It’s never too soon to start tax planning to protect your investment and avoid costly errors
When you start a business, you’re likely focused on the opportunity – the goods or services, hiring, logistics, the market niche to be served. The last thing on your mind? Tax planning.
Don’t let taxes become an afterthought, though, as doing so could trigger a substantially larger tax bill for you as your business matures. “A lot of people don’t know what they don’t know,” says John Waters, Vice-President and Director of Tax Consulting Services at BMO Private Wealth.
Waters and his team have a long history of working with entrepreneurs, helping them take advantage of money-saving opportunities and avoid tax-related pitfalls. Many business owners don’t fully appreciate that there are different tax considerations at every stage of the business, he says, from start-up to growth to maturity and exit. Making the right moves early can save a lot of money and frustration now and in the future when retirement is in sight.
Here are some tax-related issues to consider at each stage of your business.
Launching your venture
As an entrepreneur starting a business, some of your decisions will have important tax implications to consider. For instance, should you incorporate or work as a sole proprietor? Do you need a shareholders’ agreement to help mediate disagreements should they arise? How can start-up losses be used for tax benefits?
From a tax and legal perspective, one important discussion to have early on is around how to structure for the capital gains exemption and the possible use of family trusts. For instance, if you want family members to share in the success of your business, plan for that when you’re starting out, because it can allow each member to claim a capital gain exemption when the business is eventually sold, says Waters. “You can do it later, but it’s easier to do up front, and more beneficial, because you can capture the growth from day one,” Waters explains.
There are many other issues to consider at this stage, too, from the proper care of books and records, cash flow planning, external funding and more. “It’s about gaining an awareness of the opportunities that are out there,” he notes.
Grow and prosper
New issues emerge in the growth stage, including whether to invite shareholders into the business and how to take money out of the company in a tax-efficient way, says Waters. If you haven’t already done so, you should consider how to protect your assets from creditors, if your business runs into any financial difficulty.
While it might feel premature to think about leaving the business, this is also when you should start to consider your exit strategy and begin laying the groundwork, says Waters. It’s at this stage where you will want to start developing certain tax structures that could help with exit planning. “A lot of the planning may be too late so it’s just not going to have the same benefit that it would have, had you done it years before,” notes Waters. “That’s the mindset shift we’re trying to make on the planning side.”
Insurance can also play a role, ensuring you and your family are taken care of and the business is protected. For instance, critical illness and disability insurance should be considered, as well as buy-sell protection, to plan for what happens to your share of the business if you can’t continue running the company. “It’s about having that foresight and that planning in place to deal with these possible eventualities that could really affect the business,” says Waters. “There are many different strategies involving insurance.”
Refine your strategy as your business matures
As your company matures, succession planning should be at the forefront. You’ll likely want to diversify your assets with a personal investment portfolio, and consider incorporating life insurance, which is not taxable. “You’re starting to think about succession planning, maybe getting the next generation involved, or you’re starting to think about what retirement might look like and thinking about cash flow and ways of getting money out of the company,” says Waters.
The two main ways of selling the business are either by selling shares or selling assets of the business, he explains. There are pros and cons to both approaches, for both the buyer and seller, he adds. After the sale, the next step is finding the most tax-efficient ways to access the money you need, he says. At this stage, many owners are also thinking about how their philanthropic goals could dovetail with tax planning. It’s also a good time to make sure your personal assets are well diversified, so your financial future isn’t reliant on the business.
Think about your next chapter
Realistically, from a tax perspective, owners should be planning their exit at least five years in advance of their anticipated retirement date, says Waters. “For a smaller business owner, the capital gains exemption is huge. You can shelter almost $1 million of capital gains,” Waters says.
But for the business to qualify for the exemption, the Canada Revenue Agency may look back over the previous two years of financial and shareholder activity to ensure the disposition meets certain conditions. In other words, you’ll need at least a two-year window to prepare for the sale. You can also expand the shareholder equity eligible for the exemption by making other family members shareholders. But any sheltered gains will only date from the time they became shareholders, so consider structuring the business around multiple shareholders early.
Questions around succession planning are coming to the fore in Canada, largely due to demographics and the impending retirement of baby-boomer business owners. A 2022 report by the Canadian Federation of Independent Business found that an astonishing 76% of Canada’s business owners plan to exit their business over the next 10 years.1 Yet, only one in 10 entrepreneurs surveyed had a formal succession plan in place.
The COVID-19 pandemic threw a further wrench into the works, the study showed. It caused 17% of owners to accelerate their succession timeline and 22% to push theirs back, giving the business time to recover in the hope of fetching a higher sale price. Just under half of those polled (49%) expected to sell their business to unrelated buyers. The results were based on a survey of more than 2,000 private business owners across Canada.
Even if you’re among the one in four owners not planning an exit, it’s never too early to consider how to preserve the fruits of your labours, Waters says. “If you haven’t done the proper planning up front, it can come back to bite you.”
1Succession Tsunami: Preparing for a decade of small business transitions in Canada © Canadian Federation of Independent Business, 2022
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