Most people are aware that the next of kin have to pay inheritance tax on the estate left by a deceased person. But did you know that, in some cases, you may also be liable for income tax? The terms of the prenuptial agreement are of great importance here and play a significant role in determining how much income tax is due following a death.
Significant shareholder
You are a significant shareholder (AB shareholder) if you hold at least 5% of the issued share capital of a private limited company (BV). Upon the sale of the shares, 26.9% income tax (AB levy) is payable on the value of the shares, to the extent that this exceeds the acquisition cost.
Under income tax law, the death of an AB shareholder is treated as a notional sale of the shares. After all, the shares are transferred to the heirs. Suppose you bought shares for €10,000 in the past. The market value of the shares at the time of death is €1,010,000. Income tax is payable on €1,010,000 – €10,000 = €1,000,000. This amounts to a tax liability of €269,000.
Provided that the private limited company is an active business, the income tax claim can usually be carried forward.
Prenuptial agreement
The marriage contract specifies which shares are subject to income tax upon death. Amending the marriage contract may ensure that (part of) the tax liability is only payable upon the death of the surviving spouse.
Final set-off clause
Many business owners have prenuptial agreements containing a final or periodic set-off clause. As a result, the partners’ assets do not become joint property during the marriage. This is particularly important with a view to keeping the private limited company’s creditors at bay.
If the AB shareholder in the above example were to die, income tax would be payable on all the shares. The shares form part of the estate in their entirety. Under the final settlement clause, the partner has a claim against the estate amounting to half the value of the shares (€505,000). However, income tax is still payable on all the shares. This can prove very problematic if there are insufficient liquid assets available to pay the income tax.
From a final set-off clause to community of property
In some cases, it is therefore advisable to amend the marriage contract and opt for a community of property. This is particularly true if the business has since been sold and the private limited company mainly holds cash and cash equivalents. In such cases, the marriage contract is of less significance with regard to the company’s creditors.
In the case of a community of property, all assets are held in common, including the shares. 50% of the shares belong to one partner, and 50% to the other partner. Consequently, upon the death of one of the partners, income tax must be paid on half of the shares.
In the example, income tax is payable on €500,000. This results in a tax liability of €134,500 upon the death of the first spouse. Income tax is payable on the other half of the shares upon the death of the other spouse.
From community of property to a final set-off clause
However, the reverse situation may also arise. In the event of the death of the AB holder, the community of property could be converted into a marriage contract containing a final settlement clause. Under the prenuptial agreement, all shares may be allocated to the AB holder’s partner. Upon the death of the former AB holder, their estate will not include the shares and therefore no income tax will be due. Upon the death of the surviving spouse, income tax will then be payable on all the shares in a single instalment.
Do your prenuptial agreements ensure the most favourable outcome in the event of your death or that of your partner? We’d be happy to look into this and discuss it with you.