Tax and estate planning for business owners

As a business owner, having a well thought out tax and estate plan is key for financial success.

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 – a plan’s value is maximized when implemented before it is truly needed. Think about it. If we don’t worry about creditor protection until there is a known creditor threatening to sue, or we don’t 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 you maximize your wealth potential.

A tax and estate plan is just that, a plan! Without proper planning, good intentions are often just not enough. As a business owner, you 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 one of three types of structures: sole proprietorship, partnership, and corporation. Tax and estate planning affects all business owners; but as most profitable businesses are incorporated, we’ll focus on some tax and estate planning considerations within a corporate structure.

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. A creditor protection strategy essentially involves the removal of excess corporate profit out of the operating company so it is protected from unforeseen creditors while still maintaining the funds within an associated corporate structure, therefore continuing the personal tax deferral on those funds. 

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Succession planning and estate freezes

A key aspect of estate planning may be asking: how does the business pass to the next generation? There are a number considerations that need to be considered when deciding to hand your business over to the next generation. 

As part of the planning process, you need to consider if your estate is liable for tax. Upon death, you are deemed to dispose of any capital property held, which would include shares of the operating company, at fair market value. If there are accrued gains on that capital property, the estate may have taxes payable; assuming the Lifetime Capital Gains Exemption is not available or sufficient. Hence, you should always be aware of the value of your estate and the associated tax consequences, and when that value is significant, consider the need for an estate freeze.

An estate freeze is a mechanism whereby the value created to date is “frozen” in the form of fixed-value preferred shares, and the next generation then becomes the new common shareholders. This allows for all future value, and the applicable tax liability, to move from you to the next generation. There are multiple ways to accomplish an estate freeze.

The questions for the owner-manager then becomes: how much value is enough? And how do you limit your estate tax liability while still maintaining control of the company, if the next generation has not yet proven themselves in the business?

Will planning

A properly drafted will is one of the key documents used to ensure that your intentions and wishes are carried out upon your death. A will is also a key component of succession planning. As a business owner, there are a wide range of issues you should consider when preparing a will. Are there children who will take over the family business? Are there children who will not be involved in the family business? Is there a surviving spouse that needs to be taken care of? The answer to these questions can have a significant impact on the distribution of estate assets, especially when the business is the estate asset of greatest value.

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Shareholder agreements

When you, the owner-manager, are one of several shareholders, the planning you’ve undertaken can be negated if a proper shareholders agreement is not in place. Business relationships are frequently started on a hand shake and work while the principal shareholders are living, capable and getting along.

While shareholders agreements typically set out the division of duties and how decisions are made regarding financing, compensation and other important matters, a well-drafted shareholder agreement also deals with events no one wants to think about. As such, it is important to enter into such agreements when the parties involved are healthy and amicable with one another.