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Whether you run a logging company or manufacture wood products, you’ve put in a lot of effort to grow your business – but what happens when you retire?
“A common question I ask when I meet with new or existing forestry clients is, what is your plan for retirement? Common responses include selling the business, transferring the business to my son or daughter, selling the business to employees or taking my equipment to auction,” says Blair Traxler, Business Advisor with MNP’s Forestry and Forest Products practice in Prince George. “While it’s great that many of my forestry clients have a response, it’s important they get this plan into action. As a rule, I tell my clients they need to plan their exit five years in advance to maximize the business’ value and minimize taxes. Having your business ready for sale does not mean you have to sell it. But if the opportunity presents itself, you are ready to take it.”
When approaching retirement, it’s important to ensure your corporate structure aligns with your exit strategy. If the current structure does not align, it will either inhibit you from exiting the business in the way you intended, or it will result in excessive income taxes, neither of which is an attractive option. Below are some common ways you can exit your business and the tax issues that should be addressed to maximize each option.
When the shares of a business are sold, the individuals who own the shares can be eligible to claim the $835,714 lifetime capital gains exemption (tax rates as of 2017). However, if the company holds passive assets it could prohibit you from claiming the exemption. Additionally, a structure should also be put in place that allows you to multiply the number of capital gains exemptions available.
If possible, two or more capital gains exemptions are better than one. “The number one issue I see with selling a business is that clients come to us too late to maximize the business’ value,” explains James Kungel, MNP Tax Specialist. “Structuring the company to remove passive assets and multiply the capital gains exemption cannot take place at the time of the sale; it must be done several years before you want the transaction to take place. If the structure has not been implemented years in advance you will be faced with unintended tax consequences.”
Transferring the business to the next generation can be problematic from an income tax perspective, as non-arm’s length transactions have different tax consequences than an arm’s-length sale. “If you utilize your capital gains exemption, it results in tax consequences to your son or daughter. If you do not utilize your capital gains exemption, you end up paying more tax than necessary,” says Kungel.
One alternative is to have the company redeem your shares, however this will result in you paying tax at dividend rates (up to 40.95%) rather than at capital gains rates (up to 23.85%). There are other ways to mitigate the tax consequences of a transfer of the business, however they must be arranged in advance of the transaction.
Many employees would love the opportunity to take over the company, however the most common problem is that employees do not have the capital necessary to purchase the business, so owner financing is a common solution.
“Under this option it is important the owner look at a structure that allows them to retain control of the corporation or at least have a say in operations, given that the owner will bear the majority of the consequences should the business fail before they are paid out. Unanimous shareholder agreements are also extremely important in this case to minimize risk,” adds Kungel.
“The most common response I hear from owners is that they will simply take their equipment to auction. This option is fairly simple, however if properly planned, you can minimize the tax you have to pay on the distribution of corporate funds,” explains Traxler.
Exiting the industry happens in one of two ways, voluntary or involuntary. In both cases you owe it to yourself to determine the most appropriate corporate structure long before an actual sales transaction takes place.
Maximizing the value of your business and paying less tax means having more money left over in retirement to spend time with your grandchildren, travel the world or look for your next opportunity.
For more information, please contact:
Blair Traxler, CPA, CA
Business Advisor, Forestry and Forest Products Services
Client Groups:Forestry ＆ Forest Products
Related Topics:ExitSMART™; Succession Series
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