It might be one of the best-kept secrets in tax planning circles. And that’s causing some Canadians to leave money on the table instead of keeping it in their wallets.

In the 2007 budget, the federal government increased the lifetime capital gains exemption available to farmers, fishers and owners of privately held companies to $750,000, a 50% hike from the long-time ceiling of $500,000.

That means the first $750,000 of the capital gain is exempt from income taxes. With capital gains, taxpayers bring only 50% of the remaining gain into income and pay income taxes at their marginal tax rate.

That’s good news for those who plan to sell their businesses or pass them on to family members. Depending on where they live and their marginal income tax rates, the CGE can translate into a maximum tax savings of about $180,900. (The exemption amount will be less for people who have claimed the $100,000 general capital gains exemption, which was eliminated almost 15 years ago, or used all or part of the $500,000 CGE previously.)

But Adelle Leger, a financial advisory consultant with Royal Bank of Canada’s wealth-management services in Toronto, says many people who could take advantage of the CGE simply aren’t aware that it exists — or that it was amended this past year.

“Business owners, farmers and fishers should be aware of [the CGE changes],” she says, “not only at the time of sale, when a capital gain will be triggered, but also, more important, well in advance so they are aware and can plan for it before disposing of their property or shares.”

There are three tests that must be met before people can qualify for the CGE.

First, taxpayers must have owned the business for more than 24 months, the “holding period,” before the sale.

Second, during that time, more than half of the fair market value of the company’s assets must be used in an active business.

Finally, on the date of the sale, more than 90% of the company’s assets must be generating active business income.

Leger says that claiming the CGE is a complicated matter that subjects entrepreneurs to strict conditions in some instances. For example, if a farm is leased to tenants or is involved in a sharecropping arrangement, it may not be eligible for the CGE. She recommends consulting a tax expert before committing to a particular course of action.

Paul Woolford, tax partner with Toronto-based KPMG Enterprise, says entrepreneurs can take steps to maximize the benefit of the CGE. For instance, he encourages clients to keep Canadian businesses separate from non-Canadian businesses. Many small entrepreneurs create U.S. subsidiaries when they want to expand south of the 49th parallel. But, he warns, that could affect the entrepreneurs’ ability to claim the CGE.

“If you think of the Canadian company, one of its assets is an investment in the U.S. [the subsidiary], which won’t qualify [for the CGE],” Woolford says. “Keep them separate, have a Canadian company and a U.S. company. Don’t commingle them.”

There are also ways to enable a spouse and children to take advantage of the CGE, he adds. For example, if a couple wants to pass on their business to their three children, one strategy is to use an estate freeze and a family trust. Under the freeze, parents exchange their common shares in the business for preferred shares frozen at the present value of the business — say, $5 million. Future growth will go to newly issued common shares held in the trust, which has the children as beneficiaries. This effectively transfers future growth in the business to the children.

Down the road when the parents sell the company for, say, $8 million, the trust would designate the capital gains to the beneficiaries.

“Let’s say the three kids each receive $1 million,” Woolford says. “When they claim the capital gains deduction of $750,000, they would pay taxes on only $250,000. Now, we have five CGEs [one for each parent and child].”

Jack Courtney, assistant vice president of advanced financial planning with Investors Group Inc. in Winnipeg, says clients selling their businesses can defer capital gains over several years. For example, if a client receives an up-front portion of the payment from the buyer and the balance is paid off in equal instalments over time, spreading out the capital gains keeps the client in a lower tax bracket.

@page_break@ “The best-case scenario is if I receive 20% a year for five years,” he says. “But if I have a high income, more than $125,000, spreading that gain out won’t save me any taxes. I’ll pay at the top rate every year.” IE