The Power of Family Trusts in Entrepreneurship

One of the secret weapons that we typically introduce when businesses start becoming successful is the use of a family trust. I'm not saying that you don't need to still do sophisticated tax work, but the use of a family trust will allow that intergenerational transfer without any sort of triggering of tax at a specific time. The importance is that if you want to multiply your capital gains exemption and you feel like there's a value there that you can sell your business for in the future, we need to do this early so that the appreciation of value can start at a small amount and we have a higher amount that we can allocate to our beneficiaries. Good day and welcome to the Wealthy Entrepreneur podcast. I will be your host, Bob Gobro. So great to have you here today. This is the place where we dissect the elements that contribute to entrepreneurial success, from mindset and leadership to profits and revenue. And this is an exciting episode if you're interested in tax savings. I don't know if everyone is, but I'm pretty sure 99% of people want to pay less tax. This episode is going to be referred to as the secret weapon of tax savings, the use of a family trust. And this is an area where you know our sophisticated tax team of in depth tax specialists. They spend quite a significant amount of time and what their role is is essentially to look at and review individuals business structures and make sure that though those structures are optimized for tax savings. And one of the secret weapons that we typically introduce when businesses start becoming successful is the use of a family trust. And in this episode, what we're going to talk about is the seven factors and benefits of introducing a family trust. Now there's more and they get really in depth, but I'm going to talk at a high level of the seven areas of where family trust could be beneficial. So if you have a business and you're looking at optimizing your tax situation, I'm going to share with you the seven ways that a family trust could help your situation. Now, again, we need to look and review at every single situation to make sure that this applies to you. But in most cases, the use of a family trust in a sophisticated business that is profiting, the use of a family trust will provide substantial savings, if not now, in the future. So the very first area of savings that a family trust introduces is income splitting. Now, for many of us, we know we're limited in how we can income split and currently, you know, we look at dividends and dividends can be income split if you have multiple shareholders and if their share class allows you to income split and to provide dividends at different levels, different values. And we know we've been restricted on being able to issue those distributions over the past few years unless we hid certain characteristics. And, you know, the, the most popular one is making sure that a family member works at least 20 hours a week over a prolonged period of time. If that is the case, or they've done so in the past, we would be able to potentially income split with them through the use of dividends. Now, one of the things that a family trust does is it provides us the opportunity to also use income splitting through family trust. If the corporation that you own has $100,000 of profits, profits can be distributed up to the family trust and then can be allocated to beneficiaries across the board in whatever way the trustees really deem to be appropriate. So again, we need to follow the rules of the 20 hours a week at a minimum in order to be able to do this income splitting. However, it does allow us to incorporate that in here as well with a little bit extra flexibility. So income splitting is definitely one way. The other way that isn't necessarily requiring a family trust is the use of salaries and compensation or wages for family members. So we'll definitely do another session on that. But really those are the two ways that we can focus on income splitting. The family trust just gives us the option that regardless of the share characteristics in the corporation, typically the way that we would set up a corporation, we would have multiple share attributes, class A, class B common, that would allow dividends to be issued discretionarily each year to multiple shareholders or a single shareholder so that they're not at the same amount. But the family trust gives us additional flexibility in here with income splitting. So it's, it's important that this is utilized to the best case it can be. But this is just one area where a family trust will allow us to optimize our income splitting. There's more, and I'm going to get to them in a minute, but I'm going to move past income splitting for a moment. I just wanted to highlight that that is one of the options, number two, protect equity. So a lot of times what happens is businesses will incorporate a holding company. And when businesses start getting successful and they start getting surplus cash, one of the things that they want to do is get that cash out of there and protect it. What happens though, when we introduce a holding company, we're actually limiting some of our, our Tax advantages. When a holding company owns our operating company, it becomes really difficult, especially if that holding company is holding all the cash and investments, maybe real estate becomes really difficult to get access to our lifetime capital gains exemption. So what the family trust will do is it will allow us the opportunity to still get access to our lifetime capital gains exemption, but also allow us to protect our equity and remove our cash from our operating company and get it into a safe place. The way that this works is we usually have a beneficiary inside the family trust that is a corporate beneficiary. And it allows us to essentially distribute dividends from our operating company up to our holding company without paying any additional tax. And we can certainly get into depth with that. But if you are in a business where you're getting surplus cash, you're worried it's sitting in your operating company because it's exposed to risk. Should you get sued or should a risk inside your business be there? You want to protect that cash. One of the ways that we can protect that cash and do so without triggering tax, but also taking advantage of the fact that we can still get access to a lifetime capital gains exemption, a family trust is the best way to do it. Again, we distribute that surplus cash out to the shareholder, which is the family trust. And the family trust allocates those dividend distributions to one of its beneficiaries, which is a corporate beneficiary. And there's no tax on that distribution. The cash is now in a separate company and it's fully protected and away from creditors. So, number two, protect your equity. Number three, delayed taxes on death. So if you think of a corporation and you've got a shareholder that owns it, let's just say it's one shareholder to keep it simple. And it's a single person, they don't have a spouse. So, you know, if I think of my grandfather, for example, if he owns a corporation that has, it's active, it's got operational value, when he passes away, there's a deemed disposition that he sold all of the shares of the corporation. Now, that may or may not be an okay situation. But if this corporation has too much cash in there at the time of death, you don't get access to your lifetime capital gains exemption, you're paying a quarter million dollars more than you should the use of a family trust. So again, if we use my grandfather, if my grandfather owns this and we introduce a family trust and he's the trustee, he's still in charge of this family trust. If that happens and there's multiple beneficiaries that are in there that aren't entitled to anything unless the trustees indicate otherwise. So if he is a beneficiary or there's multiple beneficiaries, if he passes away, the trust is still in existence. It doesn't die with him. The ownership is still with multiple beneficiaries. We just need to bring in a new trustee. This allows us to avoid that deemed disposition that would normally occur at that time. It allows us to defer or delay taxes upon death, which otherwise doesn't happen if we don't have a family trust in place there. So that's an interesting benefit related to a utilization of a family trust as well. Number four, intergenerational transfers. So this one is really important and a lot of us, if we have a family business or if we have, if we have children that we want to eventually take over our operations, a lot of time there's some sophisticated tax work that needs to go into that. Now I'm not saying that you don't need to still do sophisticated tax work, but the use of a family trust will allow that intergenerational transfer without any sort of triggering of tax at a specific time. And what I mean is if the family trust owns the corporation, I let's say it's my corporation and I'm operating it. If I want to transfer that value to my kids, essentially I can rewrite it or make them trustees of the trust. They can take over control and any future value that's created from the operating company is transition to them. Now we can get into more complicated situations where we would want to trigger an element of the capital gain because I would want to take access to my lifetime capital gains exemption. But we can have written agreements that allow us to do this after the fact. So flexibility on intergenerational transfers of wealth are very, very important when it comes to the utilization of a family trust. Number five, tax savings. So this is one of my favorite areas, and this is where when we think of one individual owner, every individual owner in Canada has access to lifetime capital gains exemption on the sale of qualifying while qualifying small business corporation shares, which means you're a small business corporation owned by and controlled by a resident of Canada and you're operating in a for profit business and you meet certain criteria which include not having more than 10% assets of assets in your corporation that aren't active business assets. So if you meet that qualifying test, you get access to lifetime capital gains exemption of about $1 million. So meaning that if you Were to sell your business for a million dollars, you wouldn't pay tax on it. However, let's talk about a more sophisticated business or one that's grown beyond that million dollar value. When we use a family trust, what happens is that we not only get access to our, again, my lifetime capital gains exemption, but if my family trust has beneficiaries, including my wife and my two children, I can even add more in there. I could add my parents, I could add in a multitude of other people. We have to be cautious though. We don't want to do it with multiple business owners because there are some negative tax implications that could come in related to sharing small business limits. I'm not going to go there today because it's way beyond the practicality of this. But just know that when we add more beneficiaries, in essence, we're getting access to their lifetime capital gains exemption as well, which means we can share the proceeds of the sale of our business and multiply our tax free limit. So for example, I've got my, my wife Jenny, my two kids, Jack and Sophia. If I were to sell my business for $4 million, I would essentially be able to allocate between the four of us the proceeds of that disposition, which would mean we would get $4 million of essentially tax free money by using a family trust. Now if it's just me owning this corporation and I sell my shares, I would get my $1 million free and I would have to pay tax on the other $3 million, which is about 25% or $750,000 on that sale. So in this case with my family structure, the use of a family trust will eventually save me $750,000 in tax. That is no small number. And the more beneficiaries that you get in there, the more access you can have in splitting that. And I was mentioning this as number one, income splitting. This is a method of income splitting on the proceeds of disposition of the sale of your shares at some time, whenever that happens. So not only do we get to delay it, but we also are able to split it and multiply that exemption, which is typically a fairly substantial amount. Again in my case with my three family members, could add more that $750,000 of tax savings that I will eventually realize. So again, not an immediate tax savings, but if I'm planning to exit, which we all should be at some point in our lives, then we should be looking at this and say, wow, $750,000 seems like it's a good idea for me to get this started now, and I will put a subclause in there that it has to be that the family trust is in place and is a shareholder realizing the appreciation and value of your shares over a period of time. So, for example, let's say my business is worth a million dollars right now, and I'm the only shareholder. I would still keep that million dollars of value and I would have to introduce my family trust at that point. I can't introduce it back to zero value. It has to be as of a certain date for a few reasons. One, the family trust didn't exist, so we can't backdate this. It has to be come in place at a certain moment. And two, we have to actually record the transaction of the family trust subscribing for shares at a particular date too. And again, we can't go back in the past and do this. We have to do this once the trust is in existence. And what happens there is, if we're going to look at introducing a family trust, but we're selling next week, we're not likely going to get the benefit associated with the multiplication of the capital gains exemption because we really would only get the value from this week to next week and be able to split that. So the importance is that if you want to multiply your capital gains exemption and you feel like there's a value there that you can sell your business for in the future, we need to do this early so that the appreciation of value can start at a small amount and, and we have a higher amount that we can allocate to our beneficiaries and again multiply that lifetime capital gains exemption number six. And this is also one of my favorite ones is the flexibility that a family trust gives us. So, you know, one of the, one of the elements that people usually ask or one of the questions that people usually ask is, so if I add my kids as beneficiaries to the family trust, does that mean that they're entitled to anything? The answer is no. So what it does is it gives us the flexibility to split income or distribute proceeds or anything like that. If the trustees, which is you controlling this family trust, it allows us the flexibility to distribute these funds, whether it's dividends, again, making sure that we qualify to be able to split income through dividends, or if it's through capital gains, on the disposition of shares in the future. Whatever it is, it allows us the flexibility to essentially name the amount at the time we decide to split it in your corporation or your articles of incorporation, it Becomes really difficult to define the flexibility to be able to do that, and particularly on the proceeds of disposition at the end when we do that, and we're only shareholders, individual shareholders, we have to split the income based on the equity amount that those particular shares have. So for example, my wife and I own this company and we've got two children. If we own it, 50, 50. And maybe I've already, I've already sold another business or something and I've used my capital gains exemption. We can't split that where she takes the full proceeds because that's not how the equity lines up in the corporation. Alternatively, if the family trust owns this and my wife and I are the only two beneficiaries, I can allocate 100% of the proceeds on this business to her. So we get access to the full tax exemption on that sale. So flexibility is huge inside the use of a family trust. And it, it gives us more flexibility than any other structure. So that's incredible. Number seven. And I also love this element of it is that there's major scalability factors. So I talked earlier about the protection of equity. So typically when we're setting up a family trust for a corporation and a family to, to be the shareholder of that through a family trust, what we do is we also set up a holding company. Now we sometimes don't do it at the time that we set up the family trust, but we write it into the family trust document that allows any corporation that we create in the future to automatically be eligible to be a corporate beneficiary. So when you start getting surplus cash, what we do is we create this holding company again to distribute all that cash, protect it from creditors, and make sure that all of your hard earned surplus cash and investments go and are protected in the future. And again, you sell your business down the road, the family trust sells the share of your business. You continue to own your operating company up here without any issue and whenever, without any risk related to the sale of the company. So they're completely separate. So back to the scalability factor. Once you have those two systems set up, a lot of people and entrepreneurs, this is for you, like to set up multiple businesses. So a lot of times we have an operating business, while we might have a second operating business or a third operating business, maybe we get into real estate. So the important part here on scalability is whenever you set up that new corporation, your family trust subscribes the shares of that corporation in the future and you can add as many corporations as you want in there. Many business avenues as you want. It allows us to have this as a very scalable model without any additional costs. So yes, there's cost to set up a family trust, yes there's a cost to set up a holding company, but those are one time costs. So any of these new corporations you set up, if any of those start having surplus cash or investments in there, you can dividend that up through the family trust. It can also go into the holding company all tax free as a vehicle. So it gives us scalability, gives us flexibility. Major one is the multiplication of the lifetime capital gains exemption. It allows us to have more flexibility on intergenerational transfers of ownership in the corporation. Again, if you don't have intergenerational transfer, this isn't necessarily going to be a benefit for you, but it's definitely do. It's not taking anything away from you. Delayed taxes on debt, super important. It allows us to have a little bit more flexibility to prepare for deemed disposition or death tax on on debt. It gives us again a little bit more flexibility there allows us to protect our equity and it allows us to income split through dividends if you're eligible for it through the 20 hours per week or substantial investment in the corporation and also on the distribution of proceeds when you eventually sell it. So guys, this has been a podcast related to the secret weapon to tax savings which is the family trust. Now if you're interested in learning more about how a family trust can be introduced to you, we're going to put a link in here to book a session with our tax team. They will be able to support you and identify whether or not a family trust will be applicable to you and whether or not we will be able to get access to these seven, if not more than one, benefits related to a family trust. So if you're interested in learning more, there's going to be a link below to book a time with our tax team to see how we can assess your situation and introduce substantial tax savings with the secret weapon of tax. Guys, this has been the wealthy entrepreneur. Again, the secret weapon to tax savings which is the family trust. If you like this, drop a comment in here. I would love to hear from you. If you think you know a business owner who would benefit from the fact that they've got a growing business, but maybe haven't introduced a family trust, make sure you share this, tag them in this, notify us. We'll reach out to them as well because we want to make sure that we're helping as many business owners and entrepreneurs as we can again save money so they can reinvest in their business, in their families, and we can exponentially change the world together. Make sure you subscribe to this channel. We're going to be releasing another podcast next week, so make sure that you're here. We're always going to be adding valuable insights for you, so check us out next week. Follow the Podcast Share this out Leave a comment we'd love to hear from you once again. Thank you for joining me. Bob Gobro, Great to see you today.