Plan - don't predict
Happy Friday! We've started off slightly behind on publication but plan to stick with a monthly cadence. Please enjoy this month's letter.
The Business Owners Tax Toolkit
As a business owner, you toil for decades to create wealth for yourself and your family. Most business owners like the idea of planning and know it's important but are constantly pre-occupied with things like:
- just getting through the day
- dealing with clients and employees
Business owners will be familiar with the next list which covers many of their top longer-term concerns which include:
- growing their business
- minimizing their taxes
- protecting their wealth
- protecting their family
- maximizing their savings
- maintaining family harmony
Today we'll focus on the tools that entrepreneurs have available to address some of these concerns and show you why you should be thinking about tax strategies sooner rather than later.
Primary Tax Tools and Strategies
The following list contains many of the tools of a successful business owner plan, each worthy of considerable explanation. However, it's not solely the tools that matter but how and when they are used to build effective strategies.
- LCGE - Long Term Capital Gains Exemption (LCGE)
- Trusts
- Holding Companies
- Estate Freezes
- Intercorporate Dividends
- Individual Pension Plans
- Business Sale Strategies
Let's outline the LCGE on its own for now and in later issues we'll dig into how we can put some of the various pieces together effectively.
Long Term Capital Gains Exemption:
In short, the LCGE is a Canada Revenue Agency recognized opportunity for business owners to save a maximum of about $450,000 in taxes on the sale of their business either to a third party, or, more recently, to their own family members.
However, there are some key tests that a business owner must pass to extract the benefit and that includes ensuring your business is a Qualified Small Business Corporation. Those tests are applied over a TWO-YEAR period in advance of the sale of a business. For example, to qualify as a QSBC, here are some of the requirements:
- the business must be a Canadian Controlled Private Corporation
- the business must ensure that all non-operating cash and assets are transferred out of operating company in a "purification" process.
- Most of the assets in the business must be used actively within the operating company.
Here's when things get trickier from a tax perspective. You need to take cash out of your business, but if you pay it out to yourself, you will be taxed on those funds. However, using the correct tools in the correct manner can support your transfer out of those funds out without immediate tax implications. As a result, you can allow those same monies to grow TAX DEFERRED until they are paid out and taxed personally.
We have only just scratched the surface here, but if you're looking for the most tax-efficient ways to take money out of as well as sell your business, we'd love to help. Don't leave any money on the table. Set up an appointment to discuss whether your business exit and allow us to share ideas on how we can help.
S&P500 Forward Earnings Estimates - Are expectations a bit rich this year or is this a trend?
Humans are optimists, especially equity market analysts. And although professional market predictors are pretty good overall at estimating market returns, they are just as susceptible as regular humans to be overly optimistic.
The chart below shows that, on average, analysts overestimated EPS by about 2.5%. Although they still have a pretty accurate track record, for the purposes of financial planning, it's best to fold in some downside as part of the analysis. Red numbers show overestimates and green, underestimates.
Historical Estimated vs Actual S&P 500 Expected Earnings Per Share
Source: RBC Dominion Securities
However, with S&P500 forward price earnings at 22 vs an historical average of seventeen, the pundits are definitely on the optimistic side. This year's Bloomberg Estimate of S&P500 EPS for 2025 is $271. That will require a 13% increase in EPS, up from 2024's 8%. Notably the "S&P493", sans the "Magnificent 7" was actually flat. Some estimates for required earnings growth are 20%. A little cold water is in order after two smashing up years of over 20% gains in the S&P
As Howard Marks likes to say, the most important thing about successful long-term investing is not just buying good investments, it's buying investments at a good price. As the chart below shows, P/E ratios are inversely correlated with the 10-year returns that follow. So, everything else being equal, be picky about how much you pay for your investments because the mistake of buying when the market is overpriced is disappointment over the next decade.
The Human Component and Goals-Based Investing
Now that we're talking about how expectations for market returns might be over-stretched, is it time to run for the hills? No. It isn't time for wholesale portfolio changes. A trim here and a boost there could certainly make sense for some portfolios. How do you know if that's for you? Look at your financial plan and review these questions:
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when do I need the money from my portfolio?
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can my financial plan bear the risk of a down year?
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can I personally tolerate the stress I will experience if it's one of those down years.
For most investors, it's really about how close one is to retirement. If you don't have a portfolio that is designed to fulfill a financial plan, you are gambling if your investment strategy will take you where you want to go. From our perspective, portfolio performance should be measured within the context of a financial plan. Too many investors aren't sure if their portfolio makes sense because it doesn't have a clear purpose and, in the end, that portfolio ends up in neglect.
What doesn't get measured doesn't get managed.
Note: we offer complimentary portfolio reviews and financial planning strategy ideas to qualified individuals and business owners. If you're interested in solidifying your own plans and ensuring your portfolio is up-to-spec for the job, get in touch.
Now that we're back on more of a monthly basis, more or less, we'll move to sharing the monthly Global Insight. Enjoy and have a great weekend.
In this month’s issue:
Tariffs’ leverage extends far beyond trade
“Form,” as Louis Sullivan famously remarked, “follows function.” He was speaking of architectural design principles, but we think it’s a salutary reminder for policy analysis as well. When it comes to investing, we need to look beyond the labels politicians slap on ideas and focus on the economic realities that are driving decision-making.
This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ® / TM Trademark(s) of Royal Bank of Canada. Used under licence. © 2023 RBC Dominion Securities Inc. All rights reserved.