For many business owners, the corporation is often the largest asset in the family’s estate and the key asset to their succession plan. For estate planners, the discussion often focuses on a review of Wills, Powers of Attorney, shared ownership, and family objectives while the corporation’s financial statements receive only limited attention, if any at all, which may lead to missed opportunities. A careful review of a corporation’s financial statements can reveal the importance of planning opportunities and tax considerations that may otherwise remain hidden.
The Financial Statements Tell a Story
Lawyers and estate planners frequently review corporate minute books, shareholder agreements, and Wills. However, the financial statements tell a different story, it provides insight into the business, the nature of its assets, and the potential tax consequences that may arise on death of the business owner.
From an estate planning perspective, understanding the financial statements can help identify:
- The estimated value of the estate;
- The estimated tax liability arising on death;
- The availability of succession planning strategies;
- The feasibility of transferring the business to the next generation; and
- The liquidity available to satisfy estate obligations.
Do the Shares Qualify for the Lifetime Capital Gains Exemption?
One of the most valuable opportunities that may emerge from reviewing financial statements is the potential availability of the lifetime capital gains exemption (“LCGE“) in respect of qualified small business corporation (“QSBC“) shares. For many business owners, access to the LCGE can result in significant tax savings on the sale, transfer, or deemed disposition of shares on death. However, qualifying for the LCGE is not automatic and depends on numerous factors, including the nature and composition of the corporation’s assets.
A review of the balance sheet can reveal several items that may effect whether the shares qualify as QSBC shares, namely:
- Excess cash reserves;
- Investment portfolios;
- Shareholder loans;
- Non-business real estate; or
- Other passive assets.
Without reviewing the financial statements, an advisor may miss an opportunity to preserve the LCGE and significant tax savings.
Identifying Cash Trapped Inside the Corporation
Financial statements often reveal substantial retained earnings or excess liquidity accumulated over many years. While excess cash may be viewed as a positive from an operational perspective, it may raise several questions from an estate planning perspective, namely:
- Is the cash required for business operations?
- Should some of the funds be distributed during the shareholder’s lifetime?
- Would an estate freeze be appropriate?
- Are there opportunities to transfer future growth to children or trusts?
- Could the corporate structure create tax issues upon death?
Do not overlook the “due to shareholder” entry in the financial statements. This entry may indicate that the corporation owes an amount to the business owner. Is the loan documented? Is interest charged on that loan? If the amount represents a bona fide shareholder loan, repayment of the loan may generally be received on a tax-free basis. However, the estate plan should consider who shall receive the “due to shareholder” to not jeopardize the financial stability of the corporation.
A review of financial statements enables advisors to determine whether corporate wealth should be repositioned before a future succession event occurs.
Discovering Hidden Estate Liquidity Problems
One of the most overlooked aspects of estate planning for business owners is liquidity.
A corporation can be worth several million dollars on paper while generating little available cash for the estate. Financial statements can identify issues such as:
- Significant accounts receivable;
- Illiquid real estate holdings;
- Closely held investments;
- Inventory-heavy businesses; or
- Assets that may be difficult to convert into cash after death.
An illiquid corporation often creates challenges for executors and beneficiaries. Early identification allows the owner and advisors to explore solutions such as insurance, corporate restructuring, redemption strategies, or other succession planning techniques.
Identifying Shareholder Loans and Related-Party Transactions
Shareholder loan accounts are often overlooked during estate planning engagements. However, the financial statements may reveal items which have substantial estate, tax, and succession implications, namely:
- Significant shareholder loan balances;
- Debts owed by family members;
- Related-party receivables;
- Inter-corporate loans; or
- Informal family arrangements.
More importantly, shareholder loans may lead to disputes among beneficiaries and costly estate litigation. In some instances, they may provide opportunities for estate equalization or tax planning.
A careful review of the notes to the financial statements frequently uncovers planning opportunities that are not immediately evident from the face of the balance sheet alone.
Conclusion
In many respects, a corporation’s financial statements are a roadmap for estate planning. They often reveal hidden opportunities and planning possibilities that may not be apparent from reviewing a Will, shareholder register, or corporate minute book alone. For the estate planner, the financial statements are not merely accounting documents; they are strategic planning tools.
