If you plan on passing on your business to your children, there are several strategies that can help smooth the transition and reduce taxes.
Transitioning out of your business – Your first step is to determine who will be taking over your business. Giving your children equal shares of your business may seem like the fairest thing to do, but you should also consider the needs of your business.
If one or more of your children is more capable or interested in running the business than the others, it may make more sense to provide a greater share to them – or even the entire share. In this case, the child, or children, taking over your business could buy out the others, or the others could receive other assets to compensate.
You may already know which of your children is best suited to effectively run your business. If you don’t, consider having an honest discussion with them to help you determine who should take over your management roles.
Timing the transition – It is important to carefully plan for when your children take over and when you retire. If you hand over the reins too early, your children may not have the necessary experience to successfully manage the business. At the same time, it’s important they work with you to learn the intricacies of your business and establish key contacts prior to your departure.
There are several succession strategies that can help reduce taxes when transferring your business to your children – but one of the most important is an estate freeze.
An estate freeze enables you to lock in the current value of your business, and transfer its future growth to one or more of your children. With a simple estate freeze, you exchange your common shares for preferred shares of the equivalent value on a tax-deferred basis. Typically, the preferred shares would have a stated value that does not grow, while your children would acquire new common shares whose value does grow. Your preferred shares would also be voting shares – giving you control of the business until you’re ready to hand over the reins. When you are ready, you can sell or transfer the preferred shares to your children, and your capital gains tax liability would be determined based on the locked-in value.
An estate freeze can also help your family make the most of the small business capital gains exemption, provided the shares of your business are qualified small business corporation shares. With this strategy, you trigger the capital gain immediately upon locking in the value of your business, as opposed to deferring it to when you sell or transfer your shares.
Ideally, you would establish the estate freeze on your business when your taxable capital gain would be about the same amount as the exemption, so it would all be exempt. Then, your children would be able to apply the exemption against the future growth of the company occurring after the estate freeze.
Establishing an estate freeze can be very complex, so make sure you get good advice from a qualified professional.
Ensure your ongoing personal financial security – A good succession plan should also address your personal financial needs after you’ve handed over the reins. This may involve setting up a retirement compensation agreement or individual pension plan, which can provide enhanced retirement benefits compared to standard registered plans.
Kirbey Lockart is an investment advisor with RBC Dominion Securities. This article is provided for information purposes only. Please consult with a professional advisor before implementing a strategy.