It’s a bit crude to say, but the federal measure on capital gains will probably affect the dead more than the living, so to speak. And it is similar to an increase in inheritance taxes, in a way.
Why is that ? Because taxpayers who die are required to pay taxes on all their income and gains before transferring to heirs. The presumed or actual sale of their property applies both to the stock market investment portfolio and to the chalet or triplex (the gain on the main residence remains untaxed).
The possibility is therefore great that the part of Chrystia Freeland’s measure which concerns individuals – not that on companies – affects a large proportion of deceased people. Or, in other words, that the total capital gain of these taxpayers exceeds the famous annual limit of $250,000 above which 66.7% of the gain is taxed rather than 50%.
Older taxpayers who have a large gain in view therefore have every interest in planning their affairs to minimize tax at death, so that their heirs do not suffer, if that is what they wish. I explain how later.
Deceased people represent 1.7% of people reporting a capital gain, but 16% of the total value of realized gains. The average capital gain of these deceased people is almost 10 times higher than that of living taxpayers, according to an analysis by the Chair in Taxation and Public Finance (CFFP) at the University of Sherbrooke for the year 2018.
On average, the capital gain of deceased persons is relatively small ($95,000 in Quebec and $120,000 in Canada), which demonstrates the limited impact of the federal measure on individuals.
The capital gain is probably much greater for companies, particularly portfolio companies owned by professionals (lawyers, doctors, etc.). These companies are also covered by the Freeland measure, but they do not benefit from the $250,000 threshold.
That this form of inheritance tax for certain wealthy individuals is introduced is not surprising for a rather left-wing government lacking funds. Many left-wing parties around the world – notably Québec Solidaire in the last elections – are campaigning for an inheritance tax in order to break down the inequalities that these wealth transfers perpetuate.
In Canada, such an inheritance tax practically no longer exists, but the triggering of gains on death with the payment of the related taxes plays the same role. In other words, the Freeland measure increases, in a way, which is similar to the Canadian inheritance tax.
Ways to avoid it
The law ratifying the measure has not yet been adopted, but according to the known parameters, tax expert Jean-François Thuot, of PwC, suggests ways to prevent the measure from reducing inheritance.
According to his calculations, the savings can reach $87,500 for a taxpayer who has an unrealized capital gain of $1 million.
For the portion of assets that are invested in the stock markets, the solution is quite simple. In the years preceding death, it is sufficient to sell investments each year so that the annual capital gain is below the threshold of $250,000, which therefore avoids inclusion at 66.7%. The taxpayer will have to pay tax on the gain during the year of the sale, but will have the cash to do so.
For chalets and income properties, which are less liquid, the taxpayer should gradually transfer the value to their heirs before death. And once again, the portion transferred each year must not cause a capital gain above $250,000.
For example, a parent whose two children are heirs could, initially, transfer to them each 10% of the chalet at fair market value, assuming that this 20% share does not give rise to a capital gain of more than $250,000. The father would, however, have to pay taxes on this gain in the year of the transfer and find the cash to do so.
He can start again the following year, and so on. Planning also applies to income properties, although the tax calculation is more complex, given the recovery of depreciation that had been claimed over the years.
Jean-François Thuot ran various scenarios to calculate the gains from such a strategy for assets whose capital gain would be $1 million.
In these scenarios, the gain of 1 million is spread over 4 years, at the rate of $250,000 per year. As the gain is below the threshold of $250,000, the inclusion rate is only 50% each year.
On the other hand, if the $1 million gain was triggered at the time of death, a portion of $250,000 would have been covered by the 50% inclusion rate, but the rest by the new rate of 66.7%.
According to PwC calculations, spreading the gain this way over four years would essentially save between $67,800 and $87,500, depending on the taxpayer’s annual income level.
Companies cannot use this type of planning, as they do not benefit from the $250,000 threshold. In their case, Jean-François Thuot suggests triggering the capital gain before June 25 by selling the company’s assets to another company, both owned by the same shareholder. The strategy is completely legal.
In doing so, the tax savings for the corporation in the case of a capital gain of $1 million would be around $83,600. The tax would still have to be paid, which requires the company to have the cash to do so.
As you can see, the Freeland measure has several implications. And it makes many investors nervous, Jean-François Thuot told me. Accountants’ offices will be occupied by June 25.
reference: www.lapresse.ca