Successful Succession Planning

Jared Pilon

According to recent statistics, nearly 70% of business owners do not have a succession plan in place.

Additionally, over $2 trillion in business assets could change hands over the next decade in Canada.

On episode #036 of the Tax Talk Podcast, Jared sits down with Stephen van Santen of Bridgeline Wealth Strategies to discuss the importance of having a succession plan in place.

They address succession question through the lens of a fictional family farm with the following case facts:

  1. Farm family, mom & dad have been operating for 30+ years.
  2. Farm has operated as an unincorporated partnership during this time.
  3. One son is actively involved in the farming operation.
  4. The other son has pursued a university teaching career, not involved in operations.

 

At what time should the parents consider succession opportunities?

The answer to this question is simple. Early and often. Implement the plan early on in life and make changes to it when major life events occur (birth of a child, a marriage, a death, a retirement, etc.) Waiting until you are ready to retire or until a tragic event strikes the family is not the ideal way to implement planning.

 

Has the family sat down to discuss overall succession ideas?

A successful succession plan will only be put into place if the whole family is involved.

  1. Who wants to take over the business/farm?
  2. Who is capable of taking over the business/farm?
  3. When do the original owners want to retire?
  4. What are the tax rules surrounding the transfer at the time of planning?

 

Are critical documents in order and accessible?

A succession plan will be tied to many other important documents: will, shareholder or partnership agreement, and others. Do you have these documents ready for review by Legacy Tax? Have they been recently updated to ensure they express your current wishes?

 

Has the farm been recently valued?

To transfer the business to the next generation, to key employees or to a third party, you will need to determine its fair market value. A simple valuation can be completed by Legacy Tax. If your business/farm is more complex, and/or holds significant real estate and other assets, it might be beneficial to chat with a Chartered Business Valuator (CBV). Speak with Legacy Tax if you would like a CBV referral.

 

Is unincorporated partnership the right structure going forward?

If your business/farm has been operating as unincorporated entity, your succession plan might include a discuss about the possibility of incorporating. It is possible that the partnership is resulting in the original owners being subject to high personal tax. Once the cash flow of the business exceeds the personal expenses of the original owners, your business would likely benefit from the tax deferral options that incorporation provides.

 

If deciding to incorporate, what does that scenario look like?

With respect to a family operation, the following would take place (subject to change to meet your specific needs):

  1. A valuation of the farm partnership would need to be completed.
  2. Farm property with accrued gains could be transferred into a newly incorporated entity via a Section 85 election.
  3. Mom & Dad would receive preferred shares in return for the transfer of the equipment, typically with a nominal cost and a redemption value = to the fair market value (FMV) of the equipment.
  4. Common shares would be issued to Mom, Dad and son #1, presuming that Mom & Dad were still planning to work and therefore share in the growth of the farm. (see below for discussion with respect to updated tax rules in effect for January 1, 2024 that handle the inter-generational transfer of businesses/farms)

The same process would apply to an unincorporated business. Speak with a professional at Legacy Tax to gain a better understanding of your unique situation.

 

Should farmland remain in personal names?

  1. Typically, farmland should remain in personal names.
  2. This could change over time as the operation grows and Lifetime Capital Gains Exemption (LCGE) balances have been used up.

 

How will control of the farm change? (immediate or slowly over time?)

Tax rules have changed effective January 1, 2024 with respect to inter-generational business transfers. See our blog titled ‘Intergenerational Business Transfers’ for further details. In short, the original owners will need to transfer full control of the business/farm to the child(ren) within 36 or 60 months.

 

What are the income expectations of the parents in retirement?

  1. Will the parents move off of the farm?
  2. Are there plans to travel?
  3. Medical expenses?

 

What are some areas to watch for when managing retirement funds?

  1. Are there assets held personally that will generate retirement income?
  2. Do preferred shares need to be redeemed as a result of the incorporation of the farm partnership or the addition of the children as common shareholders?

 

Is there sufficient cash flow to maintain the entire family through the farm operation?

  1. If incorporating, there is likely excess cash within the farm operation.
  2. Consideration needs to be given for the preferred shares received on incorporation as well as any received on the eventual estate freeze.
  3. One of the biggest factors to consider will be external factors: carbon tax, inflation, input costs and others.
  4. Do the parents have a timeline for redeeming their shares?

 

What should be taken into consideration re: estate planning and equalization?

The division of family assets that involve significant holdings within a business or farm can be done fairly, but not necessarily equally.

If one son continues the operation, he is exposed to the risk of running the business/farm in order to eventually see his inheritance. The son that is not involved in the operation would likely receive cash as his inheritance. The division of assets may result in son #1 getting more but this comes with additional risk as well.

Life insurance is a good option to help ‘equalize’ the estate of the parents. Son #1 can retain ownership of the farm and son #2 would receive his inheritance via a cash payout. Structuring your estate in this manner can help preserve family relationships after your passing.

 

What is the tax impact of the eventual passing of the parents?

  1. Inter vivos gifts of assets: if NOT qualified farm/fishing property, deemed disposition at fair market value, taxed at fair market value, even if no cash received. Deemed received at fair market value. Important to ensure that the farming corporation qualifies for the Lifetime Capital Gains Exemption.
  2. Land, depreciable property, share of a family farm corp and interests in a family farm partnership can be transferred with favourable tax treatment (ie. tax-deferred basis).
  3. Shares held on death can be transferred to spouse or children on a tax-deferred basis. There may be any opportunity to make use of the LCGE.
  4. Most important consideration is operation of the farm after the transfer of the shares. The non-farming son may want to extract cash for his shares. This could be done through the corporation redeeming shares or the farming son purchasing the shares directly.
  5. The non-farming son would likely prefer to sell his shares as this would trigger a capital gain and the option to use his LCGE or see generally lower tax rates.
  6. Planning completed in advance could allow Mom & Dad to carry joint last to die insurance which could be used to equalize the estate.
  7. Alternatively, the farming operation via the family farm corporation could be left to the farming son and the land (held personally) can be left to the non-farming son. An agreement would be put in place for the land to be rented back to the farming son.

 

Conclusion

Please contact us at reception(at)legacytax.ca for personalized advice and guidance regarding your succession plan. Remember, implementing a plan early and revising it often (when major life events occur) will ensure that you are positioned to preserve your financial legacy.

 

Disclaimer

By using this website, blog or podcast, users agree as follows:

The information, services and/or products are for general information only and any reliance on the information provided therein is done at your own risk. If you make tax, accounting, investing or legal decisions after accessing this website, blog or podcast, it is recommended that you consult a qualified professional first.

The views and opinions expressed are those of the author, seller, guests or publisher and do not necessarily reflect the views of the organizations or businesses that these individuals are associated with.

Although we make strong efforts to make sure my information is accurate, we cannot always guarantee that the information on this website, blog or podcast is always correct, complete or up-to-date.

Posted: 1/30/24