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The Estate Freeze

By Steven Bark, B.A., B.Comm., Chartered Professional Accountant

How great would you be at strategic planning and daily management if you were able to know with certainty the outcome of the various options being considered!  But alas, unlike the world of the students’ exams where everything stands still for a brief moment, the real world is constantly moving and unpredictable.  Add to your reality unfortunate teasers like Dr Peter’s principles, and you’ll find that any business owner appreciates predictability and certainty in the factors and outcomes that affect his business. 

Unfortunately, two issues we might wish were not certain are death and taxes.  Happily, just as certain is the fact that planning can minimize the pain.  An estate freeze is a method of fixing the value of your current business and investment assets at the current value, and passing future growth on to children or other designated beneficiaries as you choose.

An estate freeze is a practical and relatively simple way for a business owner to render predictable the tax ultimately due on his death, minimize that tax, and achieve various other personal goals for the benefit of his survivors and beneficiaries.  Any business or investment portfolio that has accumulated significant value can benefit from a full or partial estate freeze.  You don’t have to wait until retirement is being contemplated to entertain the idea.

In the business environment, the Estate freeze is accomplished by having the owners’ Common shares exchanged for Preferred shares.  The value of the Preferred shares is set and fixed at the fair value of the Common shares for which they were exchanged.  The adult children or other beneficiaries subscribe for new Common shares at a nominal amount.  (Note that even though the subscription price of the new Common shares can be just a nominal amount, it does not confer a benefit on the new shareholders because all the value of the corporation is at that time held in the Preferred shares.) 

Future increases in the value of the business accrue to the new Common shares - which is the reason common shares are often referred to as “growth shares”.  Because the value of the Preferred shares never increases, the parents’ value is ‘frozen’.  With a correct designation of values by the Chartered Accountant, capital gains taxes may now be deferred for many years, or even for decades.

An estate freeze is also effective for fixing the value of a valuable investment portfolio.  The mechanics of this type of freeze are much the same as freezing the value of a business as above.  The investor and his children or other beneficiaries incorporate a company, with the parent transferring his investments into the corporation, taking back Preferred shares which will have a value equal to those investments.  The children subscribe for Common shares at a nominal amount, to which future growth in value of the portfolio will accrue.  Again, capital gains taxes may be deferred for a very long time.

With this large asset value now fixed, the couple’s Chartered Accountant may now be able to estimate the tax ultimately due on their death.  Don’t underestimate the value of the advance determination of that final tax amount, as it permits your affairs to be structured for the eventuality of its payment.  And as it is not very often that even the best planning can make tax completely ‘go away’, part of the estate freeze plan may be seeking the advice and assistance of an insurance expert.  One of the important - and often overlooked - purposes of an insurance program is determination of a sufficient amount with which to pay the tax due on the parents’ ultimate death.

But the exercise of predictability and deferral of capital gains taxes may be only one of the benefits determined during your sessions with your professional advisor.  Significant cash and legal protections are available by also including Family Trust provisions in the freeze transaction.

For a full exploration of estate planning ideas and practical tips on implementing your plan, see the Canadian Institute of Chartered Accountants’ newly released book Estate Planning Toolkit for Business Owners – Building and Preserving Your Wealth – to obtain a copy of this valuable resource please call Steven Bark 1-888-571-0111 / 705-745-8600 and arrange an appointment or you may order from www.knotia.ca/store

Coming in Our Next Installment -

Discussion of Family Trust protections and benefits