Estate planning tips for business owners

Transcript

Intro Speaker:  

Hello, and welcome to Matters Beyond Wealth with your host, Leanne Kaufman, president and CEO of RBC Royal Trust. For most of us, talking about subjects like aging, late life, and estate planning isn’t easy. That’s why we’re going to help get the conversation started on this podcast while benefiting from the insights and expertise of some of the country’s top experts. We want to bring you information today that will help to protect you and your family in the future. Now, here’s your host, Leanne.

Leanne Kaufman:

As of December 2021, there were 1.2 million business owners in Canada. So many Canadians have worked hard to drive their businesses to where they are today, and for many, this can be your most valuable asset when making plans for your estate. Protect what you’ve worked so hard to build by having the right plans in place to help achieve your goals for the succession of your business.

Hello, I’m Leanne Kaufman and welcome to RBC Wealth Management Canada’s Matters Beyond Wealth. With me today are Abby Kassar and Murray Shapiro. Abby is the vice president, business owner specialist, high net worth planning at RBC Family Office Services. She specializes in succession tax, retirement, and estate planning issues for business owners. She’s written articles on tax planning, executive compensation and retirement planning. Murray is the vice president, high net worth planning services at RBC Wealth Management Services [RBC Family Office Services]. His expertise encompasses both domestic and international family circumstances, and in many cases is focused on the challenges of transitioning a family business. He’s been a featured speaker at the Estate Planning Council, Law Society, and estate and trust industry conferences in Canada and abroad.

Abby and Murray, thanks for being here with me today to talk about estate planning considerations for business owners and why this matters beyond wealth.

Abby Kassar:

Thank you.

Murray Shapiro:

Thanks, glad to be here.

Leanne Kaufman:

So, Abby, let’s start with you. I know you spent a lot of time thinking about tax implications as part of the broader planning. So as part of an estate plan, what are the tax implications that business owners should be keeping in the back of their heads?

Abby Kassar:

So as you mentioned, Leanne, for business owners, their business is likely their most valuable asset, and to transition this asset, it does require careful planning and considerations because we do want to minimize the tax impact and ensure that the business will continue to thrive. Let’s take for example “Mary,” who’s a successful business owner. If Mary sells her business during her lifetime, she would trigger a tax liability, but she would have cash from the sale of the business to pay for the taxes. On the other hand, if Mary transitions her business at the time of passing, she would be considered to have sold her business on her death for the fair market value on that day. This would trigger a tax liability even though a sale did not actually take place and the estate may not have the cash to pay for the taxes. It’s really important to have an estate plan in place to allow the business owner to plan for this scenario and to ensure that the estate does have liquidity to fund the tax liability at the time of passing.

Now, it may be possible for Mary to defer the tax liability by leaving her business to her husband, “John,” but that does require a discussion of other non-tax considerations. Alternatively, it’s possible that Mary may want to transition the business to family members, maybe her kids during her lifetime, and a tax liability would be triggered as a result. And again, planning is required to make sure that the proceeds that Mary receives are not only sufficient to fund her tax liability, but also to allow her to fund her lifestyle needs during her retirement.

Leanne Kaufman:

Yeah, so the timing of the sale or the transfer or waiting until it becomes an estate issue is so important to the planning, isn’t it?

Abby Kassar:

Absolutely, yes.

Leanne Kaufman:

So, Murray, so keeping with this theme of estate planning, what are some of those key non-tax-driven planning issues that you think every business owner should be considering?

Murray Shapiro:

Thanks, Leanne. To begin with, I think we’d agree that estate planning can be thought of as planning for the unexpected. For example, what happens if Mary becomes seriously ill, or even worse, she suddenly dies? For a business owner, planning for contingencies like these is very important because one way or another, the doors of the business are going to open the next day at 8:00 AM. To start with, ideally, arrangements should be in place to run a business, even in the absence of the business owner. As Mary starts thinking about her estate plan, she’ll need to turn her mind to who might someday take over from her as the legal owner of her business.

In other words, if we assume that, like many other business owners, Mary owns her business through a corporation, if Mary dies, who does she want to inherit her shares? Then I think it’s fair to say that a business owner should have an up-to-date Will. So, if Mary does not have a Will or it’s not up to date, getting this in place should be a priority. However, getting a Will in place can be easier said than done. I think you’d agree that there are a lot of considerations that go into having an up-to-date Will, especially for business owners, and that this will take some time and thinking.

For example, Mary may not be the sole owner of her business. There may be other shareholders such as her spouse, John, or one or more of their children or siblings, or even non-related parties such as friends or arms-length partners in the business. If there are other shareholders, there may be a shareholder’s agreement setting out the rules as to whom Mary is allowed to transfer her shares.

One thing is for sure if there are multiple shareholders, the death of any shareholder will impact the surviving shareholders in one way or another.

Leanne Kaufman:

Yeah, no question. I think this is a good example of all of us would talk about estate planning and realize that just having a Will on its own isn’t an estate plan. All these other contingencies and interrelated documents that come into play. So, Murray, just focus in, if you can drill a little deeper on some of the key planning issues. Let’s assume Mary was the sole owner of her business and there weren’t other shareholders or other co-owners.

Murray Shapiro:

So, we’ll assume that Mary dies and she was the sole owner of her business. As Abby was discussing, if there’s no realized gain in her shares, Mary may want to leave her shares to John to be able to defer payment of the taxes that would otherwise be owing on these shares. As Abby noted, the tax deferral applies until John dies or decides to sell or otherwise, transfer his shares, and many business owners do want to take advantage of tax deferral planning. If this is Mary’s wish, she should be aware of other considerations that can make this type of planning for a business owner a bit more complicated than expected. For example, how important is it for John to own Mary’s shares after her death so that he’s not stressed about his own ongoing financial security? This is an important question because if John inherits Mary’s shares, he’s not only going to own but also control all future business decisions.

Mary and John may have children and some of them may work in the business. In this situation, Mary or ideally, both John and Mary may want one or more of their children to end up owning Mary’s shares.

So Leanne, to sum up a business owner that’s updating [their] estate plan has many factors to consider. If you don’t mind, I’ll highlight just a few more of these. For example, how old are Mary and John and how old are their children? What is Mary and John’s financial situation and what is the state of their relationship? And when you think about it, Mary and John almost certainly own other assets such as homes, cottages, bank accounts, investment portfolios, RSPs. At the end of the day, if Mary dies first, all of their family assets are going to impact John’s financial situation. So these assets need to be dealt with in Mary’s Will and therefore will factor into her overall estate plan.

Leanne Kaufman:

Yeah, so many co-dependencies like we just talked about, and then layering in what you said, some of the things about transitioning to a spouse or other family members and there’s a whole the emotional side of that. Who wants to be part of the business, who should be part of the business and so on. A lot to unpack in a short conversation.

Abby, let’s pivot back to tax for a minute. What are the possible tax planning strategies that our business owner listeners should be considering when they are doing their own estate planning?

Abby Kassar:

The first tax planning strategy that would come to mind that’s available only to business owners, is the ability to take advantage of the lifetime capital gains exemption, which would result in a tax savings of approximately $250,000. What this means is that when a business owner sells shares of an active business, approximately the first million dollars of capital gains may be exempt from tax if certain conditions are met.

Some of these conditions include the requirement that they sell shares of the business and not the assets. In addition, to qualify, the business should have 50 percent of its assets used in an active business for two years prior to the sale.

Also, 90 percent of the assets need to be used in an active Canadian business at the time of the sale. So, Leanne, you can see that these are really complex and technical rules. It’s really important for Mary to review these rules regularly with a professional tax accountant to make sure that the shares of her business would qualify for the exemption at the time of transition.

Another strategy that Mary may consider if she anticipates that her business will grow in the future is to implement what we call an estate freeze. The estate freeze may be put in place to allow a business owner to cap the value of their business at today’s value. Any future growth would be accumulated in favor of the next generation or possibly any other individual that the business owner may choose. The benefits of the estate freeze is that it allows the business owner to lock in their tax liability based on today’s value. Since the future value will grow in favor of the next generation, they’re the ones that would be subject to tax when the business is sold or when they pass. As a result, this allows for a deferral of the tax liability on the future growth in value.

Going back to Mary, if Mary was to implement an estate freeze at today’s value that value is held in her hands and we refer to that as “frozen shares.” Now, Mary may consider planning that would allow her to reduce the value in her hands over time by redeeming her shares during her retirement, which is typically referred to as a “wasting freeze.” Or Mary may consider acquiring a life insurance policy that would allow her to fund the tax liability that would be triggered upon her passing, and that policy would be calculated based on the value of her frozen shares.

I do want to mention one other advantage of the estate freeze. It’s the potential ability to multiply the lifetime capital gains exemptions that I mentioned earlier. It is possible to multiply that exemption among family members at the time of a sale of a business, which would really reduce the overall family tax liability. For example, going back to Mary, if Mary included her three children and her spouse as part of her estate freeze, she would be able to share some of the proceeds from the sale of the business with her family. This would allow them to potentially use their own lifetime capital gains exemption, which would result in additional tax savings of approximately one million dollars for the family. This makes it a great tax saving strategy.

I do want to add one last comment with regards to strategies to transition a business to family members: that until recently, business owners wanting to transition their business to their children were not able to do so on a tax effective basis. This was a great disadvantage that really impacted family succession planning for business owners. I’m happy to report that legislation was changed recently and they have introduced the intergenerational business transfer rules that do allow for a tax-effective transition of a business to family members. It’s really important to consult with a tax advisor if a business owner does wish to take advantage of these new rules because you want to make sure that you are meeting the terms and conditions of these new rules so you can take advantage of the favorable tax treatment.

Leanne Kaufman:

I think given everything that you’ve given us to think about there, it’s important to meet with a tax advisor regardless. But yeah, those new rules are definitely something everyone should be learning about.

Abby Kassar:

Absolutely.

Leanne Kaufman:

So, Murray, in the situation where a business owner has put an estate freeze in place, what are some of the non-tax considerations that they should also be thinking about?

Murray Shapiro:

Okay, well, as Abby explained, estate freeze planning basically means capping the value of your business at its current value and then restructuring the ownership of the business so that there are new owners of the future growth. While there are different ways that an estate freeze can be implemented to achieve the tax results that Abby touched on, as well as other family and business-oriented objectives, the key part of this type of planning involves reorganizing the shares of the business such that all future growth will be captured in newly issued common shares, and then taxation of this future growth will be attributed to the owners of these new shares.

So, Leanne, I think that one of the first questions Mary needs to answer is who she would like to be the owner or perhaps owners of the newly issued common shares. Mary may want to be included as one of the new owners if she only intends to freeze part of the future growth of her business. But if Mary’s goal is to cap her own tax liability, then she has to include other persons in her plan. In other words, for estate planning to make practical sense, Mary needs to choose one or more other persons to be new shareholders. These other persons are almost always chosen from amongst direct family members, meaning Mary’s spouse, children, and possibly grandchildren.

The main driver in Mary’s decision around new shareholders may well be how certain she is at the time of implementing the estate freeze about who she ultimately wants to own the new shares. Assuming that Mary can make this decision, then once the new shareholders are chosen, Mary has another important decision. Does she want the new person or persons to own their shares right away, meaning directly in their own names? Or does Mary want to take some time to decide exactly who, when, and in what proportions the new shares will eventually be owned by these new persons?

Mary may have children working in the business if they are say 40 or 50 years old, and Mary expects them to eventually take over her business, Mary may already know or at least have a good idea that she wants each of her children at some point to own a certain proportion of the new shares. In this situation, it might make sense to simply issue the new shares directly to each child in the percentages that Mary wishes. However, Mary needs to know that this choice cannot be undone and each child, for better or worse, will own those shares and in those proportions.

Subject to any constraints in a shareholder’s agreement, each child can then deal with these shares as he or she wishes. If Mary wants to take some time to make these decisions, then she may decide to issue the shares to a family trust, allowing her to keep a level of control over these shares. Under current tax rules, Mary will have 21 years before she feels compelled to finalize her decision on the specific share allocations.

Leanne, as you deal with every day, the factors to consider when setting up a family trust and the terms that will cover its operation are numerous and not always easy to understand. So I’m sure you’d agree the professional advice on trust features, benefits, advantages and disadvantages will be very important to ensure that the business owners’ planning objectives are achieved.

Leanne Kaufman:

Yep. Just like Abby in the tax, we need to make sure that all these legal implications of the permutations in combinations are well-thought-out and advice is sought. So I always ask my guests, if you hope listeners just remember one thing from this conversation, what would that one thing be? But today I’m going to offer my own first, which is get professional advice in all of these topics. It’s way too complex to do it yourself, but now I’m going to hand it over to you, Murray, Abby, what’s the one thing that you hope our listeners take from this conversation?

Murray Shapiro:

Okay. First, business owners and their spouses should try to keep their Wills up to date. Practically speaking, this means having Wills that work together to achieve their estate planning goals for their families and ideally, their business succession planning goals as well. Wills that are not up to date or that don’t work together could create some unexpected results, and it’s always possible that these results can impact the future of the business.

Abby Kassar:

For my end, I would say that it’s never too early to start planning for a business owner. As Murray mentioned, it is important to have an up-to-date Will, but it’s also really important to review the overall estate and tax plan to make sure that you have a proper structure in place and that you are taking advantage of all the tax strategies possible. So the planning should not only factor today’s circumstances, but it should also be flexible to allow you to make updates that may reflect changing to life circumstances or changes in the business or potential legislative changes.

Murray Shapiro:

Okay, so if you don’t mind us taking an extra second or two, my second takeaway keeps with the theme about being proactive with your planning. For example, if children are involved in an estate freeze, business owners should seriously consider putting in place a shareholder’s agreement. By doing so, you can try to make sure that the rights attached to these shares make sense for both your family and your business going forward.

Abby Kassar:

Lastly, although we talked about the tax planning and how important it is to make sure that the tax plan forms are part of the overall estate plan, the tax plan should not dictate the overall estate plan. As Murray mentioned, there are a number of non-tax considerations that are really essential to ensuring that you have a successful business transition. So all the aspects of your planning should be reviewed regularly and considered together to ensure that you have a comprehensive and holistic succession plan.

Leanne Kaufman:

Those are both, well, all four of them are great pieces of advice, and you guys clearly know your stuff, and I hope that our listeners who might benefit from the kind of advice you bring are able to find people with as much knowledge as the two of you bring. So thank you both Abby and Murray for joining me today to talk about just really, I think, skimming the surface of some of these estate planning and tax considerations for business owners and why this matters beyond wealth.

Murray Shapiro:

Thank you.

Abby Kassar:

Thanks for having us.

Leanne Kaufman:

If you would like more information on planning services for business owners, please visit rbcwealthmanagement.com. You can find out more about both Abby and Murray on the RBC Wealth Management website or on LinkedIn. And if you enjoyed this episode or you’d like to help support the podcast, please share it with others, post about it on social media, or leave a rating and review. Until next time, I’m Leanne Kaufman. Thank you for joining us.

Outro speaker:

Whether you are planning for your own estate, the needs of your family or business, or you are an executor for a loved one’s estate, we can help guide you, simplify the complex, and support your life’s vision. Partner with RBC Royal Trust and ensure your legacy will thrive for generations to come. Leave a legacy, not a burden™. Visit rbc.com/royaltrust.

Thank you for joining us on this episode of Matters Beyond Wealth. If you would like more information about RBC Royal Trust, please visit our website at rbc.com/royaltrust.