5 tax and estate mistakes

February 28, 2014 | Last updated on February 28, 2014
3 min read

This article looks at five damaging tax and estate planning errors you can make as an entrepreneur.

1. Not using your spouse to protect wealth

While you and your spouse are a family unit, every person is still a separate legal entity. This is particularly important in cases of exposure to creditors.

You can take the simple step of transferring assets to your spouse’s name to distance that money from creditors. As long as this isn’t done to defraud creditors, the strategy will work.

This doesn’t affect entitlement to the value of those assets in the event of marriage breakdown — in principle. But these situations are typically volatile, so asset transfers should only be done with professional guidance.

2. Failure to protect against losing the business to taxes when the owner dies

Your corporation’s shares are capital property, so on your death they’re deemed disposed for tax purposes. If your children are the beneficiaries, the tax liability may be heavy enough that the business itself could be jeopardized.

If you’re survived by a spouse, the shares can be rolled over to defer taxation. As a practical matter, however, your spouse could be unable to maintain the business.

Life insurance is the simplest strategy to ensure the tax liability doesn’t force a sale or impose a heavy debt burden on those left behind.

3. No exit strategy

When you share ownership of a corporation the expectation is that when one owner departs or dies, one or more of the others will buyout his interest. To ensure this happens, you and the other owners should execute a buy-sell agreement detailing the specifics.

Beyond making the agreement, it’s critical for there to be sufficient funding to back it up, especially for the sake of the spouse and family of a deceased shareholder. Here again, life insurance is the simplest and most cost-effective solution.

4. Paying for business insurance personally rather than corporately

When insurance is needed to pay for taxes after your death and/or to fund the transfer of the shares, it can be held personally or corporately.

While there may be reasons for holding it personally, premium cost considerations often make the corporate option more attractive.

A corporation cannot deduct the cost of insurance premiums, so it’s using after-tax dollars to pay premiums. Alternatively, you could receive taxable dividends out of the corporation to pay the premiums personally. So, no matter how small the dividend tax (which can be more than 30%), less insurance can be purchased personally.

The difference in cost would be for naught if the eventual insurance proceeds were worth different values. A corporate mechanism called the capital dividend account can be used to preserve the tax-free status of insurance proceeds, and flow them out to your spouse and other estate beneficiaries.

5. Double taxation of capital assets

Corporations can also own capital property, and the value of your shares will in part be based on the value of those underlying assets. Tax will be payable on the capital gain on share value when you dispose of the shares or when there’s a deemed disposition, as at death.

At death, the shares flow to your estate. When the estate later causes your corporation to sell the underlying capital assets (to wind up the business and distribute the estate), your corporation will pay tax on those capital gains that the deceased paid indirectly on the share value increase.

Doug Carroll, JD, LLM (Tax), CFP, TEP, is Vice President, Tax and Estate Planning, Invesco Canada.