Rob was 65 when he died in a car accident in November 2024.
His business — an operating company worth $5 million — had been his life’s work.
When he died, his family owed $1.35 million in tax on those shares.
But there was a $1.25 million tax exemption available. The Lifetime Capital Gains Exemption (LCGE).
If Rob had qualified, he would’ve saved $334,000.
He didn’t qualify.
Not because his accountant didn’t know about it. Not because he couldn’t afford to fix it.
Because he had 20% passive assets in his operating company. And he never got around to cleaning them up.
In this article, I’m going to show you:
- The 3 tests your company needs to pass to qualify for the LCGE
- Why the 90% active business asset test is where most business owners fail
- How to calculate your passive asset percentage
- The 4 ways to fix it (including the butterfly reorganization)
- Why you should NEVER attempt a butterfly yourself
Let’s start.
What is the Lifetime Capital Gains Exemption (LCGE)?
The LCGE is one of the most powerful tax breaks available to Canadian business owners.
Here’s how it works:
If you own shares in a qualified small business corporation (QSBC), you can shelter up to $1.25 million of capital gains from tax when you sell your business or when you die.
That’s $1.25 million tax-free.
At the top marginal tax rate in Ontario (53.53%), that’s $334,500 in tax savings.
Per person.
If you’re married and both you and your spouse own shares, you have $2.5 million in combined LCGE room. That’s $669,000 in combined tax savings.
But here’s the problem:
Most business owners can’t access it.
Not because they don’t know about it. But because their company doesn’t qualify.
The 3 QSBC Tests (And Why Most People Fail Test #3)
To qualify for the LCGE, your company needs to pass 3 tests.
Test 1: The 24-Month Holding Period
You need to have owned the shares for at least 24 months before you sell or die.
This one is straightforward. If you’ve owned your business for more than 2 years, you pass.
Test 2: The 50% Test (Throughout 24 Months)
Throughout those 24 months, more than 50% of your company’s fair market value must be active business assets.
Now, here’s where it gets technical:
Fair market value includes things like your customer relationships, your brand, your reputation, your systems — what’s called goodwill.
Goodwill doesn’t show up on your balance sheet because it’s internally generated. But it counts as an active business asset for this test.
Important: If you fail this test, you need to restart the 2-year holding period before you can qualify again. So this test is critical.
Most business owners pass Test 2 if they’ve been operating for a few years.
Test 3: The 90% Test (At Sale or Death)
At the moment you sell or die, 90% or more of your company’s fair market value must be active business assets.
This is where 80% of business owners fail.
And this is where Rob failed.
What Are "Active" vs. "Passive" Assets?
Active business assets are assets used to earn business income:
- Equipment
- Inventory
- Receivables
- Office space
- Trucks, machinery, tools
- Goodwill (customer relationships, brand, reputation)
Passive assets are assets not used to run the business:
- Excess cash (more than 6-12 months of operating expenses)
- Investment accounts (GICs, stocks, bonds, mutual funds)
- Intercompany loans (loans between your Opco and Holdco)
- Rental properties not related to the business
The rule: If more than 10% of your company’s assets are passive, you fail the 90% test.
Rob's Numbers: Why He Failed
Rob’s company was worth $5 million.
Here’s the breakdown:
| Asset Type | Value | % of Total | Active or Passive? |
|---|---|---|---|
| Business Operations | $4,000,000 | 80% | Active |
| Interco Loan to Holdco | $500,000 | 10% | Passive |
| Excess Cash Reserves | $500,000 | 10% | Passive |
| TOTAL | $5,000,000 | 100% |
Passive assets: $1,000,000 = 20% of total
Result: FAILED the 90% test.
Cost: $334,000 in lost LCGE savings.
How to Check YOUR Company (3-Step Self-Diagnostic)
Here’s how to check if your company passes the 90% test:
Step 1: Pull Your Balance Sheet
Call your accountant and ask them to send you your corporate balance sheet.
If you want to do this yourself, log into your accounting software (QuickBooks, Xero, Sage, etc.) and generate a balance sheet report.
Important: We’re looking at gross assets — total assets before liabilities. Don’t subtract your bank loans or other liabilities.
Step 2: Calculate Your Passive Assets
Look for these 3 things on your balance sheet:
1. Excess Cash
- Cash beyond what you need for short-term operations
- Rule of thumb: More than 6-12 months of operating expenses = passive
2. Intercompany Loans
- Does your Opco lend money to your Holdco?
- Does your company lend money to you as a shareholder?
- These are passive assets.
3. Investments
- GICs, stocks, bonds, mutual funds inside your operating company
- All passive.
Add them up:
`Excess cash: $______
- Interco loans: $______
- Investments: $______ = TOTAL PASSIVE: $______`
Step 3: Calculate Your Passive %
Divide your total passive assets by your total corporate assets:
Total passive: $______ ÷ Total assets: $______ = PASSIVE %: _____%
If you’re over 10%, you fail the test.
Which means you can’t use the LCGE.
And that costs you $334,000 or more.
How to Fix It: 4 Options
If you’re over 10% passive, here are your options:
Option 1: Pay Down Company Liabilities
If your company has a bank loan, use the excess cash to pay it down.
Example:
- You owe $500K on a business loan
- You have $500K in excess cash
- Pay off the loan → Cash is gone → Passive assets go down
Option 2: Buy Business Assets
Use the excess cash to buy equipment, inventory, or other assets used in the business.
Examples:
- New truck for deliveries = Active
- Additional inventory = Active
- Office equipment = Active
Option 3: Pay Yourself a Taxable Dividend
You can take the excess cash out as a dividend.
Downside: This creates personal tax at 48% (top bracket in Ontario: 47.74%).
Example:
- $500K dividend
- 48% tax = $240K in personal tax
- Not ideal.
Option 4: Butterfly Reorganization (Tax-Deferred)
A Section 55 butterfly reorganization moves the passive assets from your Opco to your Holdco. Tax-free.
How it works:
Before butterfly:
- Opco: $4M active + $1M passive = $5M total
- Passive: 20% → FAILS
After butterfly:
- Opco: $4M active (100% active) → PASSES
- Holdco: Received $1M passive (tax-free transfer)
Result: Opco now qualifies for LCGE. Tax savings: $334,000.
⚠️ CRITICAL WARNING: DO NOT DIY A BUTTERFLY
I need to give you a very serious warning:
DO NOT try to do a butterfly yourself.
Do not ask your bookkeeper to do it. Do not use a template you found online.
Why?
If you get the structure wrong, if you miss a filing, if you don’t document it properly — CRA will reassess you.
And you’ll pay double or triple tax on the same income.
I’ve seen business owners try to save $10,000 in professional fees and end up paying $200,000 in extra tax.
You Need a Tax Specialist (Not Just Any CPA)
Not all CPAs have the same training.
Just like your doctor isn’t a heart surgeon, not every CPA is trained in complex tax reorganizations.
You need a tax specialist — someone who:
- Specializes in corporate tax planning
- Has done at least 10 butterfly reorganizations
- Knows how to structure it correctly
- Knows how to document it properly
- Knows how to make it audit-proof for CRA
For specialists, butterflies are routine. They know the rules, the forms, the elections, the documentation.
But for someone who’s never done one? It’s extremely high risk.
Professional fees: Typically $15,000 to $20,000 for the lawyer and tax specialist combined.
This can be higher depending on complexity, ownership structure, and related party transactions.
But even at the high end, you’re paying a fraction of what you save.
ROI: $334,000 in savings ÷ $20,000 in fees = 15x return on investment.
The 12-Month Purification Window (Death Only)
Here’s something important:
There’s a 12-month purification window.
The rule says: If your company met the 90% test at any time in the 12 months before you die, you still qualify.
So Rob could’ve cleaned up his passive assets 6 months before he died and still saved $334,000.
BUT — and this is critical:
This 12-month window only applies when you die.
If you’re selling your business, you need to meet the 90% test at the time of sale. No grace period.
Rob's Story: "We'll Get to It Next Quarter"
Rob’s accountant brought up the passive asset issue in meetings. Multiple times.
Rob was busy running his business. “We’ll get to it next quarter.”
Then he died.
$334,000. Gone.
Once you’re dead, you can’t fix it.
Action Steps: What to Do This Week
Here’s what you need to do:
Step 1: Calculate Your Passive Asset Percentage
Get your balance sheet from your accountant.
Add up:
- Excess cash
- Intercompany loans
- Investments
Divide by total assets.
If you’re over 10%, you need to fix this.
Step 2: Talk to Your Accountant
Ask them these 3 questions:
Q1: What’s my passive asset percentage?
Q2: Does my company qualify for LCGE right now?
Q3: If not, what do we need to do to get there?
If they can’t answer these immediately, you might need a tax specialist.
Step 3: Get It Done
Don’t wait. Don’t say “next year.”
This takes 2 to 4 weeks once you start.
And the savings? $334,000. Per person.
Conclusion: Don't Lose $334K Because You Didn't Get Around to It
Rob had a $1.25 million tax exemption available. That’s $334,000 in tax savings.
He couldn’t use it because 20% of his company’s assets were passive.
A butterfly reorganization would’ve fixed it.
Cost: $15,000 to $20,000.
Savings: $334,000.
But he never got around to it.
Don’t let this be you.
Check your passive assets this week.
Download the Free LCGE Checklist
Need Help with a Butterfly Reorganization?
If you need a tax specialist to help you purify your company and qualify for the LCGE, we can help.
At Cedar Consulting Group, we’ve done hundreds of Section 55 butterflies for Canadian business owners.
About the Author:
Sunny Jaggi, CPA, CA, MTax, CFF is a Canadian CPA and Master of Taxation with 15+ years of experience helping business owners and high-net-worth families save millions in taxes. He is the Tax Principal at Cedar Consulting Group and co-host of The Advisors Table Podcast.
