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We have a client who took over the family business from his parents many years ago. As one of three children, his parents left him one-third of the business, as they did each of his siblings. However, he was the only one who actually worked in the enterprise.
Many years passed, the business and his own family grew. He came to us for advice on how to most effectively manage his wealth and estate. We helped him set up a family trust that would provide for himself and his adult children, while also giving him time and flexibility to develop his succession plan.
As he was creating his succession plan and implementing wealth management strategies, he wished his parents had set up a family trust. As it was, he had to pay siblings who had no hand in growing the business in order to buy them out. A trust would have given them options for ensuring all three children a fair share of their wealth without giving all three an equal share of the wealth he worked to grow. They could have been beneficiaries of a trust, without directly owning the business. There could have been a plan that would have spared the business-owning brother from seeking financing for the buyouts.
It would not only have saved the parents and children in taxes, but it would have offered them the flexibility to make inheritance decisions that may have better suited the family needs.
One of the most underutilized tools for maximizing family wealth and ensuring fairness, is a family trust.
You may hope your children will succeed you one day or you may hope to sell. Either way, a family trust offers flexibility for estate planning and wealth management long before you must make that decision.
Here’s how it works: A family trust holds property, from which trustees hold control for the benefit of your named beneficiaries. For tax purposes, the trust is a separate legal entity which offers substantial tax savings.
One of the most useful tools of a trust is that it permits beneficiaries to receive different benefits from each other from year to year. For example, you may want to pay dividends from the operating company to the trust, which are allocated to one of your children to attend university, to the complete exclusion of other beneficiaries.
Through a trust, you can pay dividends of about $50,000 a year – depending on the province where you live – to that adult child beneficiary attending school, without attracting tax, provided they have no other income. Once the dividend is allocated, they are responsible for the taxes owed. Because they likely fall into a lower tax bracket at that point in their lives, they will pay far less than the up to $20,000 that you would pay on the amount should you earn it as income before passing it to your child. It should be noted that once a beneficiary has been allocated dividends, they must receive the funds.
A family trust is a great wealth management tool that keeps more money in the family while you fund post-secondary education or help with a down payment on a home.
By law, a trust is deemed to dispose of its assets every 21 years, and would incur taxes on any appreciated gains. That gives you 21 years to make key decisions in your succession plan. If you transfer shares out of the trust to the next generation before those 21 years are up, the trust will be able to transfer the assets to the beneficiary without attracting tax, and the beneficiary will receive the assets at the same tax cost as it was held by the trust.
If you have a child who will ultimately take over the business, you have the option of winding up the trust at that time and giving that child the shares. Rolling out of the trust in that manner puts your child in the same position as if they’d always owned those shares, so you don’t have to pay tax to get it to them.
The savings can be substantial and it protects a lot of your family wealth as it is transferred to your heirs. If you had continued to hold the shares for the intervening years, the child would have to find a way to pay you out, and there could be significant tax consequences on the succession to the next generation.
If you have a business you might sell in five to 10 years, a family trust allows you to share part of the proceeds from a sale with children or other beneficiaries, multiplying access to the capital gains exemption for a significant tax savings.
When including a family trust in your corporate structure, it will often require you to implement an estate freeze transaction first, where you take back preferred shares for the existing fair market value. There are many options available for these preferred shares: You could sell them to your successor, redeem them over time, or keep and sell in an ultimate liquidation, or leave them to your children in your Will. This provides flexibility in the timeline for a buyout while ensuring both parents receive tax results that they choose.
If one child active in the business is set to have the business passed down, that does not mean that other children get nothing. But fair is not necessarily equal. Many business owners are unaware of the tax consequences to their children should they have to buy one another out later on down the road. When trying to transact amongst siblings, there are fewer options available than in an arm’s length transaction, and the tax bill is much higher in a sale situation as the use of the capital gain deduction is not very useful in a family sale. A family trust would be a much more effective way to transition the shares to the ultimate successor.
Another underutilized estate planning tool is life insurance. Children who are not active in the business could be beneficiaries of a life insurance plan, which may be a fair, if not equal, way to distribute your estate among your heirs. Alternatively, those benefits could also be used to redeem preferred shares when owners pass on, which can help with the tax effective transfer of funds to non-active children.
Another option may be a holding company. By transferring value to a holding company, dividends can be paid to the holding company and your investments can be held in this company rather than in the company. Also, it reduces your overall tax bill as you don’t have to take out dividends personally to extract these non-active assets from the operating company. This holding company can essentially be considered your own corporate bank. Should your operating company need funds for expansion or investments, they will be lent back to your operating company under a secured promissory note. If you don’t use them in your business, they can be invested, they will be there to fund your retirement.
For example, I have clients had successful operating companies, and as their business grew, we included family trusts and holding company as well. When time came for retirement, with none of their children interested in the service enterprise, they sold the operating company. They and their children shared in the wealth from the sale of the operating company. Ultimately, the children will take over the holding company with its commercial real estate investments. Yes, the business has changed, but it’s still in the family.
Wealth management and estate planning evolves as your family and your business grows. Through thoughtful, in-depth planning, you can create a personalized plan that allows you to secure your business, while exiting on your own terms and leaving the next generation with the tools and the flexibility they need to continue growing your business and legacy.
For more information, contact Kim Drever, CPA, CA Regional Leader, MNP Taxation Services, Peace Region at 780.831.1700 or
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