Business owners need proactive tax planning

A heavy tax burden is a grave concern of surviving families as many Canadian family businesses owners take an approach to tax planning that is ‘too little, too late’, according to the Canadian results of PwC’s latest Global Family Business Survey.

The study noted that the majority of Canadian family business owners are not fully aware of the domestic and international tax obligations that will arise in their estate on the shares of their business, resulting in many passing on heavy tax burdens to their surviving family members at the time of their death.

“We’ve found a lot of family business owners don’t realize that their tax obligations grow as their business grows,” says Kathy Munro, partner, high net worth practice, PwC. “With some planning, owners can avoid a lot of headaches and costs by putting a plan in place to fund the future tax and preventing it from growing. This will help reduce the likelihood of their family having to sell the business to meet heavy tax obligations.”

International and domestic tax implications were found to be one of the top three external issues Canadian family business owners felt they would face in the next 12 months.

Less than half (45%) of Canadian owners had their business valued domestically within the past 12 months to gauge their tax exposure and 41% said they were unaware of capital gains tax implications to their estate in respect to the shares of their business, the study noted.

A staggering 95% of respondents were unaware of the possible international inheritance tax implications, which is concerning given the large number of business owners who are U.S. citizens, or have children living in the U.S.

Canadians in the U.S.“It’s remarkable how many Canadians with family in the U.S. don’t realize that U.S. estate laws may apply to them,” says Beth Webel, partner, tax services, PwC. “Without proper tax planning in place, such as a family trust, the U.S. government values their estate and slaps a high tax rate on it at the time of their child’s death.”

Considering only 5% of respondents were aware of international inheritance tax obligations, many Canadian owners are at risk of bequeathing staggering costs to their families.

In December 2010, U.S. President Barack Obama temporarily increased the estate tax exemption to $5 million from $1 million and decreased the top estate tax rate to 35% from 55% on the total market value until the end of 2012.

“Given this relief is temporary, Canadian family business owners with children living in the U.S. should take this opportunity to plan for the impact of ever-changing U.S. tax regimes,” adds Webel.

Catch 21 This year, many Canadian family trusts are approaching their 21st anniversary thus becoming susceptible to high tax bills triggered by the Income Tax Act’s 21-year rule. The rule generally states that after 21 years, if the trust holds property on that date, it is deemed to have disposed of the property at its current market value and the trust must pay taxes on the capital gain.

However, many business owners don’t know that. A trust can usually transfer its assets to Canadian resident beneficiaries without triggering the tax on the gain. Trustees should begin planning for the transfer at least a year ahead of the.

Death tax deferralOne way owners can defer tax on death is to plan their will so that the tax is not payable until their surviving spouse passes away. Another is to opt for an estate freeze, which ensures the tax liability for the owner’s shares in the company will not increase after the freeze is in place.

“This is a great time to complete an estate freeze because business valuations are generally low right now,” says Munro. “If the business grows in value and a freeze is not in place, the family will have to come up with the money to pay the increased tax bill owing at death.”