Time buys opportunity!
By planning early, you create more opportunities to access strategies for sizeable tax savings, to find the right person to transition the business to and for cash to be generated to pay those exiting the business. As discussed in earlier blog posts in this series, it is never too early for a business owner to create a succession plan. However, the length of time actually needed will increase the more complicated the corporate and family structure.
Let’s start with the dollars and cents of it! A general guideline is to start planning your exit from your business five years before you want to retire. This ensures a plan can be prepared that minimizes tax by using some tax planning strategies like capital gain exemptions and deferrals. Leaving the planning too late can drastically reduce potential tax savings.
Here is an example.
24 months could save you upwards of $200,000 in tax (based on 2020 rates)!
When selling the shares of your business, in order to trigger a capital gains exemption, there are time requirements that must be met. Some of these require the seller to have held the shares for 24 months before the sale. Also most of the assets in the company must be used in active business activities in Canada over that same period therefore assets such as portfolio investments, excess cash, or real estate not used in the business must be moved out the company. As you can see, meeting these conditions alone could require more than two years.
If you plan to sell your business to a third party, you may also need to consider having financial statements prepared by a public accounting firm for three years leading up to the sale. This allows potential buyers to have confidence in what they are buying.
The tax implications surrounding a succession plan are also important for younger business owners to consider. One option available is to set up a family trust as the holder of the company’s shares. As beneficiaries of the trust, you, your spouse, and your children become indirect shareholders of your company and may share in its future growth. This strategy then acts as part of your succession plan by allowing you to access multiple capital gains exemptions (one for you, one for your spouse, and one for each of your kids) in the event you decide to sell your business when you retire therefore compounding the tax savings noted above. An added benefit of implementing a family trust is the potential to split income with your spouse and kids (once they reach the age of majority) to access their lower marginal tax rates. It should be noted that the tax changes implemented in 2018 by the federal government attempt to curtail income splitting with family members where certain criteria are not met. As such, income splitting with family members may not be available where they are not active in the operations of the business full-time or do not own shares directly in the business. Succession planning is not a one size fits all solution and will vary for each business. But by putting a plan in place, you can create sizeable tax savings over time.
Taxes aside, you also need time to determine what you want out of your business and who should be your successor. You then need to ensure that your family, friends, advisors and key employees are all aware of your wishes and have had time to process the information and accept your decisions. This all comes before worrying about tax strategies and can be much more difficult to deal with!
Want to check out our Succession blog series?
Check out Part IV of RLB’s succession planning blog series to find answers to the question of: Where should I start?
Business owners work for years to build up a business that they are proud only to come to the grim realization that they will be walking away from it all upon retirement.
Want to be your own boss? If you are a budding entrepreneur, already own a small business or are looking to purchase a business, this blog post is for you!