At Estately Wealth, we blend sophisticated financial planning with personalized strategies to help our clients preserve wealth, optimize corporate structures, and make impactful charitable contributions. At Estately Wealth, we blend sophisticated financial planning with personalized strategies to help our clients preserve wealth, optimize corporate structures, and make impactful charitable contributions. At Estately Wealth, we blend sophisticated financial planning with personalized strategies to help our clients preserve wealth, optimize corporate structures, and make impactful charitable contributions.
In the world of estate planning, there are various strategies to ensure that assets are transitioned smoothly to beneficiaries while minimizing the impact of taxes. One such approach is the “Spousal Roll and Redeem” strategy, which plays a key role when utilizing life insurance in estate planning, especially for business owners with shareholder agreements. Let’s break down how this method works and when it might be useful.
What is Spousal Roll and Redeem?
The Spousal Roll and Redeem strategy is used in the context of buy/sell agreements between shareholders, particularly when life insurance is involved. Under this method, spouses are also parties to the shareholders’ agreement, allowing for a seamless transition of shares after the death of a shareholder. The goal is to allow for a tax-efficient transfer of shares and to ensure that liquidity is available to the surviving shareholders or the corporation itself.
Consider the example of John, Emily, and Michael. John and Emily are shareholders of a company, TechCorp. When Emily passes away, her shares are passed on to her husband, Michael, through her will or a qualifying spousal trust. The spousal rollover rules come into play here, allowing Michael to acquire the shares on a tax-deferred basis at Emily’s adjusted cost base (ACB), which in this case is nil.
The shareholder agreement, however, grants Michael the right to request that TechCorp redeem the shares within a specified timeframe. Alternatively, TechCorp and/or John may have a right to redeem or purchase the shares if Michael does not exercise his option. These put and call options are funded using corporate-owned life insurance on the lives of John and Emily.
How Does it Work?
- Spousal Rollover: When Emily passes away, her shares in TechCorp are transferred to Michael under the spousal rollover provisions, deferring the capital gains tax. Michael acquires the shares at Emily’s ACB, which means there is no immediate tax consequence on the transfer.
- Insurance Proceeds: TechCorp receives life insurance proceeds tax-free upon Emily’s death. These proceeds are credited to TechCorp’s Capital Dividend Account (CDA), which allows dividends to be paid out to shareholders on a tax-free basis.
- Share Redemption: If Michael exercises his right to have the shares redeemed, he receives a deemed dividend—funded by the insurance proceeds—which can be paid as a tax-free capital dividend. This leaves Michael with no capital gain or loss because his proceeds of disposition are reduced by the amount of the deemed dividend, and his ACB is also nil.
- Impact on Other Shareholders: The effect of this strategy is that Michael avoids paying taxes on the share redemption, while John’s ownership in TechCorp effectively doubles. The tax burden that would have arisen under a typical redemption scenario is mitigated by this spousal rollover approach.
Why Use the Spousal Roll and Redeem Strategy?
The Spousal Roll and Redeem strategy is particularly effective in scenarios where “stop-loss” rules apply. Under the typical redemption approach, if there is a capital gain on the deceased’s shares, it may be offset by a corresponding capital loss. However, if the stop-loss rules are in place, this offset is not available, potentially leading to adverse tax outcomes.
The spousal rollover, in contrast, allows for the tax-free transfer of shares, eliminating the need for an offsetting loss and making the stop-loss rules irrelevant. In essence, it provides a means of complete tax deferral as long as there is a surviving spouse.
It’s important to note that the rollover is contingent upon the shares “vesting indefeasibly” in the surviving spouse. This means that the surviving spouse must obtain an ownership right in the shares that cannot be challenged or defeated by any future event. Ensuring compliance with these requirements is crucial, and therefore the advice of a qualified tax professional should be sought whenever considering the Spousal Roll and Redeem strategy.
When Should You Use This Strategy?
The Spousal Roll and Redeem strategy is best suited for situations involving the stop-loss rules where there is a surviving spouse who can benefit from the spousal rollover provisions. It ensures that the shares pass on a tax-deferred basis, providing flexibility and liquidity through the use of life insurance proceeds. In instances where no surviving spouse exists, it’s recommended that the shareholders’ agreement include a fallback provision, such as an alternate buy/sell arrangement.
Final Thoughts
The Spousal Roll and Redeem method is a powerful tool for minimizing taxes and ensuring a smooth transition of shares in a privately held corporation. By leveraging life insurance and taking advantage of the spousal rollover rules, shareholders can help protect their family’s financial security while also safeguarding the interests of the company and the remaining shareholders. However, given its complexity and the changing nature of tax regulations, this strategy should always be implemented with the guidance of experienced tax advisors and estate planners.
