2004 stop loss rules. 2004 agenda overview what are stop loss rules? what is their effect?...
TRANSCRIPT
2004
Stop Loss RulesStop Loss Rules
2004
AgendaAgenda
• Overview What are Stop Loss
rules? What is their effect?
• Examples• Solutions
2004
Stop Loss RulesIncome Tax Act ss.112(3.2)
• What are they? Rules that impact business and estate Rules that impact business and estate
planning where…planning where…• Method used is corporate share redemption• Funding is with life insurance
2004
Stop loss rulesIncome Tax Act ss.112(3.2)
• What’s the effect? Assuming the rules apply to a share Assuming the rules apply to a share
disposition by the estate….disposition by the estate….• Double tax exposure• Estate loss reduced by up to 50% of capital
dividend• Capital gain taxed on terminal return is increased
Double taxation occurs because….Double taxation occurs because….• Surviving shareholders receive NO ACB increase• The gain is taxed in hand’s of deceased• The gain is taxed again when surviving
shareholder disposes of shares
2004
Company Profile
• XYZ Inc.• FMV = $2,000,000• Owners
John owns 50% of sharesJohn owns 50% of shares• ACB of John’s shares $10,000• PUC of John’s shares $10,000
Mary owns 50% of sharesMary owns 50% of shares• ACB of Mary’s shares $10,000• PUC of Mary’s shares $10,000
2004
Company Profile
• Growth rate of company2%
• Personal marginal tax rate on income 50%• Personal marginal tax rate on dividends
33%• Capital gains inclusion rate
50%
• Assume John died last night• Assume Mary sells the business in 10 years
2004
Share Redemption with corporate owned insurance
• XYZ Inc. buys $1,000,000 of life insurance on John’s life and$1,000,000 of life insurance on Mary’s life
Ag
reem
ent
Premiums
50%
50%
XYZ Inc.
2004
Share redemption with corporate owned insurance
John dies
2004
As per Buy-SellReturns shares XYZ Inc.
For cancellation
3
Share redemption with corporate owned insurance
$1,000,000Death Benefit
1
XYZ Inc. $1,000,000To purchase shares
2
John’s estate
2004
TaxationTaxation1. Premiums paid by corporation are a non-deductible expense
2. Proceeds received by the company are tax-free
3. Proceeds in excess of ACB are credited to the CDA
4. Proceeds received by the shareholder’s estate in excess of the PUC deemed a dividend. The dividend could be elected as a capital dividend
AdvantagesAdvantages1. After-tax premium cheaper if the company is in a lower tax bracket
2. Fewer policies are required (one per shareholder)
3. Premium disparities are not an issue
DisadvantagesDisadvantages
1.1. No increase in the ACB for the surviving shareholderNo increase in the ACB for the surviving shareholder2. Insurance proceeds subject to claims from the company’s creditors
Share redemption with corporate owned insurance
2004
Mary now owns 100% of XYZ Inc.
Share redemption with corporate owned insurance
2004
Tax Implications – John
FMV of John’s shares $1,000,000
ACB $10,000
Capital gain *$990,000
Loss carried back from estate ($495,000)
Adjusted capital gain $495,000
Taxable portion @ 50% $247,500
Tax payable at 50% $123,750
*Exemptions may help shelter
2004
Tax Implications – John’s EstateProceeds received $1,000,000
Less deemed dividend (Proceeds – PUC)=($1,000,000-$10,000)
($990,000)
Adjusted proceeds $10,000
Less ACB of shares to estate ($1,000,000)
Capital Loss for estate ($990,000)
Adjustment for Stop Loss Rules $495,000
Revised capital loss for estate ($495,000)
Proceeds less PUC $990,000
Capital dividend ($990,000)
Taxable Dividend $0
Tax Payable $0
2004
*Exemptions may help shelter
Tax Implications – Mary
FMV of Mary’s Shares Now $2,000,000
ACB $10,000
Future FMV of Mary’s shares (value in 10 years assuming 2% growth)
$2,440,000
Capital Gain at Mary’s Sale *$2,430,000
Taxable Portion (50%) $1,215,000
Tax @ 50% $607,500
Receives from Sale $2,440,000
Proceeds less Tax $1,832,500
2004
Stop Loss Rules
• Prior to the introduction of these rules, it was possible to eliminate all tax on the disposition of shares for a deceased shareholder
• The department of finance determined that this was an unwarranted deferral of capital gains tax and introduced the legislation
• The Stop Loss rules apply to transactions after April 26, 1995
2004
Calculating the loss stopped• The lesser of
The capital dividend received by the estate,The capital dividend received by the estate,
and The capital loss minus any taxable dividends The capital loss minus any taxable dividends
received by the estatereceived by the estate
• Minus 50% of the lesser of The deceased’s capital gain from the deemed The deceased’s capital gain from the deemed
disposition on death,disposition on death,
and The estate’s capital lossThe estate’s capital loss
• The lesser of
$990,000
$990,000 – 0 = $990,000
• Minus 50% of the lesser of
*$990,000
$990,000 – (0.5 X $990,000)=$495,00
*Exemptions may help shelter
2004
Tax Implications – JohnPre-April 26, 1995 vs Post-April 26, 1995
Pre-
April 26, 1995
Post- April 26,
1995
FMV of John’s shares $1,000,000 $1,000,000
ACB $10,000 $10,000
Capital gain *$990,000 *$990,000
Loss carried back from estate
($990,000) ($495,000)
Adjusted capital gain $0 $495,000
Taxable portion @ 50% $0 $247,500
Tax payable at 50% $0 $123,750
*Exemptions may help shelter
2004
Tax Implications – John’s EstatePre-April 26, 1995 vs Post-April 26 1995
Pre-
April 26, 1995
Post- April 26,
1995
Proceeds received $1,000,000 $1,000,000
Less deemed dividend (Proceeds – PUC)=($1,000,000-$10,000)
($990,000) ($990,000)
Adjusted proceeds $10,000 $10,000
Less ACB of shares to estate ($1,000,000) ($1,000,000)
Capital Loss for estate ($990,000) ($990,000)
Adjustment for Stop Loss Rules $0 $495,000
Revises capital loss for estate ($990,000) ($495,000)
Proceeds less PUC $990,000 $990,000
Capital dividend ($990,000) ($990,000)
Taxable Dividend $0 $0
Tax Payable $0 $0
2004
*Exemptions may help shelter
Tax Implications – MaryPre-April 26, 1995 vs Post-April 26 1995
2004
Grandfathering Opportunities
• Where a corporation was the beneficiary of a life insurance policy on the life of a taxpayer, on or before April 26,1995, where the main purpose of the insurance was to redeem shares held by the taxpayer grandfathering will be available Applies even if coverage is Applies even if coverage is
increasedincreased Policy is converted or replacedPolicy is converted or replaced Policy lapses and is reinstatedPolicy lapses and is reinstated
2004
Grandfathering Opportunities
• It is up to the taxpayer to provide CCRA with ample documentation to prove that the main purpose of the life policy was to redeem shares
2004
Grandfathering Opportunities
• Grandfathering will also be available for agreements that were in place prior to April 27, 1995 As long as the agreements As long as the agreements
are not modified in any wayare not modified in any way
2004
One way to reduce the effects of the Stop Loss Rulesis to use the
Hybrid MethodHybrid Method
2004
Hybrid Method with corporate owned insurance
• The insurance would be corporately owned but the agreement would allow flexibility in determining at death how many shares would be purchased by the surviving shareholders and how many shares will be
redeemed by the corporation.
2004
• XYZ Inc. buys $1,000,000 of life insurance on John’s life and$1,000,000 of life insurance on Mary’s life
Ag
reem
ent
Premiums
50%
50%
XYZ Inc.
Hybrid MethodHybrid Method with corporate owned insurance
2004
Hybrid Method with corporate owned insurance
John dies
2004
$500,000Promissory note
To purchase shares
Mary
4
As per Buy/Sell returns 50% of shares XYZ Inc.
For cancellation
3
Mary Now owns 100% of
XYZ Inc.
As per Buy/Sellreturns 50% of shares to Mary
5XYZ Inc. declares a capital dividend of $500,000
7
Hybrid Method with corporate owned insurance
$500,000To purchase shares
2
John’s estate$1,000,000Death Benefit
1
XYZ Inc.
2004
Tax Implications – John
FMV of John’s shares $1,000,000
ACB $10,000
Capital gain *$990,000
Loss carried back from estate ($245,000)
Adjusted capital gain $745,000
Taxable portion @ 50% $372,500
Tax payable at 50% $186,250
*Exemptions may help shelter
2004
Tax Implications – John’s Estate$500,000 of shares redeemed
Proceeds received $500,000
Less deemed dividend (proceeds-PUC)=($500,000-$10,000)
($490,000)
Adjusted proceeds $10,000
Less ACB of shares to estate ($500,000)
Capital Loss for estate ($490,000)
Adjustment for Stop Loss Rules $245,000
Revises capital loss for estate ($245,000)
Proceeds less PUC $490,000
Capital dividend ($490,000)
Taxable Dividend $0
Tax Payable $0
2004
Tax Implications – John’s Estate$500,000 of shares sold
FMV of John’s share $500,000
Less ACB of shares to estate ($500,000)
Capital Gain $0
Taxable Portion @ 50% $0
Tax Payable at 50% $0
Proceeds less Tax $500,000
2004
*Exemptions may help shelter
Tax Implications – Mary
FMV of Mary’s Shares Now $2,000,000
ACB $510,000
Future FMV of Mary’s shares (value in 10 years assuming 2% growth)
$2,440,000
Capital Gain at Mary’s Sale *$1,930,000
Taxable Portion (50%) $965,000
Tax @ 50% $482,500
Receives from Sale $2,440,000
Proceeds less Tax $1,957,500
2004
TaxationTaxation1. Premiums paid by corporation are a non-deductible expense
2. Proceeds received by the company are tax-free
3. Proceeds in excess of ACB are credited to the CDA
4. Proceeds received by shareholder’s estate in excess of PUC deemed to be a dividend. The dividend could be elected as a capital dividend
AdvantagesAdvantages1. After-tax premium expense cheaper if company is in a lower tax bracket
2. Fewer policies are required (one per shareholder)
3. Premium disparities are not an issue
4.4. Surviving shareholder gets an ACB step upSurviving shareholder gets an ACB step up
DisadvantagesDisadvantages1. Insurance proceeds subject to claims from the company’s creditors
2. Somewhat complicated arrangement
Hybrid Method with corporate owned insurance
2004
Comparing the Strategies
• Results for each of the relevant parties
2004
Tax Implications – John
FMV of John’s shares $1,000,000 $1,000,000
ACB $10,000 $10,000
Capital gain *$990,000 *$990,000
Loss carried back from estate ($495,000) ($245,000)
Adjusted capital gain $495,000 $745,000
Taxable portion @ 50% $247,500 $372,500
Tax payable at 50% $123,750 $186,250
*Exemptions may help shelter
Share Redemption Hybrid
2004
Tax Implications – John’s Estate
Proceeds received $1,000,000 $1,000,000
Less deemed dividend (redemption proceeds-PUC) ($990,000) ($490,000)
Adjusted proceeds $10,000 $510,000
Less ACB of shares to estate ($1,000,000) ($1,000,000)
Capital Loss for estate ($990,000) ($490,000)
Adjustment for Stop Loss Rules $495,000 $245,000
Revises capital loss for estate ($495,000) ($245,000)
Proceeds less PUC $990,000 $490,000
Capital dividend ($990,000) ($490,000)
Taxable Dividend $0 $0
Tax Payable $0 $0
Share Redemption Hybrid
2004
*Exemptions may help shelter
Tax Implications – Mary Share Redemption
Hybrid
2004
Total Tax Payable
Share Redemption Hybrid
2004
Summary
• Both strategies have their pros and cons
• Corporate redemption is better from John’s perspective
• Hybrid from Mary’s• The best strategy
see if the client can benefit see if the client can benefit from grandfatheringfrom grandfathering