An often-overlooked issue for incorporated healthcare professionals is the potential for the value of their professional corporation shares to be taxed twice (as discussed in our article, “Caution! Be aware of a double tax risk for your professional corporation”).
Fortunately, the Income Tax Act provides strategies to eliminate double tax exposure by allowing you to chose between paying tax on the value of your shares as either a dividend or a capital gain, rather than both.
One strategy to eliminate double taxation on the value of your professional corporation’s shares uses a windup of the corporation to create a capital loss that offsets your capital gain. Since the capital gain is eliminated, the only tax paid is on a deemed dividend received by your heirs.
The “windup” strategy works as follows:
Let’s say your professional corporation, based on the value of its assets, is worth $5 million. The deemed disposition of your shares (the “original shares”) at death triggers a capital gain of $5 million in your final tax return. The adjusted cost base (“ACB”) of the shares held by your estate increases to $5 million.
Next, your professional corporation is “wound up”, meaning it is dissolved and its assets distributed to its shareholders (i.e., your estate). The distribution has two tax results.
First, the distribution triggers a deemed dividend to your estate equal to the value of the assets distributed (i.e., $5 million).
Second, it triggers a disposition of the shares by your estate at their fair market value, which creates a $5 million capital loss. The capital loss is calculated based on the proceeds of disposition minus the deemed dividend and minus the share’s ACB.
Provided the loss on the shares is realized within one year of death, your estate can apply its capital loss against the capital gain in your final tax return. Accordingly, your estate does not pay any tax on the capital gain. The only tax paid is on the $5 million deemed dividend.
By arranging the withdrawal of assets from your professional corporation as a dividend, the windup strategy reduces the total tax obligation on the $5 million value of your shares by approximately $1.3 million (assuming a tax rate of 26.76 percent on capital gains).
One key point is that for this strategy to be effective, the windup of the company needs to be completed within one year of the death of the shareholder.
Planning with corporations can be very complex. Do you need help with your estate planning? The experienced team of professionals at Ernst and Company CPA are available for personalized assistance. Please contact us today.
