Small Business Capital Gains Deduction Part II: Multiplying the Deduction

By issuing shares in a small business to family members, it is possible to multiply the capital gains deduction available to the family. A similar strategy allows for the multiplication of the deduction for family farms or fishing operations.

It is common practice to issue different classes of shares in a small business corporation to the operator’s spouse and to each of the children, even if they do not actively participate in the operation of the business. This allows the family to minimize income tax by “sprinkling” dividends to both spouses and adult children at their more advantageous tax rates (although this strategy is currently the subject of proposed change in recent tax changes for private corporations).

However, the government has backed away from the multiplication of capital gains exemptions within the family, at least for now.  Here is how this works:

Example: Jason is the president of Jason and Sons Inc. When the corporation was set up, Jason was issued one class A share. His wife, Monica, was issued one class B share. His two sons, Jason Jr. and Tyler were each issued one share in classes C and D respectively. Jason and Sons Inc. became a successful business venture and in 2017 the shares in the company were purchased by an investor for $2.5 million. With four shareholders, each was entitled to $625,000 for their shares. Each shareholder (Jason, Monica, Jason Jr. and Tyler) is eligible to claim a capital gains deduction of the lesser of

• Their gain (roughly $625,000 each, as the adjusted cost base of each share was $1) and
• The 2017 gains limit ($835,716) less any adjustments, such as previous claims for the capital gains limit, cumulative net investment losses or allowable business investment losses claims in prior year.

In the case of this family, the entire $2.5 million dollars received for the shares will not be taxed at all.

Next week: Changing the Rules

Additional educational resources: T1 Professional Tax Preparation – Proprietorships, CE Summits

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