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Why it’s Never Too Soon to Consider Succession Planning


In the past few months I have given presentations on the topics of incorporation and succession planning through a Manitoba government agency that provides support to new and established businesses. The incorporation presentation had 45 participants and the succession planning presentation had only 20 participants, which makes sense when you consider the majority of people who take advantage of such government programs are typically new to the business world and one of their main considerations as a new business is whether to incorporate.

The organizers made two interesting comments about the difference attendance rates for these sessions. First, they had checked with their provincial counterparts across Canada and noted succession planning presentations typically had lower attendance figures than presentations on other topics. Second, they suggested this made sense given that most business owners were not yet ready to sell their business.

The importance of timing in building a succession plan was certainly a part of my presentation, however given the organizer’s comments about business owners not being interested in the topic until they actually were ready to sell prompted me to write about subject.

There are several reasons why it is important to consider the eventual succession of the business well before the business owner is ready to exit. Although I’ll discuss a few of the tax implications, it is important to also consider non-tax issues. For instance, if the business owner is so integral to operations that the business cannot function without him or her being involved, the succession options will be reduced as there will be less people interested in purchasing the business. If this is the case, it would be advisable to develop a plan as soon as possible that allows the business to thrive without the current owner’s in-depth involvement.

Capping Estate Taxes

If you’re looking to have a family member take over your business, a classic approach is through the use of an estate freeze. The business owner locks in the value of his or her shares at the value of the corporation on the date of the freeze and the future growth accrues in the hands of the family member taking over the business (usually a child). In addition to allowing the family member to take more responsibility and participate in the growth of the business, there is also a tax benefit in that the value of the business in the hands of the business owner is capped on the freeze date. Upon death, there is typically a deemed disposition at fair market value of one’s assets and the fact the value of the business owner’s shares were capped at the freeze date will likely result in less tax to the estate, as the tax is deferred to the next generation. As a result, entering the freeze transaction earlier – assuming the value of the business is lower – can be beneficial.

Multiplying the Capital Gains Deduction

Undergoing an estate freeze and having a discretionary family trust own the new common shares may allow for the multiplication of the capital gains deduction upon an eventual sale of the business to an arm’s length purchaser. The capital gains deduction allows up to $750,000 (increasing to $800,000 in 2014) of capital gains on the disposal of eligible property to be realized without incurring income tax. Capital gains realized on qualified small business corporation shares by a discretionary family trust can be allocated to various individual beneficiaries of the trust who can each claim the capital gains deduction.

That being said, waiting to undergo an estate freeze and have a discretionary family trust purchase the new common shares can put your potential tax savings at risk in a number of ways:

The Two Year Clock

First, in order for a beneficiary of the trust to claim the capital gains deduction the trust must have owned shares of the corporation for at least two years. Although the business owner may not think the business will sell within the next two years, unsolicited offers to purchase the business can be received prior to that time. The business owner may then have to choose between waiting to sell the business to take advantage of the tax savings or to take the offer, as there is no guarantee another offer will come later.

Freezing Early

Second, even if the trust owns the shares for more than two years, only the appreciation in value from the time of the estate freeze will accrue to the shares owned by the trust. So for example, let’s assume that an estate freeze is implemented when a corporation is worth $750,000 and ten years later the corporation is sold for $4,000,000. The capital gain on the trust’s shares would be $3,250,000. In this situation, assuming the shares qualify, there is potential to use multiple capital gains deductions. However, let’s also assume that succession planning is not implemented until the corporation is worth $3,000,000. The capital gain to the original business owner is much larger and the capital gain to the trust is only $1,000,000. The potential to shield the capital gain from income tax has been greatly reduced and theoretically, the delay in succession planning has cost the family unit over $500,000 in income tax.

There are several reasons why it is important to consider succession planning early. The specific items mentioned above only represent a few of the reasons why waiting too long can be costly.