Post-Mortem Tax Planning

The terminal-year problem

When a Canadian shareholder dies, subsection 70(5) of the Income Tax Act deems them to have disposed of all their property — including shares of private corporations — at fair market value immediately before death. The resulting capital gain is taxed on the terminal T1. For an owner whose private-company shares have grown materially over time, the terminal tax bill can be substantial.

If the heirs then want to extract the corporation's cash (to fund the tax bill, to provide cash flow to the family, or to wind up the business), the cash distribution is normally taxed AGAIN — as a dividend in the recipient's hands. The result is double taxation: capital-gains tax at death plus dividend tax on the same dollars when distributed.

The pipeline solution

The "pipeline" strategy uses subsections 84(2), 88(1), and a series of corporate transactions to convert what would otherwise be a dividend distribution into a return of capital that is taxed at capital-gains rates (or not taxed at all, where the basis has already been stepped up). The mechanics:

1. The estate inherits the deceased's shares at their stepped-up FMV (the cost base reset under subsection 70(5)).
2. The estate transfers the shares to a newly-incorporated holdco under a tax-deferred Section 85 rollover, taking back debt of the holdco equal to the inherited cost base.
3. The holdco and the original corporation amalgamate (or wind up the corporation into the holdco under Section 88(1)).
4. The amalgamated corporation distributes its cash to the holdco as inter-corporate dividends (tax-free at the corporate level).
5. The holdco repays the inherited-debt to the estate. The repayment is a return of capital, not a dividend — no further tax.

The result: the corporation's cash flows to the estate at capital-gains rates (paid at death), not at dividend rates (which would be paid on top).

The 36-month window

The pipeline structure must be planned and executed carefully. The most important timing rule: subsection 84(2) (the rule that allows distribution on wind-up to be characterized as proceeds of disposition rather than dividend) is best preserved by waiting at least 12 months between the inheritance and the wind-up of the corporation. The structural moves typically run over 12-24 months from death; the full execution window is 36 months.

The Section 88(1) bump

An additional and complementary strategy is the Section 88(1) bump. When a subsidiary corporation is wound up into its parent (or two corporations are amalgamated under Section 87), the adjusted cost base of certain assets of the merged entity can be "bumped" up to FMV — sheltering future gains on those assets from capital-gains tax. The bump is available on land, depreciable property, and shares (but not on inventory, intangibles other than goodwill, or accounts receivable).

For an estate inheriting a private corporation that itself owns appreciated real estate, the bump can shelter the next disposition of the real estate from a substantial gain — potentially saving as much as the pipeline does on the share extraction.

Section 164(6) loss carryback

If the deceased's estate triggers a capital loss in the first taxation year of the estate (often through a deliberate share-redemption or sale-to-related-party transaction), Section 164(6) allows that loss to be carried back to the deceased's terminal T1 and applied against the deemed-disposition capital gain. This is the simplest of the post-mortem strategies and frequently used in tandem with the pipeline.

Spousal-rollover deferral

Where the deceased's shares pass to a spouse (or to a qualifying spousal trust), subsection 70(6) provides an automatic rollover at the deceased's cost base — deferring the capital gain to the spouse's eventual disposition or death. The spousal rollover is the right answer when the spouse intends to hold the shares; it's the wrong answer if the spouse plans to sell or wind up the corporation immediately, since the rollover prevents the cost-base step-up that pipeline planning relies on.

Insurance funding

Many succession plans use corporate-owned life insurance specifically to fund post-mortem tax. The death benefit pays into the corporation's capital dividend account (CDA), which the estate can extract as a tax-free capital dividend. The CDA-distributed proceeds offset the estate's capital-gains tax dollar-for-dollar — turning the insurance proceeds into an after-tax estate funding source.

How we work the file

Post-mortem engagements typically start within weeks of death and run for 12-24 months. We design the strategy in the first 60 days, coordinate the inherited-cost-base documentation with the accountants, implement the Section 85 rollover and pipeline structure, and handle the wind-up. Most engagements are fixed-fee for the planning phase and hourly for execution.