had taken on. Yikes, eh?

Interested in estate administration generally or the passing of accounts specifically? We can readily assist. We have offices in Ottawa and Toronto, and can provide services in most other parts of Ontario. We can be reached by phone at 1-888-59-WILLS.

What are designations, and do you know what yours are?

What is a Will, anyway?

Is it the document setting out how all of your assets will be taken care of and distributed after you pass on?

Well, it can be that document. It most definitely can.

However, in our modern world, there are other documents that are often used - alongside Wills - to transfer assets or properties upon death.

They are the documents most people don’t readily bring to mind - single pieces of paper with a few questions asked and answered, that are then typically filed away or lost in the shuffle of life.

They are called “designations”.

See, in addition to the contents of your Will, there are a number of ways to pass assets on to specific family members, friends, or charities. One such vehicle - that we have already looked at - is through a trust. A designation is another such vehicle.

Much like a trust, a designation can be used to bypass the probate system. That is, the court system that includes the paying of taxes related to the value of the estate.

Think RRSP? TFSA? Life insurance? Think designations. When you open those accounts or take out those policies, you are often required to select a beneficiary who would inherit the funds if you were to pass away. The document on which you make that selection is the designation.

So, it goes without saying that all of your designations are important to your overall estate plan. If it suits your circumstances, you can choose to designate your estate as the beneficiary, ensuring all of your assets flow through your Will. If your circumstances are different, it might be better to leave your designations out of your Will.

There are some benefits in designating a loved one as a beneficiary of a specific asset. As mentioned below, the skirting of the probate system is one. Another is the fact that the transaction is kept private. A third is the fact that it is a much faster transaction compared to the process using a Will. The fourth is the fact that it is usually protected from court claims against the estate.

Planning for Time and Chance

So, designations can be just as important to your estate plan as your Will.

Apart from the reasons already enumerated above, they carry such weight (a) because of the size of the assets they can transfer, and (b) the outsize impacts a mistake or change can have on the distribution of an estate.

A designation can transfer assets valued anywhere from a few hundred to millions of dollars. For many in Ontario for instance, the remainder of a pension can constitute a sizable asset.

Also, similar to a Will, designations are susceptible to life changes. A designation made twenty years ago may no longer reflect a person’s preference, for instance. Also, at the age of 71, funds must be withdrawn from a Registered Retirement Savings Plan, but may be transferred to a Registered Retirement Income Fund. This will, of course, require a new designation and that can trigger the need to update a Will.

In addition, and also similar to a Will, designations must be set out in the final state a person would like to have them in before any incapacity sets in. Especially but not exclusively for the elderly, dementia can be a cause for concern long before death. Accidents constitute another set of possible life occurrences that can lead to mental incapacity. To prepare for such eventualities, people would typically prepare Powers of Attorney for Property. Well, the person appointed in such a document as the “attorney” can do a whole lot, but she or he cannot change a Will or a designation. The result is that a designation in place at the time a person becomes incapable of managing property is effectively “locked in”.

Live in Toronto, Ottawa, or elsewhere in Ontario, and think you might need some estate planning assistance that would see your designations plugged into your overall estate strategy in a smart and efficient way? Give us a call at 1-888-59-WILLS, or book a consultation right here on the website! We’d be happy to help you with all of your estate planning needs.
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