As they prepare to retire, a crush of entrepreneurs will soon be selling their businesses. And one of the biggest issues they should be contemplating – right now – is taxes.
"It's the million-dollar question: What am I going to do with my business? A lot of people are asking that question today," says Frank Fazzari, a CPA and managing partner of Fazzari + Partners LLP in Vaughan, Ont.
By the time an entrepreneur has decided to sell his or her business, it's too late to take advantage of some tax-minimization strategies, so careful planning is key. "You have to prepare your business for sale much earlier than a possible sale date," Mr. Fazzari says.
More than three-quarters of small-business owners are already planning ahead, according to a survey released in 2015 by the Canadian Federation of Independent Business. They anticipate parting with their companies by 2025, with 85 per cent of those surveyed citing retirement as the reason for selling.
The survey also indicates, however, that only half of entrepreneurs have an exit strategy – or succession plan – in place.
When selling a business, owners have two options. They can sell all or part of the shares, or sell its assets, such as the goodwill, furniture, equipment, accounts receivable and inventory.
Each option comes with tax implications. Here are points to keep in mind:
- Those who sell eligible shares may qualify for the lifetime capital-gains exemption of about $835,000, meaning they would pay no taxes on capital gains up to that amount. In an asset sale, the exemption cannot be used, so the proceeds from selling assets are taxed.
- While an asset sale can be undertaken for any type of business, a share sale can only be used on an incorporated business.
- In a share sale, the liabilities, or debts, are often sold with the rest of the business; in an asset sale, the vendor may still be responsible for them.
Italo Lunardo, 44, examined all his options while figuring out how to capitalize on the tremendous growth of his Brampton, Ont.-based plumbing business in the years following the 2008 economic downturn.
With the help of his accountant, Mr. Fazzari, Mr. Lunardo started planning a partial sale of his business, Lunardo Plumbing Inc., to take advantage of the one-time lifetime capital gains exemption. The preparations began about three years before he sold 55 per cent of the shares to two associates who had been helping him.
Mr. Lunardo then reinvested the money he made from the partial sale. In 2013, he and his new partners founded LPI Mechanical Inc., which focuses on heating, ventilation and air conditioning services.
By staying on as a part-owner of both businesses, and bringing in new shareholders with different skills and expertise, Mr. Lunardo and his partners nearly tripled the staff to about 40 and increased sales to more than $10-million a year from about $3-million for both companies combined, he says.
As for his long-term plans, "the overall vision would be to probably sell to my employees, or a well-established business," Mr. Lunardo said. But again, he would be fine tuning things with Mr. Fazzari as he continues to revisit his exit strategy.
While the lifetime capital gains exemption seems like the perfect way to avoid paying taxes, Mr. Fazzari warns that business owners "have a small chance of using the exemption" because the rules are "complicated and restrictive." Also, not many buyers want to take on shares of a company, especially a business owned or managed by a family, he says.
Business owners who intend to pass on their operation to family members should consider an estate freeze, which is a tax-efficient way to transfer a business. In this strategy, the owner sets up a discretionary trust to hold growth shares of the business that the owner might want to eventually pass on, Mr. Fazzari said.
Owners can do this without losing control of their business or paying any immediate income taxes on the transfer. He warns, however, that completing an estate freeze requires you to "dot all the i's and cross all the t's."
But over all, owners should be careful not to let tax repercussions be the sole driver in their succession planning.
"The tax tail should not wag the dog," said Tom Deans, a Canadian intergenerational wealth expert. "This is not about saving tax – it's about transitioning the business to the highest buyer, either inside or outside the family."
"That is how the family makes money, and once you decide which road to go down, you can work with an accountant on tax minimization strategy," says Mr. Deans, who is based in Toronto and the author of the books Every Family's Business and Willing Wisdom.
Mr. Deans's advice hinges on the idea that every business should be sold and never given to family, which can create tensions, undermine relationships and ultimately affect the workings and value of a business.
"It should be sold to family, sold to a key employee, to a competitor or to a financial buyer – always sold. Never gifted. And always sold at a market price, not at book value. It is the job of every business owner to sell their business for the highest value they can get.
"Because when a business owner dies, where does the wealth typically go? To the surviving spouse and kids. The dollar I'm trying to protect in the family business is the same dollar that will be ultimately inherited."
Talking early and often about how the business is going to be sold is important, says Mr. Deans. Set up an annual family meeting to discuss it.
"By virtue of having meetings and keeping minutes of meetings, and bringing transparency and predictability to an estate plan, they're very rarely challenged" in court.