Taxes are often on the minds of many family-business owners. But serious tax planning beyond yea r-end corporate taxes is commonly forgotten.
BIV spoke with tax-planning specialists from PricewaterhouseCoopers LLP (PwC)and Grant Thornton LLP about issues family-business owners should be thinking about when tax planning.
Owners sometimes neglect to address the long-term impact taxes could have on their family and business. More than 40% of Canadian family-business owners weren’t aware of the impact of the capital gains tax on their business, according to the 2010/11 PricewaterhouseCoopers’ (PwC) Canadian supplement to their global family business survey.
“Taxes increase over time as the value of the business increases,” PwC B.C. private company services leader David Kahn said. “Owners need to have a plan to minimize tax on current income and also minimize tax on death to maximize wealth for the family.”
PwC is a business-management firm that provides accounting, planning and consulting services to public and private businesses.
Kahn said taxation for family businesses has two major elements. The first element is corporate tax and personal income.
Owners typically either leave the money in the company to help the company grow or take money out, as salary or a dividend. But, Kahn said, these options aren’t as black-and-white as they appear.
“A family-business owner has to think about, ‘What’s going to be in my pocket at the end of the day?’”
A salary or bonus is a deductible item to the company, but an owner’s salary is fully taxable, often at a high personal tax rate. A company could pay out less in salaries. The company would have more corporate tax, but because corporate tax rates are generally lower than individual tax rates, the company could pay out dividends at a later time with more after-tax money.
One way to manage the owner’s high personal tax is with income-splitting, suggested Doug Moore, a tax partner with accounting and cusulting firm Grant Thornton.
Instead of the owner having all the family’s personal income, sharing it with a spouse or adult children, who are taxed at a lower rate than the owner, could reduce the family’s income tax burden.
Moore said leaving income to be taxed in the company has advantages too. As companies have lower tax rates than individuals, by leaving income in the company an owner can defer the personal tax and have more after-tax dollars to invest.
Death and taxes
The second major element of taxation for family businesses is long-term planning, particularly, Kahn said, the need to be aware of what happens when an owner dies.
As a business grows, so does its tax liability, which can become overwhelming at the death of an owner.
One way to offset this tax burden is an estate freeze, Kahn said. An estate freeze helps prevent tax from growing by freezing the value of the company at a point in time so there is a known value of the business and a known tax liability. Any future growth and taxes on that growth are passed on to the next generation or spouse.
Less than half of the Canadian family business owners surveyed by PwC had their companies valued within the past year to measure their potential tax burden.
A family-business owner, with no spouse must pay a tax on the value of shares they own at date of death, the capital gains tax. In Canada, 50% of any capital gains at the owner’s date of death are taxed at the owner’s individual tax rate.
For example, if a family business owner has shares in a company with a market value of $10 million and pays taxes in the highest tax bracket, there would be a capital gains tax liability of about $2 million at date of death.
Left unchecked, the tax burden would grow as the company grows. If the same company grew to a value of $20 million, the capital gains tax would be about $4 million. An estate freeze while the company’s value is low would help minimize the potential tax burden.
“So [a family-business owner has] to be thinking about how he might help his estate provide for those taxes,” Kahn said.
He added that life insurance, selling off company assets or any available cash on hand are things owners should be looking for to help pay those taxes. Otherwise the estate would be responsible for paying the tax.
Both consultants said tax planning needs individual attention, tailored specifically to each family business, but all family-business owners should have a succession plan and an up-to-date will. More importantly, tax planning is fluid and should be continually evaluated as the business changes.
“Maximizing wealth means in some respects minimizing your tax burden,” Kahn said. “It’s never too early to start tax planning for the owner or family.”
40% of Canadian family business owners surveyed weren’t aware of the impact of the capital gains tax on their business
50% of Canadian family business owners surveyed had not had their companies valued within the past year