Business owners sometimes say, “My business is not complex or big enough to warrant a tax and estate plan.” But quite often this is not the case – when a plan is implemented, its value is maximized even before it is truly needed. Think about it. If we do not worry about creditor protection until there is a known creditor threatening to sue, or we do not plan for the succession of the business until there is a medical emergency, fewer planning opportunities may be available.
Having a plan in place today can help ensure that your assets are protected, your business carries on profitably, and your wealth potential is maximized.
Planning within a corporate structure
A tax and estate plan is just that, a plan! Without proper planning, good intentions are often just not enough. You, as a business owner, have put significant time, resources, and effort into making your business successful. So how do you proceed with protecting that value? A proper tax and estate plan works with you and your business throughout its life cycle to ensure you are maximizing wealth and minimizing taxes, both now and in the future.
A business can be operated using three types of structure: sole proprietorship, partnership, and corporation. Tax and estate planning affects all business owners, but, as most profitable businesses are incorporated, we will focus on tax and estate planning considerations within a corporate structure. These include income splitting, creditor protection, and succession planning.
Income splitting
Directing income from your business to members of the family who participate in the business can be an effective strategy for reducing the family’s overall tax bill.
If you extract additional cash from the corporation, that income is taxed in your hands, typically at the higher marginal tax rates. Paying a salary to a member of your family may be an option, but there are restrictions. Salaries paid to a principal shareholder who also manages the business (commonly referred to as an “owner-manager”) are not subject to reasonability tests, but salaries paid to members of the owner-manager’s family are – meaning that you can only pay a salary for work performed, and the salary has to be reasonable compared to a salary you would pay to a non-family member. This can limit the ability to income split a salary with your family members.
Family trusts and their use in the corporate structure
Often the idea of income splitting conflicts with having family members as direct shareholders of the corporation. A family trust can be a great way to limit direct control over the shares of the corporation, while still providing a potential opportunity to income split dividends with family members, although restrictions may apply. It’s a relationship created by a settlor with trustees to hold and manage property for the benefit of the beneficiaries of the trust. The trustees make the day-to-day decisions about the affairs of the trust, keeping the beneficiaries’ interests in mind.
Family trusts are typically introduced as part of an “estate freeze,” allowing the trust to subscribe to common shares of the operating company at a nominal cost. Most family trusts are discretionary in nature, meaning any distributions of income and capital to the beneficiaries are at the discretion of the trustees.
If an owner-manager is the sole shareholder of a profitable, qualified, small business and is able to sell those shares, the resulting capital gains realized on the sale may be sheltered by the lifetime capital gains exemption (LCGE).
A benefit of having shares of a qualified small business held by a family trust is that the family trust can allocate a capital gain resulting from the shares to beneficiaries, including minor-aged children, which can potentially multiply the use of the LCGE.
Creditor protection
There are two types of creditors: known and unknown. Your bank, credit card company, and supply vendors are all known creditors and are part of normal business operations. It is the unforeseen creditor that leaves the profits of a business vulnerable.
Creditor protection essentially involves the removal of excess corporate profit out of the operating company so it is protected from unforeseen creditors. If the shareholders do not need the excess cash, the withdrawal of the funds personally would defeat the tax deferral of the corporate structure – in this situation, a holding company is the solution.
Unlike dividends distributed to an individual shareholder, tax paid income can generally be paid as a dividend tax-free to a holding company. A holding company is a separate corporation, and as such, if the operating company (Opco) is sued, the assets of the holding company (Holdco) typically remain protected.
When it comes to tax and estate planning, the issues can seem overwhelming. Reach out to us to at Scepanovic & Associates IG Private Wealth Management to build a plan tailored to your vision for the future of your business and family.
This is a general source of information only. It is not intended to provide personalized tax, legal or investment advice, and is not intended as a solicitation to purchase securities. Scepanovic & Associates is solely responsible for its content. Seek advice on your specific circumstances from an IG Advisor. Trademarks, including IG Private Wealth Management, are owned by IGM Financial Inc. and licensed to subsidiary corporations.
