Estate freezes are a business succession planning tool that transfers future growth to the next generation while minimizing tax liabilities.
What Is an Estate Freeze?
An estate freeze is a sophisticated estate planning strategy designed to transfer the future growth of a business or other assets to the next generation while locking in the current value for the original owner. This approach is particularly beneficial for minimizing tax liabilities, facilitating succession planning, and ensuring the orderly transfer of wealth within a family.
Mechanically, an estate freeze typically involves reorganizing the ownership structure of a business or assets. The current owner exchanges their growth-oriented shares (e.g., common shares) for fixed-value preferred shares, which are equal to the fair market value of the business at the time of the freeze. These preferred shares retain voting control, allowing the original owner to maintain operational authority.
Meanwhile, new common shares, which will capture all future growth in value, are issued to the next generation or a family trust (which I will discuss in more detail in my next article). This ensures that any appreciation in the business or assets accrues to the new shareholders, often the children or beneficiaries of the original owner.
Tax Deferral
One of the primary benefits of an estate freeze is tax deferral. By freezing the value of the business at its current level, the owner can defer the capital gains tax that would otherwise be triggered upon the transfer of the business.
This is particularly advantageous because, under subsection 70(5) of the Income Tax Act, a taxpayer is deemed to dispose of their property at fair market value upon death, which can result in significant tax liabilities. By locking in the current value, the owner can better plan for these taxes and reduce the overall tax burden on their estate.
Business Valuation
Business valuation is a crucial step in executing an estate freeze. A proper valuation ensures that the fixed-value preferred shares accurately reflect the fair market value of the business at the time of the freeze. This is essential for calculating the owner’s future tax liability and avoiding disputes with tax authorities.
Additionally, valuation helps the owner decide whether to undertake a full freeze, a partial freeze, or a reversible freeze, depending on their succession planning goals and financial needs. For instance, a partial freeze may allow the owner to retain some growth shares, while a reversible freeze provides flexibility if the business’s value increases substantially after the freeze.
In summary, an estate freeze is a powerful tool for succession planning and tax minimization. Consulting proactively with legal and tax professionals is critical to tailoring these strategies to your unique circumstances and maximizing the benefits of an estate freeze. If you would like to discuss your business succession planning opportunities, please contact Pavel Malysheuski at Boardwalk Law: [email protected] / 905.863.7428.
Business Succession Planning (Part 2 of 4): Family Trusts
Business Succession Planning (Part 3 of 4): Buy-Sell Agreements
