Who Pays the Tax When a Business Owner Dies?
When a business owner passes away, most of the early questions are about the business itself: who steps in, who owns what, and what happens to the team and the clients. A question that tends to arrive later, and can catch families off guard, is about tax. Who pays it, and where does the cash come from?
Death is treated as a sale
When a person dies, they are treated as having sold everything they own just before death, even though no sale actually took place. For shares of a private company, that sale is valued at fair market value, and the gain (the value of the shares at death minus what they originally cost) is reported on the owner’s final tax return.
Shares that pass to a surviving spouse or common-law partner can generally move over on a tax-deferred basis. That postpones the tax until the spouse sells the shares or passes away, but it doesn’t remove it.
The cash has to come from somewhere
The tax on the final return comes due, but the value of a private company is rarely sitting in cash. It is usually tied up in the business or its investments. Without planning, there can also be a second layer of tax when the company’s value is paid out to the family, which can leave much less than they expected.
This is a need that doesn’t go away. It exists whenever the owner dies, whether that is in ten years or forty, so the coverage has to be in place when that day comes. Life insurance pays a tax-free benefit, which gives the estate liquid cash to deal with the tax.
At Cove, we think less about “term” versus “permanent” and more about plan design: whether premiums are level, whether they are paid for life or for a set number of years, and whether the policy has cash value. For a need like this one, a policy with cash value is one option to look at, since it can offer a death benefit that increases over time, can be paid up, and may be more economical over the long term. The right design depends on the company, the shareholders and how the will is written, so it is best worked out with your accountant and lawyer alongside your advisor.
Worth a second look
If you already have coverage in place, it may be worth checking that it still matches the value of the company today. A policy set up years ago may no longer reflect what the shares are worth now, and the tax bill grows with the value.
If you’d like to talk through how this might apply to your business, you can book a meeting with us and we’ll help you think it through.
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