Your Estate

I was having dinner with Joe Rager, the owner of Absalom Engineering, when he said, “Alex Brown died.” “I heard that. How old was he?” I asked.

“Just 55.” Joe put down his coffee. “Alex was one year behind me in high school.”

“How’s Sonya doing?”

“She’s devastated.”

“I hope things work out for her.”

“I’m one of the executors, Hank, and I have a question for you. Alex owned all the shares of his company, and I’ve been told the estate will owe about $120,000 in tax on those shares. I thought small business shares were exempt from capital gains tax.”

“The shares of active small businesses are eligible for a $500,000 capital gains exemption. But there are some tests the shares must pass before they qualify for the exemption. The most difficult one is that at least 90% of the company’s assets must be used in the active business at the time of disposition — which would be the date of death in this case. If Alex was keeping outside investments in the same company that the business was in, he might have tainted the shares of the corporation. However, you might still defer the taxes using a spousal transfer, if the will allows it.”

“Alex’s passing has made me consider my own plans,” Joe said. “My company is worth about $1 million now, but I’ll be working for another 10 years. What can I do about the taxes?”

“The first thing you should do is purify the company. That means pulling any outside investments out of it. You can incorporate a holding company for those investments. Although owning your business real estate in the active company won’t taint the shares, it’s a good idea to move it to the holding company. It’s advisable to have minimal assets in your operating company to protect yourself against creditors. If the company is ever sued, the fewer assets in it the better.”

“All right,” Joe said. “I’ll look into that.”

“On the subject of creditor proofing, you should consider life insurance products. Generally, they are protected from the creditors of the estate. People are more reluctant than they should be about using life insurance. The industry has come up with some interesting solutions for business owners.”

“I don’t think that’s necessary. I’m in pretty good financial shape.”

“Of course. But if you had a prolonged illness your financial situation could become much worse and so could your company’s. Or if you’re personally on the hook for the company’s bank loans, they could eat up much of your estate. Putting a life insurance program in place to protect your wife and other heirs might be the best thing you could do for them.”

“Point taken.”

“Since your business is worth $1 million today and it’s growing, you might want to consider ways of multiplying the number of capital gains exemptions you’re entitled to.”

“Multiply the exemptions? I thought each person was entitled to just one.”

“That’s right. But you might structure your ownership so your wife can get an exemption. Just bringing up the idea with Marie might be useful. It would provide an opening to discuss your estate issues.”

“That’s a good idea. Sonya Brown knew absolutely nothing when Alex died, and I think her ignorance has been a major cause of anxiety.”

“You might also consider making your sons shareholders. They’d be eligible for exemptions as well.”

“I don’t know,” Joe shook his head. “That might complicate my life. I have one son who is in the business and another who is unlikely to come on board. Right now I don’t think I want either one of them owning shares. I haven’t worked out my estate plan yet, and I wouldn’t want to finalize a corporate structure prematurely.”

“That’s not unusual, and it might lead you to consider a family trust. You could purify the company and sell half your shares to the trust. You’d trigger a capital gain exemption of about $500,000. At that point you would have removed half your shares from your estate — and the estate would not have to pay tax on those shares if something happened to you.”

“Whoa, Hank. You’re moving a little fast for me. I have never considered a trust before.”

“My point is this. You can avoid many of the tax problems associated with capital gains if you just do a little planning in advance. The solutions are comparatively inexpensive — and the costs of doing nothing can be high, as you found out dealing with Sonya Brown.”

“Okay, Hank. I hear you.”

“There’s another benefit as well, and it might be worth even more than the tax savings. If you begin now to deal with the situation of your estate and what your wife and children inherit, you’ll open up many important family issues. Those family matters really should be discussed and settled while you’re in good health. Unfortunately the great majority of people avoid doing that. Often their wills come as a complete surprise to their heirs — and emotional problems are created that are quite unnecessary. They can lead to dissent and anger — not a legacy that anyone wants to leave behind. It’s an important parental role, but it’s easy to duck since it’s not the most pleasant thing to deal with.”

Joe nodded. “I’ve seen a bit of that with Alex Brown’s family. The will conveys a huge emotional impact. It’s the last message of a loved one, and it comes from beyond the grave. It would have been very useful if Alex had discussed his affairs with his wife when he was able to.”

Hank Bulmash, MBA, CA is a principal of Bulmash Cullemore, chartered accountants of Toronto, e-mail: hbulmash@bulmashcullemore.com