Perhaps the most challenging aspect of retirement planning for business owners is getting through the maze of legal, tax and financial issues.
Here are some of the major issues you'll need to discuss with a team of professional advisors.
Death & Taxes: Life's Certainties
Tax issues are perhaps the biggest single factor in estate planning. The goal is to legally minimize the tax burden for the deceased owner's estate, spouse, family and business itself.
Under Canadian tax law, an individual who sells shares in a "Qualified Small Business Corporation" (QSBC) has a lifetime exemption from the tax on up to $500,000 of capital gains. Taking advantage of this exemption means meeting several conditions that only a tax professional can properly assess.
The most common method for triggering the exemption is an estate freeze. The objective is to crystallize the current fair-market value of the owner's business at a moment in time, usually by:
- Exchanging your old common shares for new preferred fixed-price voting shares; and
- Issuing new common limited-voting shares to other family members with all future growth attached
An estate freeze is just one of many tax strategies and may not be best for all businesses. Consult a tax professional.
Each province sets its own probate fees-usually a sliding percentage of the estate's value. Probate is a judicial process that confirms the authority of an executor. To protect themselves from legal liability, third parties such as financial institutions usually require probate before they transfer assets to the executor.
Owners and their families can plan to minimize probate fees, primarily by minimizing the amount of the estate that is subject to the probate process. This can be accomplished various ways, such as transferring assets before death, using spousal trusts, and other options that are beyond the scope of this Guide.
A lawyer or estate planner can discuss options that apply specifically to you.
Dividends or Capital Gains?
Federal reductions to the tax rate for capital gains have many tax advisors suggesting that business owners revisit their retirement plans.
At higher marginal tax rates, capital gains treatment can have a lower tax rate than deemed dividends. You may benefit from having your will and shareholders agreement reviewed.
A professional tax advisor can tell you more.
Income Splitting with Children
Canadian tax law requires a related minor who receives certain income, usually dividends, to incur a special tax liability. He or she is taxed, at the top marginal rate, on the following types of income from the following sources:
- taxable dividends and other shareholder benefits from private shares of related Canadian and foreign companies (directly or through a trust or partnership); and
- income originating from a related business (as above) that is channeled through a partnership or trust.
These rules do not apply to income received from normal arms-length investments. Consult a professional tax advisor to see how these rules apply to your situation.
Alter Ego & Joint Partner Trusts
The Canadian government recently enacted changes to the tax laws that allow seniors to create an alter ego trust. This type of trust:
- reduces probate taxes by removing assets from your estate;
- allows you increased control over who ultimately receives the assets transferred to the trust (in case your will is disputed); and
- serves as an efficient alternative to a power of attorney if you are incapacitated.
The terms of the trust must say that only the individual setting up the trust (the "settlor") is entitled to income earned before his/her own death, and must name contingent beneficiaries after death.
Another variation is the joint partner trust. No dispositions are triggered when the property is first transferred to the trust, and the income is taxable in the joint partners' hands during their lifetime.
Got Cross-Border Assets?
Increasingly, business owners have personal or business assets in other countries, such as the United States. A professional advisor will need to factor the special tax consequences into your retirement plan.
Family Laws: Your Unseen Business Partner
Most business owners are aware that marital breakdown can affect the company. In calculating each spouse's net worth, a value for interests in partnerships and shares in corporations is usually included. Lump sum settlements or buy-outs require liquidity, which may not always be there.
Pre-nuptial agreements are often used to protect active businesses. A lawyer can advise you about available options.
Consider a Legal Review
A thorough legal review can identify aspects of your business that could derail a retirement strategy, such as:
- organizational structure;
- board and director positions;
- securities and financing;
- human resources and personnel policies;
- intellectual property;
- risk management; and
- shareholder agreements.