Further to my previous entries on succession planning, family trust, estate freeze here is a great article written by Alexandra Lopez-Pacheco from the Financial Post.
As usual, If you have any questions, please do not hesitate to contact me.
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Taming your tax liability
To ensure the best possible conditions when a business owner is ready to pass the helm to the next generation, succession planning can maximize the company's value from the start. That's why it's never too early to begin the process, although typically many wait until three to five years before they plan to retire - and even more wait until it's too late. Developing a long-term strategy that will ensure a company's sustainability, independent of the owner, and over years enrich the skills, abilities and experience of those chosen to be the next leaders makes the company more valuable, as well as provide more retirement funds for the owner.
Part of this process is a solid tax strategy. The longer a company engages in astute tax planning to minimize its tax bill, the more money will stay in the business, as well as in the owner and his family's pockets, leaving more funds available for the next generation to buyout the owner.
According to tax specialist Paul Woolford, partner with KPMG's enterprise services, most small businesses are doing a pretty good job with accounting, but a large percentage of them are not taking advantage of all the tax-minimizing strategies available to them. And no wonder, every time there's a new federal or provincial government budget, the rules seem to change. This is where, of course, a good tax accountant comes in. They not only know the current tax rules but also keep up with new ones. "There are ways to achieve what you want in minimizing the tax bill, but you also have to be very careful to abide by the appropriate rules, and that's something that comes into play when you're looking at estate planning and succession planning," Mr. Woolford says.
When putting together a business tax plan, keep in mind it is necessary to review all possible variations and combinations available to tailor a strategy that will meet the specific needs of the company, its owners and often, his or her family. Many accountants contend business owners should put together their succession plan before the tax plan. What's more, small businesses are often about close interconnections between the owner, his family and the company. From effective use of tax exemptions and deductions, including the $750,000 capital gains allowance, to income-splitting and family trusts - there are many options available to considerably shave down the tax bill if an accountant can see all the pieces of the puzzle.
"I look at the corporation and the shareholders, and look to minimize and defer tax on both levels, and that's often one way of keeping the tax liability down or keeping more money in the company or in the individual's bank account," Mr. Woolford says.
As profit increases and the business becomes more complex, so too can the tax planning. "There are always levels of planning, from the basic planning to the complex planning to the high net-worth situation," Mr. Woolford says. "The idea is to put in a structure. It could be a family trust with beneficiaries that may include your spouse and adult children, for example. There are ways you can pay dividends to that family trust and have that trust allocate those dividends to individuals who may be in a lower tax bracket."
A good plan will cut the tax bill and, if incorporated into the succession planning process, it will also address specific needs related to ownership transfer. For example, if an owner knows he wants to sell the company to his adult child, he might prefer to keep the company's value down to lower the tax liability at the time of transfer. On the other hand, if he is planning to sell to a third party, achieving the highest possible valuation might be a better strategy.
When Bill and Bev Wostradowski were ready to turn over the company they established in in 1978 - Lake Country Building Centre, a building supply business in Lake Country, B.C. - to their son and daughter, they solicited help from their lawyer and their accountant, Bill Corbett, tax and succession planning partner at KPMG in Kelowna, B.C. "We had very good advice from Bill and our lawyer, and we put faith in them that they were going to steer us in the right direction," says Mr. Wostradowski, who is a member of the Canadian Association of Family Enterprise. He used the organization's resources and links to educate himself on the process.
The Wostradowskis chose an estate freeze - literally freezing the value of the shares the couple owned, and issuing common shares to the two adult children who had chosen to carry on with the business, Sherri Williams and Kevin Wostradowski. "That way, the growth and value accrues to the next generation," Mr. Corbett says. It also reduced the senior Wostradowskis' tax liability. Step two was to set up voting shares for the retiring couple.
"My wife and I sold our equity shares in the building supply business to our children and they were to pay us over a period of time, but we still retained voting shares. Then over five years, we gave out a few of the voting shares each year to the point that the children now own them all," Mr. Wostradowski notes. This ensured the couple had enough control should any conflict arise between their son and daughter during the transition.
They also set up holding companies for each of their successors names. By making the holding companies the shareholders, the main business can pay Sherri and Kevin through lower-taxed dividends to their holding companies rather than to them individually. And, in an example of how tax and succession planning can be integrated, this structure also allowed Sherri and Kevin to manage their own share of the profits as they wished. "One could be a saver, the other a spender, and since each had their own holding company, there would be no conflict," Mr. Corbett says.
Another component of succession planning is estate planning, which involves strategies to minimize or defer tax. Not very many people think of consulting their accountant before writing their will - but that's exactly what they should be doing. "An area that sometimes is overlooked is having two wills: a separate will that would hold the shares of your private corporation and then a normal will that contains everything other than your private shares," Mr. Woolford says. "If they only have a single will, then the shares of the private corporation could be subject to probate fees."
Another way of minimizing probate fees is to name beneficiaries wherever possible - for everything from RRSPs to life insurance - or make the intended beneficiary a joint tenant, which would simply mean that upon the death of the owner, the assets would immediately become theirs.
"It is pretty good idea to name your company as a life insurance policy beneficiary," Mr. Woolford says. That ensures there will be tax-free money available to protect a business's sustainability in the case of the owner's untimely death.
These days, the senior Wostradowskis are enjoying the fruit of their five-year-long investment in their succession planning. "The kids are all in a position that they can look out for their families and have their turn at the business, and my wife and I have enough money to travel and enjoy our life. That's all we were interested in," Mr. Wostradowski says.
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