Planning the (blended) family business

Estate planning done badly is one of those areas where only the lawyers make out well in the end. This is particularly true when it comes to tax and estate planning for blended families.

Even if a client’s decisions are not particularly contentious, there are still places where a significant amount of money can be left on the table — Canada Revenue Agency is usually one of the biggest beneficiaries when any estate is settled — and seemingly small decisions can have rather large and unintended consequences.

In their simplest forms, blended families are usually made up of parents who’ve remarried and include children and sometimes grandchildren from several different marriages — the client’s own children from their first marriages, children from the new spouse’s first marriages, and so on.

Grossly complicating the issue are situations where the family owns and runs a business that includes different business partners and family members. If this business was a going concern before the new spouse arrived on the scene, you can expect further complications.

Business and the blended family It goes without saying that drafting proper wills is an essential part of the planning process. But wills must be re-written after a second marriage, as existing wills are nullified by marriage.

Shareholders agreements too, which outline what happens to the client’s shares in the event of death, disability or divorce is a prudent measure, as is a marriage or domestic contract. Sensible business partners, family or not, should probably insist on such things as well, to avoid the possibility they could one day find themselves in business with their partner’s new spouse.

“The notion of a domestic contract or a prenuptial agreement, that’s something people choke on when they’re going into a first marriage. When you get to second marriage situations where people have assets, where each might have children from previous marriages, it’s entirely fair (to expect one),” says Doug Carroll, vice-president of tax and estate planning at Invesco Trimark. “There might even be a moral responsibility for the two people who are about to get married to engage in some kind of review of their assets and put something in place.”

Similarly, he says it is entirely fair for non-marrying business partners to ask for such documentation. “Estate litigation is nasty. Family law litigation is nasty and it could be the end of the business if things go off the rails later on. It’s a reasonable thing to ask for.”

Tax planning for the transfer of business shares, meanwhile, will depend on whether or not children in the family are already involved in the business and whether they are able to successfully take over.

Jamie Golombek, managing director of tax and estate planning at CIBC Private Wealth Management, points out that a properly thought out and executed plan can mean more than one shareholder is able to take advantage of the Lifetime Capital Gains Exemption, currently worth $750,000. He says shares qualify for the exemption “if 90% or more of the corporation’s assets are used in active business, you’ve owned the shares for at least two years and during that entire two-year period, more than 50% of the corporation’s assets must have been used in an active business.”

Investment using the corporation’s assets is where clients may inadvertently disqualify themselves from ultimately claiming the exemption. He says simple strategies to keep a client’s operating companies “pure” include debt repayment, regular distribution of non-active assets, purchasing additional active business assets, paying a retirement allowance or paying inter-corporate dividends to a connected company.

Karen Slezak, tax group partner at Soberman LLP also suggests drafting two wills — one to deal with any shares and debt from the private corporation, if applicable, and another to cover all other assets. In this way the private company shares do not necessarily need to go through the process of probate if the board of directors is comfortable with the business will.

It’s also worth noting though, that some efforts to bypass probate fees — putting assets in joint name, for example — can be more trouble than they’re worth. In this case, not only are the joint-name assets exposed to any financial difficulty (bankruptcy, separation or divorce) the second person in a joint-name arrangement might have, but such moves can also unwind any trust or tax planning set up in a will.

“Sure, you saved the probate fees but now you just unwound all the tax planning you were setting up to take care of ongoing taxes,” says Slezak. “In some cases it’s a better choice to pay the probate fees.”

Trusts Trusts established by a client’s will are called testamentary trusts. Although assets will be taxed before going into the trust, having assets held in such a structure help beneficiaries avoid high ongoing taxes in the future. The trust itself is taxed as an individual, which means lower rates are used to tax any income earned in the trust, whereas leaving a large outright inheritance to someone who likely already earns some income, will push that person into higher tax brackets for as long as they continue to earn interest or investment income from their inherited assets.

Spousal trusts, meanwhile, are set up in a will for the care and benefit of a spouse or partner. In this case, the client’s assets are taxed on death and placed in trust so income generated will continue to support the spouse. Once the second spouse dies, the money or assets held in trust are then passed on to the client’s intended beneficiaries (children from a first marriage, for example).

Such a move is often used in lieu of an RRSP rollover — although rollovers to a spousal RRSP occur on a tax-free basis, once the assets are transferred to the client’s spouse, his or her heirs have no claim on the assets, no matter what the client intended. (Insurance is another way to equalize an estate in a tax-efficient way on death.)

In all cases, dealing with such planning and explaining it while you’re alive is likely the best way to avoid dissention.

“You’ve got to really face it,” says Slezak. “The worst mistake people make is to shy away. They don’t draft a will, don’t deal with it properly, then leave a nightmare for everyone to deal with. You’re never going to be sure that everyone is happy (but) it’s much more powerful to deal with it in your lifetime.”

(04/09/10)