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How Can Succession Planning Minimize Taxes?

Whether you’re the CEO of a large firm or own a small family business, there’s a good chance you’ll want the next generation of your family to be at the helm.

Having a viable succession plan in place is a great way to ensure transferring the business to the next generation goes smoothly. Proper business succession planning is also an excellent way to significantly reduce your tax liability.

Without proper planning, your estate could end up with a massive tax bill that requires the sale of assets or even the business to cover it.

If family succession planning statistics are any indicator, history is not on the side of optimistic business owners.

  • ~30% of family run businesses make it into the second generation
  • 12% are still operating in the third generation
  • Only 3% of all family run businesses make it to the fourth generation

Below are a number of steps you should consider when it comes to family succession planning.

Start Early

You might not be thinking about retiring for a number of years yet, but the sooner you start thinking about family succession planning the better.

It can take several years to implement a plan that minimizes your tax liability.

Why does it take so long? There’s a lot that needs to be dealt with:

  • Preparation of succession
  • Transfer of ownership, leadership, and control of the business
  • Adequate retirement income
  • Minimizing income taxes

Minimize Capital Gains Tax

When a business is passed on to family in a sale or as a gift, the Canada Revenue Agency sees it as being disposed of at the fair market value.

You are taxed on half the gain of the company’s value at your top tax rate. The capital gain is calculated on the difference between the business’s initial share cost and where it’s at today.

Consider Incorporating your Business

If the family-run business is a qualified small business corporation, you can claim a lifetime capital gains exemption to reduce the capital gains tax. The exemption in 2019 is $866,912.

That means a gross gain up to that amount is tax-free. Because the capital gains exemption is indexed to inflation, it increases each year. In 2018, it was $848,252 and in 2017 it was $824,176.

There are several conditions that must be met to qualify for the capital gains exemption. A small business tax professional will be able to assist you with that.

Note that only incorporated businesses qualify for the lifetime capital gains exemption.

Estate Freeze

An estate freeze allows you to lock in the capital gains tax based on the value of the company.

One way of doing this is by exchanging common shares in the company for fixed-value preferred shares. Then, issuing the common shares to your children. Future company growth goes to the common shares and isn’t taxed until your children sell or gift the shares.

A freeze essentially allows the owner to transfer the business to the next generation while allowing that person to retain control of the business (if they want) and provides a source of income by paying dividends on their freeze shares.

If your business isn’t incorporated, you also may not be able to do an estate freeze. If it sounds confusing, that’s because it is. An estate freeze is one of the most complicated areas of succession planning.

FBC – Helping Canadian Businesses Minimize Tax Risks

There is a lot to consider when it comes to succession planning. It can also get confusing; there are different rules for farming and fishing businesses. For over 65 years, the tax professionals at FBC have been working with Canadian small business owners, entrepreneurs, farm operators, and independent contractors minimize their tax risk and maximize their deductions.

At FBC, our uniquely tailored tax strategies also help Canadian business owners maximize their opportunities throughout the various stages of growth; from start-up to succession planning, and everywhere in between.

For more information on FBC and the services we offer, call us today at 1-800-265-1002 or submit an online form and an FBC tax specialist will contact you at your earliest convenience.