Own a small business? Don't miss out on future tax relief

Make sure you qualify for the lifetime capital-gains exemption.

Deanne Gage 23 December, 2014 | 6:00PM

You'll be hard-pressed to find an incorporated business owner who hasn't heard of the lifetime capital-gains exemption (LCGE). For this tax year, the LCGE was increased to $800,000 from $750,000, and that amount will be indexed to inflation.

To qualify, for starters, you must be a shareholder of an incorporated business. If you have adult family members who are also shareholders of this business, they too could qualify for their own LCGE. "This is an important tool in terms of planning for wealth creation within the family," says tax guru Evelyn Jacks, president of the Knowledge Bureau in Winnipeg.

But the qualifications aren't that simple. Unfortunately, many business owners have not taken the steps to ensure their incorporated business actually qualifies for this exemption, says Frank DiPietro, director of tax and estate planning at Mackenzie Investments. "LCGE is one reason why many business owners choose to incorporate," he says. "But some don't pay attention to the details because they have no immediate plans to either sell the business or shares of the business."

This thinking can backfire. "You'll want to ensure the business qualifies for the exemption no matter what because we don't know what tomorrow brings," DiPietro says.

If the owner or shareholder were to die suddenly, the shares would be deemed sold from a tax perspective. If those shares don't already qualify, they aren't eligible for the capital-gains exemption and thus lose out on the potential tax savings.

For sellers to obtain tax relief, shares of a qualifying small-business corporation must meet the following three criteria:

  • First, at the time of the sale, the fair market value of the assets used in the active business (as opposed to passive investments) must meet or exceed 90% of the business' total assets. "This is the test that many business owners have challenges with," DiPietro notes. "The business generates more cash than it needs to fund the business. So you have a lot of business owners that end up with a lot of investments inside their operating company. They need to ensure that no more than 10% of its assets are in passive investments."
  • Second, during the previous two years before the sale, 50% or more of the company assets have to be used in the active business carried on primarily in Canada by the corporation or a corporation related to it.
  • Finally, in the two years before the sale, the shares must not have been owned by anyone other than the seller or a person or partnership related to the seller.

Farmers and fishers have separate rules when it comes to LCGE. For instance, qualifying property for farmers includes land and buildings, shares of the capital stock of a family-farm corporation that the individual or spouse owns, and eligible capital property such as milk and egg quotas, Jacks notes.

Evelyn Jacks

For fishers, qualified property includes land or fishing vessels, shares of the capital stock of a family fishing corporation that the individual or spouse owns, and eligible capital property such as fishing licences, she adds.

Jacks says shareholders can defer the capital-gains tax on common shares if the full proceeds of disposition are reinvested in the shares of another qualifying small business within certain time frames. This might be done within 120 days after disposition of the business.

If the shares were acquired near the end of the year, however, the new shares must have been acquired within 60 days in the new year. As well, capital gains can be deferred only if the new business does not have assets exceeding $50 million in value, the adjusted cost base (ACB) of the old shares does not exceed $2 million and the qualifying cost is the lesser of actual cost and $2 million.

What if you have a loss on the shares in a family business? The good news is that loss may be considered an allowable business investment loss, Jacks says. This type of loss can offset other income of the current year, be carried back three years and carried forward 10 years to offset all other income in those periods. After this, business investment losses become normal capital losses, which can be carried forward indefinitely but used to offset capital gains only.

Also, note that business owners should not include minor children as shareholders of small-business corporations, since the LCGE is not available to them.

The LCGE is complex, so DiPietro and Jacks both recommend that incorporated business owners meet with their tax professional regularly to review all the specifics.

About Author

Deanne Gage

Deanne Gage  Deanne Gage is a Toronto-based writer who has specialized in personal-finance issues since 1999. A recipient of several journalism awards, including one from the Investment Funds Institute of Canada, she is also a former editor of Advisor's Edge and Advisor.ca. She can be reached at deannegage@gmail.com.