It is important to understand that an
unincorporated business has no independent existence separate and apart
from its owner meaning that when the
owner dies in the case of a sole proprietorship or when the first partner dies in
a partnership, the unincorporated business ceases to exist. During the owner’s
lifetime, the income of the unincorporated business is reported as personal
income, against which the business
expenses are deducted. The owner
faces unlimited liability for all business
debts and enjoys all of the profits.
Disposing of an unincorporated
business in a Will necessitates that
the debts of the business are property
addressed and that the assets of the
business being transferred are clearly
defined. For example, the term “business” does not describe an unincorporated business with sufficient certainty
to ensure the business assets will be
distributed pursuant to the testator’s
wishes. Generally speaking, the assets
of the business will be distributed to the
beneficiaries net of the liabilities unless
the Will expresses a contrary intention.
Unfortunately, it is not uncommon for
families to litigate over the distribution
of the assets and debts of an unincorporated business. Where proper estate
planning has not been put in place,
the assets of the sole proprietorship or
partnership can pass to the beneficiary
free of any encumbrances, while the
remaining beneficiaries are left to bear
the burden of the business’s debts.
The Incorporated Business
Passing on an incorporated business
is more straightforward as the testator
can gift his or her shares in the corporation. The corporation has a perpetual
existence and its control and ownership
is easily transferred via a Will.
However, there are specific tax
considerations to plan for, including
income tax and estate administration
or “probate” tax. The Income Tax Act
provides for a deemed disposition of
all capital assets immediately before
death, which means that the estate of
the deceased must pay any income tax
liability assessed against any gain in
those capital assets. This, of course,
includes shares of a corporation. An
attractive planning tool might be to
utilize the rollover provisions found in
subsection 70(6) of the Income Tax Act,
available when the capital property is
gifted directly to or exclusively for the
use of a spouse, thereby deferring the
payment of capital gains tax until the
spouse dies or disposes of the property.
It is also possible that, if the business
owner has not taken full advantage of
the lifetime capital gains exemption
from the disposition of qualifying small
business shares, some tax relief may be
available to the estate.
The Corporate Reorganization
Another common option is a corporate reorganization or estate freeze
during the life of the business owner.
Because the future increase in value of
the business assets will accrue to persons other than the business owner, this
has the effect of quantifying the owner