There can be a significant tax impact when a taxpayer dies, resulting in a deemed disposition of property at fair market value.^[1] This can create onerous tax consequences, particularly for Canadians owning private company shares.

Capital property will generally “roll-over” to a Canadian resident spouse on death.^[2] However, if private company shares are owned on a last-to-die basis, this can create a potential for double tax (and possibly triple tax) in the estate of the deceased.

First Layer of Tax – Capital Gains

The first layer of tax that will apply is capital gains tax on the value of the shares at death. Let’s say a taxpayer passes with corporate shares worth $2,000,000 with a cost base and paid-up capital of nil. This results in a total capital gain of $2,000,000 ($1,000,000 taxable capital gain at current inclusion rate^[3]). Applying the highest combined Alberta marginal rate to the total capital gain, this could result in tax up to as high as 24%.^[4]

Second Layer of Tax – Dividends

Let’s say the deceased’s personal representative decides to wind-up the company. This results in a deemed dividend of the fair market value of the shares less paid-up capital. In this example, this would result in a deemed dividend of $2,000,000 with tax up to approx. 42%.

If the corporation has assets to sell prior to wind-up, this could create a third level of tax (including taxable capital gain or recapture). If only the above two levels of tax are considered, this can result in an effective tax rate just over 66% on the total value of the private company shares.

There are a couple of solutions which can be employed by the estate of the deceased taxpayer to mitigate this potentially negative tax result.

Loss Carryback

If the shares are held by a graduated rate estate (GRE), the wind-up of the corporation within the first taxation year of the estate creates a capital loss (and deemed dividend), which can be carried back to the deceased’s final tax return to be claimed against the capital gain noted above.^[5] Planning must be conducted to ensure the wind-up occurs within the one (1) year timeframe.^[6]

The loss carryback results in the capital gains layer of taxation being eliminated and the estate being subject only to the dividend taxation rate.

Pipeline Planning

Alternatively, the estate could consider incorporating a new company (“NewCo”) and transferring the shares of the private corporation to NewCo in exchange for a promissory note. The retained earnings of the corporation could then be distributed to the estate via the note on a tax-free basis.^[7]

The pipeline plan results in the dividend layer of taxation being eliminated and the estate being subject only to the capital gains taxation rate^[8].

Bottom Line

In both cases, post-mortem (after death) planning is complex, and accounting and legal advisors should be consulted to take advantage of these strategies. Significant potential tax liability can be mitigated resulting in greater distribution to your estate and your beneficiaries.

For more information, please contact Eric Dalke at edalke@walshlaw.ca / 403-267-8454 or any member of our Walsh Tax & Estates team and we would be happy to answer your questions.

Note: This article is of a general nature only. Tax laws may change over time and should be interpreted only in the context of particular circumstances. These materials are not intended to be relied upon or taken as legal advice or opinion.

^[1] Subsection 70(5), Income Tax Act, RSC 1985, c 1 (5th Supp) (“ITA”).

^[2] Subsection 70(6), ITA.

^[3] Finance Canada has announced a deferral of the capital gains inclusion rate increase to 2/3 to January 1, 2026.

^[4] This calculation of the highest marginal tax rate applies to the total gain, i.e. $2,000,000.

^[5] Subsection 164(6), ITA.

^[6] Amendments have been proposed to extend the 164(6) timeline to three (3) years.

^[7] Certain requirements must be met including the corporation being in existence (and maintaining its assets) for a period of time after death.

^[8] “Bump” planning could also be considered whereby non-depreciable capital assets in the private corporation could be bumped to reflect capital gains tax already triggered on death.