The tax vultures began circling when my friend’s stepfather prepared to sell his medical research practice a few years ago. Unfortunately, when they bit, they took a large chunk – as in hundreds of thousands of dollars in taxes.
The real bad news is that it could have been prevented. Her stepfather and his tax advisors (who weren’t cheap) missed a small detail, one that had happened two years before the sale. It caused the company to be denied the tax-free exemption.
The lesson for doctors and business owners – plan your exit strategy early in the game. In doing so, you can greatly reduce the amount of taxes you pay on the sale, or even sell your business tax-free.
The whole incident with my friend’s family reminded me of Christmas Day, 1998. I was sitting by the pool at a resort in St. Martin, completely enthralled in The E-Myth by Michael Gerber, when I came across a piece of advice that stuck.
I rarely remember exact details of where I am when I read things, but this particular day has stayed with me. As I looked up from my book, I saw Santa Claus. Ok, a man in a Santa suit was walking towards the pool. After a moment of disbelief, the 20 or so kids in the pool suddenly and simultaneously began flailing through the water to get to him as fast as they could. It’s something I can still picture vividly.
After shaking my head and taking a decent sip of my drink, I got back to my book. And that’s when Gerber offered his unforgettable pearl of wisdom. He suggested that one of the biggest reasons to start a business, should be to sell it. Like the kids running towards Santa, I was equally surprised and inspired by what I had just read.
As a financial advisor, most of the doctors and entrepreneurs that I meet usually haven’t thought about this. They’re so busy running their companies that they don’t think about their exit strategy until it’s too late. This is a shame as there are many ways you can reduce the amount of tax you pay on the sale of your business or practice, if you take the time to get the planning right!
When you make a profit on the sale of an investment in Canada, it is usually subject to “capital gains” tax. This means that if you make a $600,000 profit on the sale, half of it is subject to the same type of tax you’d pay on income. That means $300,000 would be taxable income. You’d likely be subject to at least a 46% tax rate if you live in Ontario, which would equal $138,000 in taxes ($600K/2 x 46% = $138,000).
Fortunately in Canada, the first $800,000 of profit from selling your business is tax-free, often referred to as the lifetime capital gains exemption. However, it’s actually possible to sell your business for over $800,000 and not pay any taxes. If you use holding companies and family trusts strategically, spouses, family members and even friends can link together to use their lifetime capital gains exemptions and reduce their tax bite.
For example, a husband, wife and two children (of any age) could set up a family trust to own their company that is being sold. In doing this, they would have a combined $3,200,000 lifetime capital gains exemption ($800,000 per person) to utilize against the sale of a business. If their business were to be sold for a $3,000,000 profit, they would not have to pay any capital gains taxes on the sale.
A word of warning: Be careful that you don’t have too much cash in your corporation within the two years leading up to and including the sale of your business. If there is, you’re company may not qualify as a small business, rendering you ineligible for the exemption. This is why you must plan early! Research how to structure your operating and holding companies properly well in advance of the actual date you plan to sell.
If you have any questions regarding a pending sale of your business, or just want to be sure, feel free to contact me at your convenience.