During uncertain times, it is natural for people to wonder if their affairs are in order and if their assets are protected if anything should happen to them. While we feel estate planning should always be a priority, it is especially important during this unprecedented time. In this article, we will discuss just a few items to consider in developing your estate plan.
Having a valid Will and reviewing your Will
A valid Will ensures that your property goes to your intended beneficiaries when you die. A Will is also important to ensure that your estate is processed in a timely and tax efficient manner. With the down-turn in the economy, it is important to not only ensure you have a valid Will but also review your Will to verify that it still meets your intentions given the impact of COVID-19 on your estate assets and liabilities.
Having a Power of Attorney
In light of the COVID-19 pandemic, one should also give serious thought to a power of attorney. If a serious illness renders you incapable of making financial or personal-care decisions, well-planned powers of attorney ensure that a trusted person can make these decisions on your behalf. A continuing power of attorney persists if you become mentally incapable of managing your own affairs.
Using a Capital Dividend Account (CDA) to generate tax-free distributions and reduce the value of the corporation
The CDA is a notional account that tracks various tax-free amounts that a private corporation receives. The following are amounts, among others, that are added to a private corporation’s CDA balance:
- Non-taxable portion of capital gains in excess of non-deductible portion of capital losses realized by the corporation;
- Capital dividends received by the corporation; and
- Proceeds of life insurance policies that are tax exempt.
To pay a tax-free dividend from its CDA, the corporation must file a tax election to designate the amount of the dividend to be a capital dividend and must file prescribed supporting documents. Failure to file the tax election and supporting documents by the due date will result in a penalty that increases monthly.
A corporation’s CDA is valuable because it indicates the amount that an individual shareholder can receive as tax-free distributions from the corporation while reducing the value of the corporation shares for estate purposes. Timing can be crucial to maximize the benefit of the CDA. If a corporation crystalizes losses as a way of reducing taxable income – which is certainly a strategy that many businesses are considering due to COVID-19’s effect on the economy – the corporation may be unknowingly reducing (or even eliminating) the CDA balance. Business owners who plan to incur capital losses as part of a plan to generate liquidity through the reduction of current year taxes, or recovery of prior year taxes, should consider paying out the full balance of the CDA before crystalizing those losses.
Utilizing an estate freeze or refreeze to transfer future growth to the next generation
An estate freeze refers to planning that has the effect of transferring the future growth in value of a business, investments, or other assets into the hands of subsequent generations. The current owners (typically the parents) are effectively divested of this future growth by exchanging their common shares (growth shares) for fixed value preferred shares (freeze shares) and then the next generation or a family trust then subscribes to common shares. An estate freeze then limits the value added to the parents’ Estate to the value at the date the freeze is implemented.
The main reason to implement a freeze or a refreeze is to maximize the value of the family assets that will ultimately pass to the freezor’s beneficiaries. An individual is deemed to dispose of his or her capital property on death at fair market value, so reducing the value of one’s personally held property that will be subject to these deemed disposition rules serves to reduce taxes owing from the Estate at death, and maximize the value of the family assets received by the beneficiaries from the Estate and owned directly or indirectly after the freeze. For this reason, an estate freeze becomes more effective if implemented when the assets of the freezor are expected to appreciate. During the economic downturn created by COVID-19, the value of many businesses has dropped and so it may be a good time to implement an estate freeze or refreeze.
COVID-19 has created a situation where we are considering our loved-one’s health and their economic well-being. These considerations pair well with having a proper estate plan that considers your specific family situation and goes well beyond the few topics discussed in this article. For help with your specific estate plan, feel free to reach out to your Virtus Group LLP representative.