Byline: Francis Mackan (as published in Biz Magazine)
Despite the title, this is not another article preaching the dire consequences of not having a succession plan for your business. Business owners have been inundated with facts, figures and prophetic warnings regarding the need for succession planning. But why are so many refusing to act? Usually it is because the focus is on running the business, but perhaps it’s because there is a lack of direct experience or real life examples of the perils of delaying this important business plan.
So the purpose of this article is to give you, the corporate business owner, a real life example, an impetus if you will, that you can use as motivation to get started.
A key component of any good succession plan is tax minimization on the succession of your business. This could mean the transfer of your business to family members, a disposition on death, or in the real life case described below, the outright sale to a third party.
Recently I was referred to Brad Martin (not his real name), the owner of a successful manufacturing company. Brad’s company was growing quickly, and he recently had some soft inquiries from competitors about selling his company. Brad wasn’t looking to sell, but the dollar amounts being discussed would certainly allow him to slow down and spend more time with his wife and three teenage children.
Brad had no formal succession plan in place. However, he had already taken several positive steps forward and as a result, had a business that was sustainable without his involvement.
Brad’s tax knowledge was limited to his understanding of the Lifetime Capital Gains exemption of $750,000 on the sale of small business shares. The competitors were offering amounts well in excess of that number so he assumed taxes would have to be paid.
As I met with Brad and began understanding his business, the first thing I found was the company was structured in too simple a manner for its size and worth. He owned 100% of the common shares of his corporation directly. There were no other family members involved. And since Brad started the company from scratch, the shares had an original cost of $1.
The first item to discuss with Brad was income splitting with family members. Income splitting is the concept where a family unit will pay the least amount of tax when all members of the family can share in the income earned. I wanted to immediately implement a reorganization that would see Brad create a holding company and a discretionary Family Trust. We would freeze the current value in Brad’s common shares, and then introduce his wife and three children as common shareholders through the trust. No-one had broached this subject with him in the past.
I was introducing Brad to long range tax planning. I wanted to ensure that he maximized the benefit of the Lifetime Capital Gains exemption. If one shareholder could earn $750,000 tax free, then five shareholders could earn $3.75 million of taxable capital gains tax free. I told Brad, “If we implement this structure now, and enough time passes before a sale of shares occurs, then significant tax savings could be achieved”
Two months passed and Brad received a cash offer of $10 million for his company. Closing would be in 90 days, pending successful due diligence and the majority of the price would be paid in cash. There would be no time to implement our plan.
Business owners who have undertaken succession planning understand the benefits of long range tax planning inherent in the process. The value of any business can be increased by taking advantage of all incentives and deductions, thereby leaving more cash in the company. Furthermore, when the shares are sold, significant tax savings can result.
Unfortunately for Brad, it was too late. My lament to him was that I wished we had met five years ago so that a proper tax minimization plan could have been put in place. Although we were able to implement some immediate tax minimization strategies, the lion’s share of what could have been saved was lost.
In the end, Brad accepted the offer to sell, after weighing those very important lifestyle decisions against the prospect of implementing our plan and waiting for the next suitor to come calling. He gave up $750,000 in taxes paid that he would have otherwise saved had he implemented a formal long range succession and income tax minimization plan.
Filed under: For Horne clients and associates
