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There are numerous benefits of including family members as owners in the business, and many of these benefits can be linked to income splitting opportunities.
Income splitting refers to the ability to pay income to family members in a tax-advantageous manner. Many business owners would like to utilize the marginal income tax rates of their spouse and children, especially when funding expenses for the family and the children.
If your spouse is included as a shareholder of the company, it will be possible not only to pay the spouse a reasonable salary for work performed, but also to distribute earnings in the form of dividends to your spouse. This can lower the family’s overall tax burden. We should also consider the use of the capital gains deduction – in Canada, each individual has a $750,000 lifetime capital gains deduction that can be used on certain eligible properties, including qualified farm property, qualified fishing property, and qualified small business corporation shares. If your spouse is included as a shareholder of your operating company, it may be possible to utilize the capital gains deduction for each person on an eventual sale of the business.
Consideration must be placed on the advantages and disadvantages of including your spouse as a shareholder, some of which are tax motivated, and some are family specific. For instance, if the business is owned by two unrelated families, there might be disadvantages to including a spouse as a shareholder, such as inter-personal conflicts, succession issues, buy-sell agreements and the goals of the shareholders. There are also many other benefits to including a spouse – many times, the entire family is engaged in the family business; therefore, the ownership of shares will better reflect the true economic situation, while rewarding the entire family for their efforts to build a successful private business.
What about children? It is generally not advised to include minor children as shareholders of your business, or even to include adult children, who are not active in the business, directly as a shareholder. If your children are included as a shareholder, and the company is later sold, the child will receive their share of proceeds on a sale. This may not be desired simply due to the age of the child or the quantum of the proceeds.
There are also situations where a non-active child has an equal portion of the company as an active child, which can create undue family conflict. This can become even more complicated if the non-active child has voting shares of the company.
A discretionary family trust may be the ideal tool for the inclusion of family members as shareholders. A discretionary family trust will enable the trustees to hold the shares for the benefit of the children, but the children do not have legal title to the shares. The trustees will decide which beneficiaries will receive dividends, the amount of the dividends to be received, and when they will be received. In addition, the trustees have discretion to decide which beneficiary will ultimately receive the shares from the trust. If the shares of the operating company are sold, it would be possible to allocate a portion of the capital gain to the beneficiaries of the trust, and they would be able to utilize their capital gains deduction to shelter the capital gain from tax.
The decision to include your family members as shareholders is a personal one, and your personal situation should be discussed with your tax advisor prior to proceeding with any plan to include your family members as shareholders.
For more information on tax benefits for your family business, contact your local MNP advisor.
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