Latest / Wealth On Main Street / 179. Estate Freeze with Richard Canfield & Henry Wong

Transcript

179. Estate Freeze with Richard Canfield & Henry Wong · Wealth On Main Street

• 0:00
  Speaker A: You are listening to the wealth without Bay street podcast, a canadian guide to building dependable wealth. Join your hosts, Richard Canfield and Jason Lowe, as they unlock the secrets to creating financial peace of mind in an uncertain world. Discover the strategies and mindsets to a financial future that you can bank on. Get our simple seven step guide to becoming your own banker. It's easy. Head over to Sevensteps CA and learn exactly the learning process required for you to implement this amazing strategy into your financial life. That's Sevensteps ca. So we want to pass our business and some of our wealth on to the next generation, and we want to do it in such a way where it's efficient so that that money is working for the people we love and care about, our family members, et cetera, rather than going to places that we can't control. How do you effectively plan for the taxes on intergenerational wealth transfer? Well, that's something called estate planning. And joining with my good friend Henry Wong today, we're going to talk about an example of effective estate planning and some of the big pitfalls and landmines you might walk on if you don't have appropriate planning in place. So I'm excited about this topic. I think this is something that's going to add a ton of value to our listeners, Henry, so thanks for going over this with us. For those listening on the audio, make sure that you circle back to the YouTube channel and watch this. Henry's going to display a little bit of information on the screen today, but definitely be able to follow along on the overall gist of just how impactful this type of planning can be. When we're talking about selling a business and transferring things, whether you want them to be transferred or not, the transfer is going to happen basically, I think is the right way to say it, right, Henry?
• 1:48
  Speaker B: Yeah, absolutely. Thanks for having me here, Richard. And I'm really excited to talk about this topic because there's not a lot of information generally available for Canadians when it comes to this topic. And I will say, in terms of what we're going to talk about, it's really oversimplified because this can get very detailed and everyone's situation is really going to be different because of how many people or entities or what's involved in the equation and where they are at their particular point in journey. But the main part that I want to highlight for everyone who's going through this topic is we've talked initially in a previous podcast related to deemed disposition for a business owner, and that is exit plan, believe it or not, that a business owner has, whether it's planned or unplanned, the circumstances can be quite large for it. But there's other different exit plans that a business owner may encounter, which is by, let's say, even a third party sale, meaning they want to sell their business outside of their family, or they want to sell it, or a child wants to take the business. Whatever the exit plan is, most of the time, what I find myself in terms of dealing with business owners is that's not front of mind for them to think about. They're more focused on their current day operations or the next hurdle that they're going over, but they're not thinking about the long term end game. And this is where what we're going to talk about is that end game to ensure that a lot more related to what is built by the family is kept within the family.
• 3:34
  Speaker A: Well, and I think it's important to understand that the more successful you are at growing your business or building up amounts of wealth in the process of doing that, whether it's through, let's say, the acquisition of land or buildings or real estate that you might have that support or tie to your business, et cetera, over time, these things that are good strategic decisions, most likely, that have really helped you in your business world, they also have this double edged effect where they could create a really monstrous tax problem unnecessarily. And this is an area where the devil's in the details, I guess, because we've got this giant thing called a tax code book, and it gives you all the rules about how you can manage that system. So you can only pay your fair share, but you have to know what those rules are and you have to know where to find them. And so that's where good professional advice is critically important. And of course, we love working with accounting professionals to be able to assist them in servicing the client the best way possible so we can maximize what's available to the client and their family.
• 4:42
  Speaker B: Yeah. And if we take a step back and look at the overall objective of a corporate business owner, in all honesty, whether they say it or not, their objective is to increase value to the business or the asset that they're building. And the increase in value can come in different forms. It can come in the form of property as like a real estate asset that is held in there, whether it's a manufacturing facility or a multi residential real estate, or it can come in the form which there's a hard tangible asset that generates. But the key part is it's generating cash flow from that. The other elements include things like equipment or cranes or whatever, that they're ways of developing business. Some people have vehicles that they rent and they earn income from that. So those are aspects, if you're a.
• 5:33
  Speaker A: Dentist or a doctor and you have like x ray machines and that sort of equipment, that sort of stuff would be included in there as well.
• 5:40
  Speaker B: Yeah. Or you have a digital business, like an ecommerce business, that you are selling products or selling digital products online. Those are all going to be cash generating items that essentially formulate an asset or a value that if you were to transition that to someone, there is some component that you're not going to accept nothing for. You're going to accept something of much higher value of. And this is where the wonderful tax code will introduce itself, because what you started that value with is likely very low to nothing. And you, through your sweat equity, your time, your other capital that you've invested, have increased that value. And as you increase that value significantly, that disparity between what you paid for and what you've built up to gets so large that if you do not intervene and make the proper, structured decisions to make a plan in place, a large portion of that could go to other people's hands, mainly the cra. If you're not properly structured and planned in place for that.
• 6:53
  Speaker A: Awesome. Well, let's dive into this. And I know you've got a great example for us. There's some foundational knowledge you want to make sure gets conveyed before, of course, we go up to that example, Henry. So where's a good place for us to start really unpacking this for our listeners?
• 7:06
  Speaker B: For sure. So I'm not going to go into diving into what's called an estate plan and the details of that estate plan. So in our previous podcast, we've gone through talking about things related to a deemed disposition of a business owner. We've talked about introducing a holding company. Now we're kind of talking about a little bit more of the structural environment. And part of that is once you've introduced, there's a reason why you introduce a structured environment. One of that is if and when you want to transition what you've built to someone else. And believe it or not, when you're transitioning this asset that you've built with a high amount of value, if you want to transfer to your children, it does not transfer to your children tax free. There is no specific tax codes that exist for a pure transfer to your children. And this is so counterintuitive for a lot of people, except farmers and some other very specific groups. But for all a majority of Canadians, if you want to transfer the value of some asset or property that you've built to your children, there will be a taxable event. And that's the spot that we're going to talk about today, which is, how do you transfer the value that you've built to your children in a tax effective way? And this is using a very specific mechanism called an estate freeze. Now, an estate freeze is a tax planning strategy where business owners can transfer future growth and their value of their assets, usually in the shares of companies, to their next generation. And what that means is freezing whatever the value the shares are at this time, at a specific point in time, and then transferring that future growth, whether you're working on that growth or your children are working on that growth, to continue that growth journey on that asset. That is not really as much as the details, but you're trying to essentially cap the growth at where you are so that you can transfer that growth to make a problem for your future generation and roll it over to them in a very effective way. And that's what the estate freeze is going to do.
• 9:26
  Speaker A: And one of the key features of that is, I like how you identified the freeze is freezing a point in time and the value of things in a point in time. And so what you're dealing with is your work, your effort up to the point of the freeze, and you're now dealing with, like, a known tax event. You can actually determine and essentially crystallize that tax event to be a known value. And now from that point moving forward, you're back into an unknown value, but you're now able to spread that taxable event over more bodies to some degree, as you look at transitioning things on the assets, the business, et cetera.
• 10:08
  Speaker B: Yeah. So it's more bodies and length of time. So you're kind of pushing the value forward and crystallizing it into a very particular part of the generation that you're moving into so that you're still retaining that value and dealing with the legalized consequences of taxes when it comes to dealing with that. So what are the benefits of doing an estate freeze transaction? Well, the first is by initiating this process, it facilitates a smooth and orderly transition of ownership and control to the next generation. If you don't intervene with an estate freeze transaction, then other people get involved like, let's say I'm just throwing this out there. Probate or government or other kind of bodies will intervene creditors, perhaps creditors, they will intervene in their own objectives to figure out what the proper distribution is. Whereas you, in the time that you have, if it's important to you, will look at how can I solve this problem? Because I know eventually I'm going to pass away. But one of the things that a lot of people take for granted is they actually may not even know. We don't know when our best before day is. And it's actually really important that it would be more prudent for you to go through doing this process and setting up the structure and environment for you so that when that unpredictable event happens by accident, you don't have that unnecessary intervention. At least if an accident were to happen to you, there is a sequence of steps in place to ensure the transitions that move to the family is done in a controlled manner. And as part of that estate freeze transaction, that is going to involve a very special element in the tax code called the capital gains exemption. And in Canada, every business owner has an ability to not have to pay taxes on capital gains. And in 2023, the amount is 971,190. So that amount you can build value in, whatever that asset is for shares up to that amount where you do not need to pay taxes for. It's just like when you own a principal residence and you sell it for a higher value, you have a principal residence exemption, provided you didn't taint your property by doing things with that property similar to corporations and shares, you can taint that capital gains exemption. And obviously, the objective of every business owner that wants to exit a business, either by deliberate choice or not, they want to have the ability to utilize that capital gains exemption because that's big.
• 13:07
  Speaker A: Well, the fact that we're going to be able to give people, maybe not a full on guide on how to do that, but at least give them the awareness on how they can go about creating those necessary steps, I think today is really tremendous. So I'm excited as we delve deeper into this.
• 13:23
  Speaker B: Henry yeah, and the point is not for you to take this knowledge and go do it yourself type of thing, because tax code is extremely complex. It's created by the government and the laws by how it's been created. But what you now know of is there's a capital gains exemption that you can take advantage of, and how do you preserve and make sure you take advantage of it? That's one part we're going to go over today. The other benefits of doing an estate freeze transaction is if structurally, we talked about in a previous podcast of a lot of business owners just have a hold code. Why would you introduce another corporation in your corporate environment? The other is to creditor protect your operating company from the assets from that creditor, whether it's by lawsuit or by a loan that you may have, and a lot in terms of a plan in place. How do you structure something like this? Is making sure that the operating company has the minimal amount of resources it needs to operate while the real resources are shelved somewhere else, away from harm. And that's where, again, part of the estate plan includes sheltering and protecting against creditors.
• 14:41
  Speaker A: I'll give you, just to give an example of that. So you have an operating business, and that business is generating good cash flow. It has 500 grand of cash sitting in the bank account, but it only really needs, let's say, in a rolling 90 or 120 day period, maybe it only needs $100,000. So it's got $400,000 of essentially excess cash sitting there waiting to do something. Well, in the event that the business owner dies or something, at that point, there's a lot of extra cash sitting on the books that maybe could have been sitting somewhere else, like in a holding company, and that also could be an asset of real estate. Maybe you bought a building for your dental practice and you're running your practice out of there. But if it's owned by the operating company, well, now it's accumulated and raised in value. We've owned it for ten years or 15 years, and the value has gone up substantially. That's dragging down. It's a resource that's underutilized capital, essentially, which is going to mess up your exemption if you don't move it out properly. So there's a strategic way, working with the accounting professional, that you would go about, I think the correct term. Correct me if I'm wrong here, Henry, but of purifying the operating company by transitioning these other assets out of operating company into, effectively another company, which would be a holding company.
• 16:01
  Speaker B: Yeah. So a couple of things just to unpack there, Richard, is that if we think of how a general business operation works, it collects revenue, it then pays expenses. There's a net profit, and that net profit, let's just assume, is cash. What a lot of business owners do is while they have that choice, where we talked about in one of our podcasts, active income versus passive income, where they park their money and what they do with it, there's a series of rules that ends up getting attracted. If they pull it out in salaries, they'll get attacked a certain way. They pull it on dividends, they get taxed a certain way. Well, if you leave cash or you leave it in some form of an investment, like a GIC product or even a life insurance, a cash value life insurance product, if it's sitting in an operating company, these elements are nonproductive to the operations of the company. In the definition of the tax code, of course, we can use the cash values in a very particular way that we coach our clients through, but those are specifically non productive ways that will taint the capital gains exemption. So as you mentioned, the general lingo is used as to purify the business. Meaning? Well, if you have only an operating company that is holding on to those, I'll call it unproductive assets. How can you purify it? The only way you can purify it is to withdraw all the cash or do something so that there's no way of tainting the test to meet the capital gains exemption. And that's where all this corporate environment structuring starts coming in to ensure that you maintain the eligibility of that capital gains exemption.
• 17:40
  Speaker A: And the holding company, if you do move these assets out to a holding company or restructure it as necessary. So now the OpCO has the minimal amount of unproductive resources and those have been shifted out. So now you're able to participate in that capital gains exemption, whereas in the holdco environment, because those were assets, it's not operating in that nature. It didn't qualify for the lifetime capital gains exemption anyway. Am I getting that correct, Henry?
• 18:13
  Speaker B: Now we've kind of laid out the stage of what an estate freeze is, or maybe what the objective of introducing different corporate structures in the environment. What I now want to talk about is because we'll face people who are very proactive, and there's also people who are not so proactive. And so I kind of started with the people who are not so proactive. Let's talk about the people who are too proactive. And the problem is some people who find a business idea that is really great for them, however, is still, I'm just trying to be direct in this conversation here, is it needs to prove viability on a sustainable standpoint. There's some people who want to start a business and immediately they want to have the most complex organization structure, or yada yada. Should I have a whole co company right now? Should I have a trust? Should I have all this stuff right away? And their business hasn't reached a stage where it can actually support it. And so that's where I talked about at a holco company. Sorry, when you want to start probably thinking about holdcos, if you know you have a sustainable profit consistently of about at least 100,000 in today's time. 100,000 is still, believe it or not, not a lot of money for some businesses, but nonetheless, that's just a numerical benchmark just to share with there. So when is the right time to do it? Well, this is where the best is, when there's a predictable, sustainable level of viability to the business and there's a clear demonstration of value. And that value demonstration is very different for different organizations. So some people who are real estate agents, as an example, who has created a real estate corporation to transact their real estate dealings in that way? Well, the value is really just the individual. Whereas there's some where there's a business owner who owns a manufacturing facility, with equipment, with skilled labor, trained, and that business owner is not there, it'll still be a very heavy impact. But the business as a model, if someone has the capability of the business owner, steps in, same production, same thing still operates. So the part going back is when is the best time to do it, is when the value of your business is actually increased and you will have an idea of what that is, either in form of your consistent increase of profits, or some form like that. And actually, even if you have made thoughts of what do I do with this business, where it is today, and what am I going to do with it in the future, and if that involves exiting third party or transitioning to children, or when you pass away, which are generally the three avenues, that's when you actually need to start this estate planning process. And the reason, or the estate freeze process. Sorry. And the reason for doing that is because the longer you delay, there needs to be amount of time that the shareholders can be involved. If you do it too last minute, you won't be able to meet the justification of what I'm going to share with you today, of including other shareholders into the estate plan structure. And there's a very important reason of doing that, as I'm going to describe to it, because if you do it too late by you delaying bringing them in, the value of that business may not have the opportunity to grow under their hands, and under their hands they may not be able to get to utilize the strategies that we're going to talk about when it comes to an estate plan. I'm just going to share my screen. There's a few common structures, and this is by no means a template of an example. For every single situation. There still needs to be a very in depth process to understand the individual's circumstances and where they are in their journey today. So I'm just going to share my screen. So the first one, just to unpack, is related to just a general one where there's a company, and in the company, this was the original founder, they're going to implement an estate freeze, and they're going to freeze the value of their shares for a particular type of shares. And the most particular type is preferred shares. Not going to go into all that detail here, just not to lose the attention. And then they will do a specific tax maneuver that will give the growth shares to that new generation of family members. So this doesn't include additional corporate structures or anything. This is just like this possibility exists. I'm just wanting to share what that possibility is. The second one is now, we kind of talked about it in a previous podcast where we introduced a holding company, and the holding company is going to own those frozen set of shares. The founder is going to own the growth or the common shares of the holding company, and then the next generation is going to own the growth shares and it's going to go to them. So this is an example of freezing the value of the current owner of those shares today and transitioning the untapped potential of where that business value is going to go in the future to that next generation, where we are doing that time and movement part.
• 23:29
  Speaker A: And in this situation, Henry, the founder, who's now implemented Holdco and Holdco, owns the frozen shares. The founder could also own shares in the future growth of the business from that estate freeze point. So they have everything up to the estate freeze, and then they can also participate in future growth. But now there's an independent tax bill. So that's a way where they could transition. They're transitioning to the next generation, but they're also doing it more on an incremental basis would be a way of establishing that. Am I on track?
• 23:59
  Speaker B: Yeah. So this is where things can get really complicated with the kind of share types that are being owned and transferred, but ultimately, just to kind of keep it a little simple, all I just wanted to show was there's a new introduction of another corporate structure to help with the tax maneuvers that would help happen again. Richard, as you just shared, this is where the devil is in the details to the situation and the goals and objectives of the founders and the family and all of that. That actually has to be taken into consideration. That's why this can't be templated I would definitely lead this in the hands of very experienced tax professionals. The last one. Again, people will see this on Internet and all this stuff that gets marketed. And this is where there's an introduction of a trust structure. And a trust structure has other elements that include where this is a very important element if those family members want to be involved. And now you can do something where this is where the strategic planning of, if you delay it too long, it impacts the ability to transition the growth to these individuals. But if you do it in a good amount of time, this is where you want to have that trust structure in place. And that trust structure of beneficiaries include family members at a personal level. Anything can include corporate beneficiaries, like a holding company at that level, too. So this is where, again, the devil is still very much in the details, who owns what. And this is where I will also share in terms of a trust, specifically, the lingo that is written in the trust agreements and the type of arrangement that is described in the trust is also very important. And there are terms like settler, I'm not going to go through those details, but settler trustees, beneficiaries. And there's also discretionary, non discretionary, there's a whole bunch of other legalese terms that when it comes to the implementation, it's not as simple as the diagram makes it really simple, because pictures say 1000 words, but the layers behind the diagram and how it's been architected with the specific language is very, very key. And again, beyond the scope of this podcast, but just highlighting that why this can get very complicated and the implications to you can be very detrimental if not handled properly. So this is kind of where now I want to talk about using a very specific example. I'm just going to show a family here of five, two parents and three children, and even potentially grandparents. So there's a family of seven here, but I'm not going to include the family of seven. I'm just kind of keeping a little bit of a simple example, but I'm just showing you that you have to take into consideration the overall family. Now, I will still go through the example, just a separate example, but I'm just sharing that you've got a corporate environment and then you've got a personal environment that needs to be included in this equation. So let's just use an example with the business related to an estate freeze. So, an estate freeze where let's assume the business has increased in its value to 3.9 million. And this is where a lot of Canadians if they have not had professional intervention, this is what can happen, be it when they want to sell the business or if they've gotten an accident and become an angel in a good way. This is if they were unplanned. And this is what would happen now if they did not have professional intervention. The example here that I'm showing with you is, again, every Canadian who owns shares can have private company shares, can have this lifetime capital gains exemption. This is what happens if you do not meet it because you have too much cash, let's say, parked in the company, or too much unproductive assets. Most people who start a corporation, who start the business, will pay a nominal amount, let's say $100 for the shares. And in this case, when a sale happens, that disposition happens, the gain is going to be 3.9. Subtract the cost of those shares, which is 100. The capital gain is three, eight, 9900. And again, because there's no capital gains exemption, the taxes paid on this event would be 1,043,808, which is 26% of the $3.9 million. And the calculation, this is using Ontario as the example. 3.89 is the gain, 50% is taxable. And then in the highest tax bracket in Canada is 53 point. Sorry. In Ontario is 53.53. So that's what that 1 million is. So ultimately, after you've received 3.9 million in the sale, you've got to pay the government 1,043,000. What's left in your pocket is 2.8 million.
• 29:16
  Speaker A: Become your own banker and take back control over your financial life. Hey, is this even possible? You may be asking, can I even do this? Well, you better believe it. In fact, it's easy to get going. So easy that we've put together a free report. Seven simple steps to becoming your own banker. Download it right now. Go to seventeps ca. That's seven steps ca. Now, let's get back to the episode now. On that note, Henry, I think what's really important about this know, again, you're showing the worst case scenario if we haven't done some good planning and we're not able to take advantage, specifically of the lifetime capital gains exemption in this case, for the business owner. And this is very common, I think, for a lot of businesses know, especially the mom and pop operations, they've done some things successfully. And as a business owner, you're just busy, busy, busy, busy, busy, busy. And then these things just get put off to the wayside and they never really get dealt with until it's kind of too late. And so what I think is really important about this case that you're showing is that the capital gain is that value increase in the business. Now, the value of 3.9 million that you're showing, there could be many things that create that value. The customer base, the goodwill, the cash on the books. Maybe there's an insurance policy in the operating company that probably shouldn't have been there in the first place. Maybe there's the manufacturing, building, the equipment, it's all these things. Now, some of those things, even though it's the value of the business, some of those things may need to be paid for. So in order to pay this tax bill, the business owner or the family of the business owner, or the business owner has passed away, they may have to start selling off all these assets at a discounted price, or, quote unquote, a liquidation price, so they can raise the money necessary just to pay the tax bill. And then the business value might have been, at the time of death, 3.9. But once the business owner is gone, the value might drop because the business owner is no longer there, and then employees might leave, and then everything gets precipitously worse. But we're paying tax on the value of the business at the day that the business owner died, not the value. Six months later, when the business owner is gone and everyone's left around fumbling to pick up the pieces of what's left. And that's where a lot of business owners really, we see their life effort dismantled. Unfortunately, because of a lack of planning.
• 31:45
  Speaker B: This is very true. So in the element of the exit being an unforced event of like, a deemed disposition at death, that is the worst case. The first event is they have built the value at that time. Deemed disposition is considered fair market value at that time, but they don't consider the events, the series of events that happen afterwards, and the value of that business afterwards, where employees are scrambling, the customers are lost, there's no more intellectual understanding of how to run the business anymore. The value may not be there anymore, and then the family members are stuck with dealing with whatever they can in that event, and that's not a good place to be now. There's also other circumstances, again, because we live in a world where no one's path is exactly the same, sometimes other professionals may be involved, like, yeah, they have an accountant who deals with their tax compliance, they have an insurance advisor who has given them insurance and talked about the importance of insuring it, but they never connected the dots and putting it together. And that's where, that's also a problem, where they've built a policy of, let's say they understand a high cash value policy and that does do really good things for the business. The only problem is that it was structured positionally in the wrong place and there hasn't been a change in environment because of a change in circumstances. And that event with good intentions was set up for good intentions. However, that has as a consequence, impacted their lifetime capital gains exemption. That was not a full win. The business owner didn't get a full win win in that situation. And I've personally seen this as part of our process that we go through when we meet people. We do a deep dive to understand exactly how you are structured from an income asset liability standpoint, personal standpoint and a corporate standpoint and everything in between. The next stage is, well, let's just say that's the worst case scenario and maybe the business didn't get into the circumstances where they lost their capital gains exemption. Well then this is where they can have, this is the impact of if they have the capital gains exemption. And let me just use it with two people. So actually, if there can be a switch with how I just described something, one of the things that I wanted to further describe is when you are getting an offer for sale of a business, there's usually a time period for that offer of sale. Imagine if you were not properly set up to receive offers for sale of a business to exit, then how are you going to untaint your business to take advantage of the capital gains exemption? That's not going to work that way too. So aside from deemed disposition at death, there's also offer of sale. And if your business is not properly clean for a transfer of sale, then you're going to be stuck with an unfair position in the deal. Now going back to the capital gains exemption. And now this is with two people, let's just say husband and wife own 50 50 of the shares of the operating company and there is a capital gains of, again $100 for the shares, $50, $50. So the capital gain is three, eight, 9900 with the lifetime capital gains exemption. Again, the amount in 2023 which rises each year generally around with CPI is 971 190. So for two people, that combined amount exemption is $1.9 million. So the net taxable amount, if I subtract 3.89, subtract the 1.9, what's taxable is. So the taxes paid on that is 523, nine, 30 or 13.43%, which is the 1950 times 50% times 63, 53%. So if I subtract the proceeds or the offer of how much you receive the 3.9, subtract the taxes that gets paid, 523, nine, 30. The net taxes is 337-6070 so much higher than before, mainly because of that capital gains exemption.
• 36:23
  Speaker A: So just to recap on this, Henry. So example one that we went through is the worst case. We had too many other assets and things that were not considered productive from a tax perspective. We lost the capital gains exemption for both of those people. In this example, they implemented some planning. The operating business that's being sold. The business being sold now qualifies for the capital gains exemption. And because there's two people, most likely either business partners or let's say husband and wife spouses, they're both able to qualify individually for that capital gains exemption, they each get 971 grand capital gains exemption. We join that together for a little over 1.9 million. That means we can take the business value, subtract the total capital gains exemption that's able to be used, and then the net remainder is what actually is going to have to pay tax. So we've gone from example, one, kind of the worst case situation in this $3.9 million business to roughly paying almost half or maybe even, maybe even more than less than half of the tax than we did in the first example, just by making sure that the things that are left in the corporation are the right type of things so that they can maximize that value. Did I get that correct?
• 37:44
  Speaker B: Correct. So the main part for the key takeaway is, as a business owner, you want to have the lifetime capital gains exemption and understand what you need to do to preserve that exemption. Because who wants to pay more taxes? If you were to ask that into a crowd, I don't think many hands would go up.
• 38:05
  Speaker A: I've actually done that a time or two. And you're right, not very many hands go up.
• 38:10
  Speaker B: Now, the third example that I'm going to do is here is where there's a professional plan in place, how that plan got laid out. There's an estate freeze. That happens, okay, if they have multiple other corporations, a trust, whatever, all that jazz doesn't matter. The key part that I just wanted to highlight is there's a post freeze that has happened, and this is including a tax plan with two children. So the capital gain is still 3.8900. But this is why you want to introduce an estate freeze in a reasonable time frame on your situation and circumstance of that. And before I kind of dive into this. The problem that exists, in my opinion, in the marketplace is the team of professionals that the business owner may have with them may not trigger that conversation. When business owners come to us because of, by virtue of the process that we go through to determine insurable needs and other goals and objectives as it pertains to becoming your own banker, this is where something like this gets flagged and identified as an opportunity for the business owner. And I would be going through these conversations with the business owner to talk to them about, have you considered, you know, by virtue of becoming your own banker? We build a family banking system. That objective already is really kind of aligned with now, putting that family banking system in the right operating structure in Canada, which includes that corporate environment. And that's where I get the opportunity to ask the question. And I can see from how they're structured, have they considered doing a proper estate freeze or plan in place to pass on the wealth that they're building to their next generation? So the first part is, by virtue of what we do, they will come to us from that aspect, and that opportunity gets flagged. The other is the business owner will do it other ways is very less likely if someone is to prompt them to tell them to think about an estate freeze. Because in all honesty, if a professional was to come to you, which we know involves a general tax practitioner, a lawyer, a business evaluator. So three professionals in that general equation, those three professionals have some fees that they would be charging, and that ultimately ends up as a bill of over, generally around the five figure mark and above, again, depending on the level of complexity that gets involved. So someone approaching you, Richard, for a five figure professional fee, without the context of being educated of what an estate freeze is, I'd show you the door no faster than the split second that I can.
• 41:20
  Speaker A: Well, not only that, I think what you're speaking to, Henry, is the difference between proactive versus reactive. And unfortunately, there's a lot of circumstances in life where we are often in a reaction mode, where something has already happened and now we're picking up the pieces. And when it comes to planning, certainly tax planning, I think every business owner wants to have proactive tax planning, but they end up with reactive tax planning is generally the case. And it's not nothing against any tax professional. I think most tax professionals, in a perfect world, they would love to provide proactive tax planning, but they can also only work with what they're given with. And so we're kind of in this like chicken and an egg scenario with the business owner and the tax professional who's got an obligation, and dates, and due dates, and a very busy tax season, and the business owner who wants 100 billion things done. And they're asking questions of the professional, but they're usually asking at the wrong time, and they don't really get that planning sorted out, necessarily. And so generally, in my experience, just me personally, I haven't found that a lot of accountants, although wonderful and amazing people, they're often reaching out and saying, hey, by the way, I'm looking at doing your financial statements, and I notice you've got all these assets here sitting in Hopco. We should have a meeting as soon as we get this filed, we should have a meeting about planning an estate freeze. So those are the types of things that you're looking for, but probably, it's probably few and far between where that actually proactively happens. And I don't think it's anyone's necessary fault. It's just the fact that we don't know and understand, and as a business owner, we often don't know what to ask for. So if you ask for it and you know what you're asking for, part of this podcast will hopefully give you some indication when it's appropriate to do that. You can start putting these things in place to protect yourself.
• 43:13
  Speaker B: Yeah. And that is the objective of this podcast was to help educate the listeners to get a grasp that there's actually first, by taking no action, you can already see that there's a potential of heavy consequence in place. By taking the time to get educated, at least you now have it in the back of your mind that, hey, I remember that there's an option available, and then I can talk to my tax professional or my team of financial advisors to explain whether or not this is suitable for me at the specific standpoint. So that's what I wanted to first highlight. Now let's dive into this part where when you properly structure and state freeze, this is again by choice and option not everyone will take this advantage is you can pool your capital gains exemption, and if you give enough time, that's why you can make it valid and legitimate. So by pooling it together, so that business value is 3.9 million, the capital gains 3.8900. If I take the 971190 of the four family members who are part being pooled for the capital gains exemption, that's 3.884,760. So the net taxable ends up being 15,001 40. So the taxes paid is $0. I'm just keeping it very simple, $0 and ultimately the net tax, sorry, net after tax proceeds to the family on the exit of the business, whatever that way is, is 3.9 million. So just summarizing all of that together again, the sale of the business, 3.9. Worst case, without proper scrubbing and ineligibility of the lifetime capital gains exemption, the business owner or family is left with 2.8 million. If there is a lifetime capital gains exemption and the business is pure enough to be eligible for it, it's 3.3 million. And with proper structured planning in place, there's 3.9 million, which is pretty much eliminated the tax event from proper tax planning with being proactive with the situation.
• 45:34
  Speaker A: Now, a question I have for you on this, Henry, and I'm just curious. So in the estate plan model you showed, we've got the husband and wife or the parents, and then we've got two children. And so what if the children are under the age of majority at the time that that planning is put into place? Does that have any particular effect on this? Can you walk us through that?
• 45:54
  Speaker B: So that part includes potentially, that's why you would include the trust and with the trust. So let me take a step back. Back in 2018, the government introduced the tax on split income that prevented minors from being part of corporate organization structures. But it still didn't limit the ability of the trust to do the things that it needed to do. And if they're part of the beneficiary group of the trust, and if you structure the trust with the right terminology, then you can describe how to transfer the benefits to the children in a tax effective way. I don't want to say that there's ways around it as a negative way of doing it, but what is available to Canadians with the proper advice, you can actually include things in that way. Again, the rule was brought in because they didn't like that the overall structure included income planning for minors, and people's opinions on that differ. But nonetheless, I'll just say that for what it is there.
• 47:07
  Speaker A: So the summary is whether they're adult children or minor children, tax planning can be done effectively to maximize the utilization of a capital gains exemption for all parties involved, correct. With appropriate planning. And that's the key takeaway. So thank you for that. I'm glad that I asked that question because I think that's going to be very beneficial for our listeners. And a question I have for you kind of on this next is the estate freeze is completed and, and done. And in this, our example here, we're looking at the value of the business is the same. The value of the business hasn't changed here. Let's assume for a moment that the business value of 3.9 that we've walked through is the case. And now we go ten years out and the business owner, the original business owner, the founder, they've moved on, they're in their honeymoon period of life. And the children, let's say, have taken over the business in this situation, or maybe it's a family farm or what have you. And now the business has grown again and it's grown, let's say, another million dollars. And now they look to sell it at that point so that the original value, estate planning, has already kind of locked in where we're at. And now that additional increase in value of an extra million dollars, that would now attract tax at a different point, because we've set the adjusted cost basis now at 3.9 million, effectively, and now we're only going to be dealing with the gain over and above that level for the new ownership structure. Am I on track there?
• 48:39
  Speaker B: Yeah. So I'll just be a little bit more specific. So if it was set up properly, the parents would retain their frozen value of what that gain was, and if that business value jumped from 3.9 to 10 million, but now those value of those shares were in the hands of the children. I'm just keeping this example really simple, that now the children have to deal with 3.9 to the 10 million on that element, and that's a different ballgame to deal with when it comes to estate planning and everything like that. But that's just effectively what you're trying to. What the estate freeze for this current generation did was to freeze it on the parents for that value. And then the 3.9 to the ten is frozen. Sorry, not frozen yet, but it's been handed off to the next generation to deal with.
• 49:30
  Speaker A: All right, so one of the reasons why I asked the question was just to preempt, I guess, one of Nelson Nash's golden rules, which is you got to think long range. Nelson said, you got to learn how to think beyond your own lifespan. And in this scenario, one of the ways that you would do that is starting to think about, okay, now that we've done this freeze, we still have the business, we're still either tied or connected to it in some way, or the family is, or whether it's a family farm or whatever that is that we're looking at, there's going to be secondary, second layer generational tax planning that still needs to happen, so that on an ongoing basis, you can create some continuity of maximizing the retention of the wealth that you're building up. And the same premise of the operating company being, I guess, as we identified, purified in such a way where there's not, from a tax perspective, what the CRA would indicate as non productive assets, even though some of the assets, you know, we might feel differently about how we would label those assets specifically. The cash value policy to me, is very productive, but from a tax perspective, it's not considered that way in relation to the capital gains exemption. So I think that's the summary point I want to have, is that when we're looking specifically at the lifetime capital gains exemption that's available to canadian business owners, certain items that might sit on the books and the balance sheet of your business may deteriorate your ability to qualify for that. And the terminology that's used by the tax code is non productive assets. And so being able to make sure that those aren't sitting in the operating company, in fact, they're sitting somewhere else, is effectively the direction that you want to be as you continue building your wealth along this path.
• 51:20
  Speaker B: Yeah, and this is kind of the stuff that we talk about in our new book, keep taxes away from your wealth. We've launched, and this is not very specific to, like, what we're talking about is very specific. It's not possible to be dealt with in the easy read that we've developed here, but we've summarized the mechanisms. Essentially, we are using a multitude of the five strategies of deferring, dividing, changing the definition and designing. And I haven't talked about the disconnected. So this estate freeze already incorporates all four of those elements altogether in terms of keeping taxes away from your, well, transferring your legacy that you've built to this generation, to the next generation, effectively. And as you mentioned, there's other generations that need to be taken into consideration in this overall mechanism.
• 52:28
  Speaker A: And then the implementation of the fifth d. Only just like icing on the cake, but it's like a bunch of tax free icing on the cake. Is that an okay description?
• 52:39
  Speaker B: Tax free icing with a cherry on top? And this is the one where I'll talk about the disconnect. So, one of the things that, again, if you seek an insurance advisor professional who may not have the scope of understanding of the tax codes and the rules around all that, or you speak to a specific tax professional who doesn't understand the insurance component route, too, this is where the world doesn't operate in silos the world operates with many moving parts working together, and that's why it's important to incorporate what we kind of talk about specifically of that family banking system. Now, again, I've run into experiences watching, seeing clients current structure where an insurance policy was placed, and nothing wrong with that placement. However, in the circumstances of the goals and objectives in the long term, some maneuvers need to happen to change that circumstance. And it's important that those updates happen. And even when you have one estate freeze happen, it may be just by the grace of goodness in this universe that in two years that 3.9 that you transferred to your judge suddenly became 7 million. Now you have to engage into another type of plan in place to figure out what to do there. It's not based on tying, it's based on value that was created by that business. As you've gone through this journey, and like it or not, it's a good problem to have, but that means there's just a lot more work that needs to be involved. But going back to all of this is when you work with our team here, we really look at the overall circumstances and we want to look at things holistically. And this is where I want to now bring in that disconnect element on the family banking system with that estate freeze, because corporate business owners will get approached to do the estate freeze. But there could be some slight differences that can change because we're looking at implementing the family banking system that will enhance the estate freeze even better. And that could change how you organize your estate freeze. So I'll just kind of use a very. But nonetheless, what I wanted to highlight is some of the advantages of including a participating dividend paying whole life insurance policy. Not many professionals understand that placement of that type of policy, but let me kind of walk through that here. So on the left side, we kind of have a current estate plan that is created and if you want to extract money from the estate in the form of the corporation right now, let's say, and you want to take money out, most people are aware of you can take a salary, and I'm using 100,000 as an example. The general taxes you would pay on withdrawing 100,000 out is 27,000. If you take it in the form of a salary, you can also take it in the form of a dividend, which would be about $16,000. This is not about what's better, salary or dividend. The key is to get money out in the corporate environment to the personal environment. There's going to trigger taxable events. Now, if you include the process of becoming your own banker, I mean, you can take the option of a salary, you can take the option of a dividend, however, based on when the corporate owner has passed away, which is part of the planning that we do, especially for the. I'll call the second generation family who's come to us and we've go through this conversation, they're like, hey, I want to build my family banking system. Can I build a system of policies on my grandparents, on my parents, because they're going to pass away first. Can we start planning their estate, too, and include this process as part of it? Because in very plain speak, they're going to be the ones to pass away first. We want to make room for windfalls, we want to make room for more, taking into preparation of all the other obligations that they have. So let's just say the death benefit occurs of $5 million that has come to that corporate plan by virtue of the death benefit. I'm using very simplified numbers to explain the points, but this is, again, just for educational purposes, there will be a creation of a capital dividend of 4.5 million. Again, very simplified numbers. It could be different numbers along the way, but nonetheless, I'm using 4.5 as that. And with that 4.5, it's basically a bridge that's been created in the tax code to allow the family to extract money in the form of capital dividend. Again, if you've done the estate plan properly or the estate freeze properly for the plan, then you can have proper mechanisms in place to document how capital dividend, because capital dividends have to be documented in the tax code to come out for the tax reviewers, but you can extract money out tax free. So that's 4.5 million that you can extract tax free. And if you imagine the parents are the. I'm just going to use grand. Yeah, the parents are the ones who have passed away, created the death benefit. There's now a capital dividend in the plan. Now, they can individually, if they lived off of, and this is what I work with a lot of my clients with, is to create this plan. If they were surviving off 100,000, well, that 4.5 million, they can pull out $100,000 each year tax free. And that, to me, is very exciting. And unfortunately, a lot of professionals are not aware of the huge opportunity that is available with this capital dividend account.
• 58:46
  Speaker A: So the summary here is that when you incorporate all the estate planning thought process and the tax planning thought process around the advantage of estate freeze, when needed, when necessary with appropriate insurance planning. In other words, you're not separating your tax planning from your insurance planning when we're talking about this level. At this level, these things need to be openly discussed. And the insurance professional and the tax professionals need to be able to have open lines of communication so working together and in tandem, they can support the business owner and the client's needs as much as possible. I think that's the key that we're talking about here, Henry. This last segment here is all about the fifth d that we talk about in the book around disconnecting from the system as much as possible and $100,000 a year for 45 years, tax free to me is a pretty good disconnect from the system that wants to take a bunch of tax out of your back pocket so you can finally just slap the hand that's reaching into your back pocket away for a 45 year period of time in that example, which I think is pretty good. And so if you haven't already got a copy of the book, keep taxes away from your wealth. Make sure you go to keeptaxes away.com and you can access it there. And video content like Henry and I are doing here, this type of podcast conversation, we have a whole treasure trove of those available as bonus material that you can access by going to keeptaxes away.
• 1:00:18
  Speaker B: Yeah, and just the key takeaway that whoever is listening to this podcast is, it's not a one person takes care of one professional takes care of one job, one professional takes care of one job, and so on and so forth. Imagine the power for the client when there's a tax professional who handles the maneuvering of the tax code in the saber of the business owner. There's the lawyer who is involved with drafting the agreements to create that estate freeze and plan. There's the business valuator that puts together the value of the business for how much it needs to trigger, and all those elements for the lifetime capital gains exemption. That right now is the standard equation that most professionals understand. But the equation that they're missing is the authorized infinite banking practitioner who takes care of helping the client become their own source of financing, disconnecting from the system as in as an example, parking their money into a properly designed participating whole life dividend paying insurance policy to now no longer deal with 50% passive income tax rules. And then at the end, there is a death benefit, such as what we've shared with you with a capital dividend account where money can come out of the corporate environment tax free all together supporting the business owner and the family to build that intergenerational wealth. And this part cannot be underemphasized because it involves a team to get together collaboratively to help the business owner. It's not a one man show, it has to be a multiple people involved.
• 1:02:01
  Speaker A: Bati love it well, and thank you for being a part of our team, Henry, and both at Senate Financial and really a regular contributor here on the wealthy street podcast. I appreciate that and all of our wonderful conversations. And for those of you watching on the youtubes, go ahead and check out there's a new video right there that just popped up right below. Go ahead and click that so you can continue your journey of learning. And we absolutely look forward to adding more value on the next episode of without Bay street. Thanks for listening to the wealth without Bay street podcast where your wealth matters. Be sure to check out our social media channels for more great content. Hit subscribe on your favorite podcast player and be sure to rate the show. We definitely appreciate it. And don't forget to share this episode with someone you care about. Join us on the next episode where we continue to uncover the financial tools, strategies, and the mindset that maximize your.