Changing small business ownership can have tax implications
Posted June 27th 2013
Small business owners do receive some tax advantages. For example, they may be able to pay family members for doing work for the company, effectively splitting some of the business income. But as the business grows and revenues increase, owners may be tempted to make a spouse or other family member a partner to potentially reduce their tax obligations even further.
First, you cannot just add a partner to your business. You will need to file an actual disposition from a sole proprietorship to a partnership to make it official. And the transfer of property from the sole proprietor to the partnership must be done at Fair Market Value (FMV). You can elect to do the transfer at values other than FMV to defer some or all of any gains on the transaction but there are specific tests that must be met before you are allowed to do this.
For tax purposes, the sole proprietorship would cease business on the transaction date, although you can make an election to carry on business as usual or until your normal year-end date.
If the parties agree to defer any gains on the transfer of property from the proprietorship to the partnership, the tax values of the property in the partnership remain at the elected amounts. In order to choose this option under Subsection 97(2), you need to complete Form T2059 to defer the gains.
And when the time comes for the original partner to sell his or her partnership interest or retire from the business, the deferred gains need to be claimed by the original partner in addition to his or her share of gains accumulated from the date the partnership started. If the partnership sells its business or ceases to operate, the original partner would report his or her gains as above and the remaining partner(s) would report their share of the income or gains accumulated from the time the partnership commenced to when it is sold or closed.
If you are thinking of bringing in a partner for potential tax savings, make sure you understand the implications before moving ahead. And you cannot back date a partnership transaction. So if you come to the end of the year and you have earned more money than expected, don’t think you can just make your spouse a partner to lessen the tax bill.
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