This single decision can have awesome tax benefits. Or it can destroy your business.
Client’s often asked whether they should include their spouse or common-law partner in their corporate ownership structure.
Like marriage itself, this is an important question, and difficult to change as time goes on. Making adjustments later can come with a whole host of extra tax complications.
In this article, I am going to walk you through things you’ll want to consider before taking the plunge.
Adding your spouse as a corporate shareholder can come with some real monetary benefits.
A long-time client of mine had this same question when incorporating their business.
Their relationship was on the newer side and although they really liked their spouse they were a bit uncertain of the future. After some contemplating, they decided to add their spouse as a shareholder of their corporation.
Their spouse ended up working in the business and turned into a great asset, bringing skills and perspectives to the table that my client didn’t possess.
Being an owner allowed the spouse to feel more invested in the corporation and helped steer the business towards success.
In addition to a different perspective and skillset, we could also capitalize on some tax advantages.
Because the spouse was both a shareholder and significantly involved in the corporation we could utilize dividend allocation options.
Being able to declare dividends towards the spouse meant taking advantage of lower a tax bracket.
When the client eventually sold their business, they could utilize the lifetime capital gains exemption for both themselves and their spouse. This allowed them to double the cash they could take out of their business tax-free.
This is a huge advantage of adding a spouse to a business.
Adding their spouse to their corporation was a significant benefit for this business owner and allowed them to save thousands in taxes.
But, not every business ends up in the same situation.
Another client of mine started a business with their spouse. They had been married for years and becoming 50/50 owners of the new corporation seemed like a no-brainer.
They both worked in their corporation and their business became quite successful. However, it pushed their marriage to the breaking point.
No clear boundaries were established for roles or responsibilities within the business and when disagreements broke out there was no identified individual who could make the final call.
Disputes started at work were taken home and owning a successful business together didn’t turn into the dream they’d both envisioned.
After a rather difficult divorce, the business was in shambles.
Incomplete documentation and continual infighting meant thousands of dollars lost in both legal fees and unnecessary taxes.
This client is one of many who has struggled with transitioning a former spouse out of a business and moving on successfully after a separation.
It can be really difficult if things go south.
Removing a shareholder from a business adds not only tax complications but also legal issues. This is true whether you are in a marriage, a common-law relationship, or just friends.
"This single decision can have awesome tax benefits and potentially destroy your business." - Jillian Battaglio, CPA, CA
Adding & Removing Shareholders
So why is it so tough to make changes to your corporation’s structure later on?
First, let’s talk about adding your spouse.
If your business has become quite successful and you add your spouse without any actual money or other consideration changing hands at fair value, then a shareholder benefit could be construed by the CRA.
This could mean a big, unexpected tax bill.
The second risk is attribution rules.
Even though you’ve added a spouse to your business, the CRA may recognize this was done for purely tax reasons and can attribute the income you’ve allocated to your spouse back to yourself as the original owner.
This means those lovely tax benefits you were looking for have just gone out the window.
These risks can be mitigated by adding your spouse upon initial incorporation rather than adding them later.
Next, let’s talk about removing your spouse.
Removing a shareholder from a corporation can cause ‘deemed’ dividends to pop up.
This happens when a shareholder is removed and can mean thousands of extra taxes.
Separation and divorce considerations can also mean huge cash draws from a business.
This can spike your personal taxes and can get really messy, really fast.
Now, for some good news.
There are options for changing a corporation’s ownership structure after you’ve incorporated.
Things like trusts, interest-accruing debt and rollover provisions can all be beneficial.
However, these take time, planning and significant legal and accounting fees can pop up.
So now that we know what we are walking into. What is the best decision for you?
To make the best choice I would recommend:
Carefully contemplating your relationship
Setting clear roles and responsibilities within the business.
Talk to your lawyer and consider if a shareholder agreement would be beneficial for times when disputes arise.
Consider if one individual should have control rather than a 50/50 split so a clear decision maker is identified.
There is no right answer to this big question but talking about the difficult aspects early on can help set you up for success.
The right decision isn’t a 'one size fits all' approach.
Instead, it requires a deep dive into the stability and longevity of your relationship along with good communication to help things go well.
All right, I hope this article has helped you decide if you should include your spouse, or not, in your business. That’s all I have for today.