Buy Sell Agreements, Charitable, and other

Question 1

A cross purchase, buy sell agreement for shares of a corporation

Answer 1

Is a buy/sell agreement that is executed amount the shareholders of a corporation, and that obligates the surviving shareholders to purchase the interest of a deceased shareholder. The agreement may specify a purchase price, or it may set out a formula by which the purchase price it to be determined.

Because the number of shares remains the same after the shareholder’s death, and the remaining shareholders are each obligated to purchase a proportionate share of the deceased shareholder’s shares, the surviving shareholders will increase their proportionate share of the business.

Question 2

Insurance policy in cross purchase buy sell agreement for shares of a corporation

Answer 2

Upon death of a shareholder, the corporation would receive the death benefit from the insurance policy.

The excess of the death benefit or face value over the policy’s ACB would be credited to the corporation’s capital dividend account.

The surviving shareholders need to receive the insurance proceeds to purchase the shares of the deceased. The need to acquire the shares of the deceased before paying a dividend from the capital dividend account.

Each of the surviving shareholders would purchase the appropriate number of shares of the deceased’s estate and pay for the shares by the issuance of a promissory note to the estate.

The surviving shares holders through the director’s could then instruct the corporation to pay them a dividend from the capital dividend account. They would use this dividend to pay off the promissory notes issued to the estate of the deceased to purchase the deceased’s shares. The dividend form the capital dividend account would be tax free.

Question 3

Share Redemption Plan

Answer 3

The agreement is between the corporation and the shareholders.

The corporation redeems the shares of the deceased. The surviving shareholders are to maintain their proportionate interests in the business.

Question 4

Sinking fund to fund a buy sell agreement

Answer 4

Riskiest method of funding a buy-sell agreement.

Using a sinking fund involves each shareholder or the corporation establishing a separate fund, making contributions to it on a regular basis in order to build up a cash reserve with which to purchase of the shares of a deceased shareholder.

Two major drawbacks of a sinking fund include accessibility to creditors and the time required to build the fund up to a suitable amount.

Because of the drawbacks of a sinking fund, most buy-sell agreements include a provision for a life insurance policy to ensure that sufficient funds are available upon the death of one of the parties to the contract. This insurance may take the form of either cross insurance whereby the shareholders own the life insurance policies on each other’s lives, or a corporate owned insurance.

Question 5

Buyout agreement

Answer 5

addresses the situation where one of the shareholders wants to dispose of his shares prior to death, perhaps at retirement or as a result of irreconcilable differences with the other owners.

Question 6

Tax credit for donations and gifts

Answer 6

is a non-refundable federal tax credit to provide income tax relief for donations and gifts.

The conversion rate on the first $200 of annual donations is the lowest income tax rate. The conversion rate for annual donations in excess of $200 is the highest income tax rate.

A taxpayer can claim federal and provincial tax credits on eligible charitable donations, up to certain limits. The charitable donations tax credit is non-refundable. A non refundable tax-credit is a tax credit that is not paid to the taxpayer if the non-refundable tax credits exceed tax otherwise payable, meaning that a non-refundable tax credit cannot be used to generate a refund.

The taxpayer is not obligated to claim his charitable donations in the current year. He can choose to claim part or none of the donations in the current year, and carry unclaimed amounts forward for up to five years.

For donations made in the year of death, unclaimed amounts cannot be carried forward, so the ITA permits unclaimed donations to be carried back one year to the year prior to death.

Question 7

Claiming spouse’s charitable donations

Answer 7

CRA will allow a taxpayer to claim both her and her spouses donations and the same carry forward rules applys.

Question 8

Limit of how much of a charitable donation can be claimed when alive and in year of death.

Answer 8

Alive, up to 75% of net income

In year of death and year prior to death, a taxpayer can claim an amount of charitable donations up to 100% of net income. In the year of death, charitable donations can be carried back one year to the year prior to death. If the income tax return for the year prior to death had been filed, the carryback would require the amendment of the income tax return prior to death.

Question 9

The variety of ways an individual can make charitable giving part of his estate plan:

Answer 9

• making the gift now - this will allow him to claim the donation on his current tax return, up to his net income limits of 75% from crown and charitable gifts, and 100% for cultural gifts.
• making the gift through his will - his will allows him to claim the donation on his tax return for the year of death and the immediately preceding year, up to the net income limits of 100% for crown gifts, charitable gifts, and cultural gifts made in the year of death
• establishing a charitable remainder trust by transferring investment assets into an inter vivos trust that names himself as the income beneficiary, and the charitable as the remainderman. He will receive a donation receipt for the present value of the estimated value of the investments at the time of his projected death, and he can claim the amount of this donation receipt in the current year, subject to the net income limits; or
• establishing a residual trust by transferring capital property in an intervivos trust that names him as the life tenant, and the charity as the reminderman. Like charitable remainder trust, his will gives him a donation receipt for the present value of the estimated value of the capital property at the time of his death, and he can claim the amount of this donation receipt in the current year, subject to net income limits.

Question 10

Residual trust

Answer 10

is a trust under which the settlor retains the right to use and enjoy the gifted property as long as he is alive or for some other specified period of time; while the charity receives the property upon his death.

The charity receives the residual interest in the property; while the settlor retains life interest. A residual trust often holds non-investment trusts, which could include real estate or art work, which the donor wishes to continue to enjoy during his lifetime, but which he wishes to pass to the charity upon his death.

Once assets are transferred to a charitable remainder or residual trust, and estate freeze is in effect. Any future capital appreciation will accrue to the charity and will not be realized until the charity disposes of the property. Charities are not taxed on capital gains, so this estate freeze benefits both the donor and the charity.

Once assets are transferred to the trust, they no longer form part of the donor’s estate.

So probate fees are not assessed on the donated assets at the time of the donor’s death.

Question 11

Life interest

Answer 11

is the right of a beneficiary to use and enjoy the trust property thoughout his lifetime. A life tenant is a beneficiary with a life interest.

Question 12

Remainder Interest

Answer 12

is a right of a beneficiary to receive title to a trust property after the death of a life tenant. A remainderman is a person having a remainder interest in a trust, a right to receive title to a property after the death of a life tenant.

Question 13

Remainder trust

Answer 13

Is a trust that provides for remainder interest. A taxpayer who wants to leave investment assets to his favourite charity, but who wants to continue to benefit from the income generated by those assets during his lifetime, may choose to establish a remainder trust.

The charity is named as the remainderman of capital beneficiary; which the donor retains a life interest. In this way, the donor continues to receive income generated by the investment assets, but the assets transfer to the charity upon his death.

In order to be eligible for the charitable donation tax credit, a remainder trust must be irrevocable and the donor amy not have any access to the capital. As a result, the charity can be certain that it will eventually receive the property.

When the trust is established, the settlor/donor is entitled to a donation receipt for the present value of the remainder trust. This is determined based on the life expectancy of the donor (or joint life expectancy if the gift is conditional on joint last to die arrangement) and an appropriate discount rate.

Question 14

Most common ways of implementing an estate freeze in corporation

Answer 14

• selling or gifting assets to the intended beneficiaries
• transferring the assets to an intervivos trust
• creating a new holding company, issuing the common shares of the holding company to the intended beneficiaries, and then rolling the existing assets into that holding company at their Adjusted Cost Base using the Section 85 rollover provisions, in exchange for preferred shares. Any future appreciation in the value of the assets accrues to the benefit of the common shareholders
• reorganizing the share structure of an existing corporation, such that the intended beneficiaries hold the common shares and the taxpayer holds the preferred shares.

Question 15

Estate freeze using an inter vivos trust

Answer 15

One way of effecting an estate freeze is to transfer the assets to be frozen into an intervivos trust. However, unless it is transferred to a spousal trust or other rollover trust, the settlor is deemed to have disposed of that property at its FMV, and this becomes the ACB for the trust. While this deemed disposition could result in a capital gain for the settlor when the assets are placed in a trust, any further capital appreciation accrues to the trust of the beneficiaries.

Inter vivos trusts used for estate freezing are subject to the 21 year rule, which means that they will face a deemed disposition of capital assets 21 years after they are created, and every 21 years there after. In order to avoid this deemed disposition, the trust deed should provide for the transfer of trust assets to the beneficiaries prior to the expiry of the 21 year period. If this is done, the beneficiaries will acquire the assets at the ACB of the trust, and the realization of capital gains will be deferred until the beneficiaries dispose of the property.

Question 16

When is an estate freeze appropriate?

Answer 16

An estate freeze is a strategy that provides the taxpayer with an opportunity to minimize the income taxes due upon his death by freezing the value of capital property at an earlier point in time, so that any future appreciation accrues to his intended beneficiaries.

An estate freeze is only an appropriate strategy if:

• the assets to be frozen are expected to appreciate in value between now and the taxpayer’s death
• the taxpayer has sufficient assets to last her throughout her retirement
• the taxpayer no longer needs the additional capital growth, and,
• the taxpayer is willing to give up some control over the assets.

Question 17

Resident of the US

Answer 17

is an individual who lives there, regardless of the length of time, with the intention of remaining there permanently.

Question 18

Resident alien

Answer 18

is an individual who is a resident of the US, but not a citzen

Question 19

non resident alien

Answer 19

is an individual who is not a citizen of the US, who choses to live there regardless of the length of time, but does not intend to remain there permanently.

Question 20

US Estate tax

Answer 20

For deaths in 2014, the US imposes an estate tax at rates ranging from 18% of taxable assets of very small estates to 40% for taxable estates over $5 million.

For deaths in 2014, before any tax credits, the estate tax on a US taxable estate in excess of $500,000 is calculated as:
–(($155,800 + (US taxable estate - $500,000) x 40&)).

A unified tax credit or unified credit is a tax credit that can be used to offset US estate and gift taxes. It is available to all US citizens, US residents and, on a prorated basis, to non-resident aliens. The tax credit effectively exempts a portion of the estate from tax.

The exclusion amount is the amount of estate assets that would effectively be exempt from US estate taxes because of the unified tax credit.

Non resident aliens can claim a portion of the unified credit proportionate to the ration of their US assets to their Worldwide assets.

The prorated unified tax credit that can be claimed by the deceased’s estate is calculated as:
*((value of US situs assets / value of Worldwide assets) x maximum unified tax credit.)

The Canada - US Tax treaty provides a martial tax credit for resident aliens and non resident aliens, in addition to the unified tax credit.

The martial tax credit is a tax credit for property that passes directly to the decedent’s spouse, provided that the property would have qualified for the estate martial deduction under US domestic law for US citizens.

The amount of the marital tax credit is calculated as:
–(the lesser of (A and B) where:
A = the amount of the prorated unified tax credit; and
B = the amount of US estate tax that would otherwise be imposed on US situs property transferred to the surviving spouse.

Upon the death of a non-resident alien, the amount of the US estate tax that would be payable is the amount calculated as:
— (estate tax on deceased’s US taxable estate - prorated unified tax credit - martial tax credit).

Question 21

Unified tax credit

Answer 21

For 2014, the maximum unified tax credit is $2,901,800

The prorated unified tax credit that can be claimed by the deceased’s estate is calculated as:
*((value of US situs assets / value of Worldwide assets) x maximum unified tax credit.)

A unified tax credit or unified credit is a tax credit that can be used to offset US estate and gift taxes. It is available to all US citizens, US residents and, on a prorated basis, to non-resident aliens. The tax credit effectively exempts a portion of the estate from tax.

The exclusion amount is the amount of estate assets that would effectively be exempt from US estate taxes because of the unified tax credit.

Non resident aliens can claim a portion of the unified credit proportionate to the ration of their US assets to their Worldwide assets.

Question 22

Step up in basis

Answer 22

A beneficiary of an estate situated in the US is entitled to receive a step up in the basis of the property inherited from the deceased’s benefactor.

Basis (American term for ACB)

Is an increase in the basis of the property to it’s FMV as the date of death, regardless of what the decedent paid for the property.

Question 23

Sale of depreciable capital property, UCC, terminal loss

Answer 23

If FMV exceeds the ACB and UCC of property, realize a capital gain and recapture of CCA to the extent the ACB exceeds the UCC.

If FMV is less than ACB , but in excess of the UCC, the taxpayer will realize a recapture of CCA to the extent the FMV exceeds the UCC.

If UCC is less than FMV, the taxpayer will realize a terminal loss to the extent the UCC exceeds FMV and this amount can be deducted from any other source of income at time of death.

Any reduction in value of a depreciable capital property is deducted as CCA or a terminal loss upon disposition of property. A taxpayer cannot realize a capital loss when he disposes of a depreciable property.

A terminal loss is a loss that arises when the last depreciable asset in a CCA pool has been disposed of and there is a balance remaining for the undepreciated capital cost pool. A terminal loss is deductible from the taxpayer’s business or property income.

Question 24

RSP Spousal contributions after death

Answer 24

The ITA allows for the personal representative to use estate assets to make one final spousal RSP contribution on behalf of the estate, subject to his RSP contribution room, provided that the contribution is made within 60 days after the end of the year of death.

Question 25

Personal amount for an eligible dependant

Answer 25

is the amount on which you may be able to claim a tax credit if, at any time in the year, you supported a dependant relative. the amount is indexed. The conversion rate is the lowest income tax rate.

For 2015, the personal amount for an eligible dependant was $11,327 and the income level cut off is $11,327.

The tax credit is calculated as:
-((the greater of ($0 and (personal amount for an eligible dependant - (the greater of ($0 and the dependant’s net income)))) x conversion rate)

You may be able to claim this amount, if at any time in the year, you met all of the following conditions at once:

• you did not have a spouse or common law, or if you did, you were not living with, supporting, or being supported by that person.
• you supported a dependant; and
• you lived with the dependant (in most cases in Canada) in a home that you maintained.

You cannot split this amount with another person. Once you claim this amount no one else can claim this amount.

You cannot claim this amount if someone is only visiting you.

In addition, at the time you met the above conditions, the dependant also must have been either:

• your parent or grandparent by blood, common law, or adoption; or
• either be under 18 years of age or have an impairment in physical or mental functions.

The personal amount is respect of spouse/common law is an amount on which you can claim a tax credit it, at any time in the year, you supported a spouse/common law.

Question 26

Clearance Certificate

Answer 26

Before a personal representative can distribute and estate, he must obtain a clearance certificate from the CRA.

A clearance certificate is a document that certifies that all income taxes, CPP contributions, and EI premiums, and interest or penalties that have been assessed to the taxpayer have been paid. If the personal representative distributes an estate without first obtaining a clearance certificate, he can be held personally responsible for any unpaid amounts.

A clearance certificate will not be issued until all required income tax returns up until death, including final return, have been filed and assessed, and all amounts owing have been paid or secured.

Question 27

The financial planning process can be adapted to estate planning

Answer 27

1) establish the client-planner engagement
2) gather client data and help your client establish objectives
3) clarify your client’s present financial status and identify any problem areas or opportunities
4) develop estate planning strategies and present the plan
5) assist with the implementation of plan
6) provide ongoing monitoring and planning assistance

Question 28

During the estate planning process, the financial planner must make a number of assumptions about the future, including:

Answer 28

• the rate of return on estate assets
• the rate of inflation and its effect on the needs of survivors
• the client’s effective tax rate at time of death, and
• the beneficiaries effective tax rates after the client’s death.

Question 29

External estate freeze under section 85

Answer 29

Under section 85 of the ITA, you can rollover your shares at your ACB. You could also rollover the shares at proceeds in excess of your ACB and trigger a capital gain that could be eligible for the lifetime capital gains exemption for shares of an eligible small business corporation. When you eventually redeem the shares of Holdco that were taken in exchange for your share of Opco, you would be subject to taxation on any capital gain from the excess of the proceeds over the ACB. A deemed disposition would occur upon death if not earlier.

A holding company is a corporation whose function includes ownership of property, frequently this property would be the common shares on an operating company.

Question 30

Crystallization of a capital gains exemption

Answer 30

is a tactic that involves creating a capital gain on the disposition of a property that is eligible for the capital gains exemption, using the capital gains exemption and thereby, increasing the ACB of the property.