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All In One Basket

by Lisa Collins, QC, TEP | April 1, 2015

You have probably heard the advice “don’t put all of your eggs in one basket”.

We see a lot of businesses that suffer from the eggs in one basket syndrome. Like the phrase suggests, this can result in greater risk and cost them in the long run.

For families in business, this can describe a couple of situations. One is that all of the family’s wealth is tied up in their business and they have not diversified some of their wealth away from the business (in a tax efficient way). Another is where most of the family’s assets, including assets not directly used in the business, are owned by the corporation that also owns and operates the business.

It is not unusual to see a situation where a business structure has not changed from when it was first set up, after 10, 20 or even 30 years or more in business. The business has grown and evolved over the years, additional assets have been acquired, circumstances have changed and the wealth has grown. Notwithstanding, no one has paid much attention to whether the business structure and ownership still makes sense for the business and the family.

A common situation is where commercial real estate, investments and/or cash (excess to working capital requirements) have been acquired or left to accumulate in the operating company. They are all in the same basket as the business.

Here are some of the ramifications:

  • Those non-business assets are exposed to the risks of the business. Should the business suffer a financial downturn or failure, those assets could be lost to the creditors of the business.
  • The shareholders may not be able to use the capital gains exemption, with a potential tax cost to each of them of $170,000 or more. The capital gains exemption is only available for shares of a corporation that uses 90% of its assets in carrying on an active business. The non-business assets could throw that offside.
  • The business owner may have plans to some day sell the business but retain the commercial real estate where the business is carried on and lease it to the business. That is difficult to do when the business and the real estate are owned by the same entity. It won’t happen without potentially significant tax cost.
  • Estate planning can be challenging with this inflexible structure. In many cases the founders intend that the business be left to certain family members (who take an active role in the business) and leave the non-business assets to other family members. This is almost impossible to do (at least in a tax efficient way) when everything is in one basket.
  • Where a family has more than one business, the succession of those businesses to the next generation can be more complicated if they are held in one corporation. Having them owned in separate corporations can provide greater flexibility as to future management and ownership among family members.

It is important for a business family to make sure that their business and corporate structure continues to make sense and takes advantage of opportunities. It involves a careful review of the current situation and structure, taking into account the family’s objectives.

Things can be restructured, and often in a very tax efficient way. In a recent case, we were able to move the commercial real estate, investments and excess cash to a new “wealth accumulation company” for the patriarch of a family business, without triggering tax on the assets. What’s more, the structure will allow him to move the excess profits of the business into his wealth accumulation company on a regular basis very efficiently. He now has the opportunity to better protect those assets and further diversify his wealth away from the business by pursuing other investments. He also has greater flexibility in his estate plan, accommodating his desire to ultimately leave the business to one of his children and equalize things with his other children using his wealth accumulation company.

Note that any possible restructuring involving the next generation becomes much more complex and more expensive (costs and taxes) if both of the parents are no longer in control of the corporation. Therefore, it is very important that the business structure be reviewed regularly and certainly before mom and dad have given up control (whether intentionally or as a result of their death).

Don’t Let The Tax Tail Wag The Dog

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by Lisa Collins, QC, TEP | Mar 17, 2015

I haven’t met a business owner that didn’t want to save taxes. And I am a firm believer in arranging business affairs to pay as little tax as possible (legitimately). However, sometimes people take great pains to save a dollar in tax, without realizing that what they are doing may cause them a lot more pain down the line. I refer to it as letting the “tax tail wag the dog”.

When we let the desire to save taxes drive the agenda for business succession, things can go off track badly. It can result in a narrow focus when what is really needed is a whole picture view of a family’s business, financial situation and family circumstances.

The problem is that when some people think of the succession of a business or a family’s wealth, they think it is primarily an exercise in saving taxes. In fact, it is primarily an exercise in transitioning the management and operation, and perhaps eventually, the ownership of a business to the next generation. We just want to be sure that we are minimizing taxes in the process.

There are many legal and other aspects that are an important part of any succession plan and they need to be integrated. This is why it is critical that a business family’s accountant, lawyer and financial planner be on the same page and work together. The problem is that often they are working in silos and don’t have the whole picture to operate from. Having the whole picture is left to the business owner who is then expected to know what needs to be done and direct the various players. Many business owners feel ill equipped to play that role and frankly, don’t want it.

A few years ago I began working with business owners, Peter and Irene, who had already restructured their business at the recommendation of their accountant. The business ownership structure had been changed (without triggering tax) and a family trust had been set up. The problem was Peter and Irene did not understand what the new structure was to accomplish and in fact were not even making use of it. Moreover, their estate plan did not reflect the change in ownership structure. Their financial advisor was not even aware of the restructuring and the impact that it could have on Peter and Irene’s personal financial plan. They were also really struggling with transitioning the operation and management of the business to their son and daughter. It was a classic case of a tax saving strategy setting the agenda for the family and losing site of what else was important.

I worked with Peter and Irene and their accountant, lawyer and financial advisor to develop a game plan that was refocused on what they wanted to accomplish. It had a number of recommendations relating to tweaking their ownership structure, winding up the family trust, putting in place a new estate plan and helping with the transition of management and operations to their son and daughter.

In the end Peter and Irene were happy to be saving some tax, but they came to realize that it was one of the by-products of a successful transition of their business to the next generation. It was no longer a case of the tax tail wagging the dog. The family dog was happy too!

A Game Changer for Estate Planning

by Lisa Collins, QC, TEP | Dec 18, 2014

Legislation Blue Marker

The federal government has introduced changes to the taxation of trusts, and the implications are so significant, it is a real game changer for estate planning.

Last year the government announced that it was looking at changing how a trust set up under a Will (known as testamentary trusts) is taxed. Previously such a trust was subject to graduated tax rates (like an individual). The government proposed that a testamentary trust be taxed at the highest personal tax rate on all of its income (which is how it is for “life time” or “inter vivos” trusts.)

However, the legislation that was released in late August, 2014 not only implemented those changes, it introduced other changes that appear to result in some unexpected adverse consequences. As a result, this will require a review of and changes to many estate plans.

These tax changes will have the biggest impact on estate plans where trusts are being used. This includes testamentary trusts, as well as certain lifetime trusts, such as Spousal Trusts, Alter Ego Trusts and Joint Partner Trusts. The family situations that may be impacted the most are those involving:

  • second marriages, where there are children from previous relationships, and where a trust is being used for the spouse
  • a disabled beneficiary

The rule changes will also impact situations where charitable gifts are being made by Will.

Here are some of the highlights (or lowlights) of the changes. Future blog articles will drill down into some of the detail, by providing some examples.

  • An estate can take advantage of graduated tax rates for its first 36 months, but there are strict requirements that must be met, including the making of an election. These graduated rates will not apply to a trust set up under a Will.
  • Only an estate that qualifies for the graduated tax rates can access new flexible donation credit rules and take advantage of the nil capital gains inclusion for donations of marketable securities.
  • Only graduated rate estates are able to take advantage of certain rules allowing for post-death tax planning.
  • There is a new “Qualified Disability Trust” for a disabled beneficiary that will qualify for graduated rates, but the requirements for a trust to qualify for this are very specific and can be penalizing if not adhered to.
  • When the life interest beneficiary under a trust dies, the trust is deemed to sell its property at that time and tax would be payable on any gains or other income. Previously this tax was payable by the trust, and thus would be paid using the remaining assets of the trust. The new rules will result in the tax being payable by the estate of the person who has died. The ultimate beneficiaries of the trust and of the deceased person’s estate may be different people, resulting in a frustration of the estate plan (and fighting among family members!).

The changes to the tax laws have not yet been passed by Parliament as of the date of writing this, but it is expected that they will without significant amendment. They are proposed to be effective starting in 2016, with no grandfathering for existing situations.

It is important to review your estate plan to see how these changes may affect you. In my next blog article I will provide an example of an actual situation and explain the impact the changes have made. In the meantime, if you would like our help in reviewing your current estate plan, please contact us to set up an appointment.