You started a business from scratch that’s now worth $1.7 million. If you sold today, you’d be able to avoid paying capital gain taxes as both you and your spouse have your $850,000 capital gains exemption room.
However, you’re not ready to sell and you’re wondering, “How can I shelter the future gains my business generates without losing control?”
The solution: A family trust.
Scenario 1 – Capital gains exemption WITHOUT a family trust
Let’s start by looking at a scenario without a family trust, and let’s fast forward 20 years.
You’re ready to sell and your $1.7 million dollar gain has grown to $5.1 million. After deducting both of your $850,000 capital gains exemption you’re still left with $3.4 million that’s taxable, which results in approximately $850,000 of taxes.
How a family trust can help
First things first, you would need to complete a corporate estate freeze.
This is accomplished by converting your common shares into preferred shares. This would lock in your $1.7 million gain tax-free due to your capital gains exemption.
The next step would be issuing brand new common shares to your family trust. This would result in all future growth being pushed to the trust and its beneficiaries. Making yourself the trustee and beneficiary would also leave you with full control of your business.
Scenario 2 – Capital gains exemption WITH a family trust
So, let’s fast forward 20 years again. We’ve already frozen the first $1.7 million gain, but the new common shares have grown by $3.4 million. A total gain of $5.1 million, just like our first scenario. However, this time you’re able to shelter the $3.4 million gain by using your family trust.
One of the benefits family trusts have is their ability to allocate income to any of its beneficiaries. By having also added your four children as beneficiaries you’re able to split the $3.4 million capital gain between all four of your kids, and you’re able to use their capital gains exemption. When it’s all said and done, you’re left with the full $5.1 million in your pocket, $850,000 more than our first scenario.
If you’re kicking yourself for not having more children, don’t! You can also add your grandchildren as beneficiaries and really go wild with this strategy.
More options available
This has been a high-level overview of how trusts can help you multiply the capital gains exemption as a business owner. There’s much more that I haven’t touched on that could be considered. So, if you are planning on selling your business within the next 5, 10, 20 years, give me a call, text, or email to see if trusts make sense for you. If you’re a farmer, definitely reach out to me as you have additional options available for your transition planning.