Estate freeze: A tax planning tool for business owners

What’s an estate freeze?

An estate freeze caps the value of your investments at the time of the freeze for tax purposes. Generally, it involves transferring your investments into a corporation or exchanging shares in your already-existing corporation for new fixed-value preferred shares. This is beneficial because when you eventually pass away and the estate taxes associated with your investments are triggered, it’s calculated based on the frozen value.

What are the potential benefits?

An estate freeze can provides greater financial certainty to you and your family, as you can more accurately estimate, and plan for, the amount of taxes that will be owing at death.  

If you leverage an estate freeze in an economic downturn, your new shares wouldn’t increase in value as the markets recover, thereby locking in the taxable value of your investment at that lower value. Future growth in value is attributed to new shareholders—usually the current shareholder’s children, family members, key employees, or family trust. 

An estate freeze can also be beneficial even in a strong economy, if the value of the business is expected to rise due to future growth or other factors. 

What happens if the value of your investments decreases?

If you previously implemented an estate freeze and the value of your shares have decreased further, it could be an ideal time to “thaw and refreeze” to take advantage of the reduced value and lower your future tax bill. 

Using the same example, if you previously froze investments when it was valued at $5 million, you can “thaw and refreeze”. This essentially reverses the existing freeze and issues new fixed-value preferred shares at today’s lower value of $3.5 million,  similarly reducing estate taxes by over $400,000 when the market recovers. When the markets recover, the growth above $3.5 million will now be transferred to the new shareholders. 

It may seem counter-intuitive, but it’s a strategy that recognizes the current economic downturn as a reality. By choosing this approach, you’re adjusting the value of your investment to reflect that reality, while enabling your tax liability to match the new—and more accurate—value of your investments.

How does a family trust fit into the plan?

Creating a family trust to hold new growth shares can give you more flexibility on who will benefit from the new growth shares. Also, a well-structured family trust can afford you flexibility and control to adjust as needed—e.g., if you need more personal income than you have access to in the future. Family trusts remain an important tax planning tool despite changes, as there are still multiple tax and non-tax advantages to using a trust. Note that you should consider how the tax on split income (TOSI) rules could affect your planning. 

Takeaway

Together, an estate freeze and family trust can help you manage economic headwinds. As no two businesses are the same, it’s important to properly plan and implement your estate freeze, based on market conditions and your objectives. It’s also imperative to structure your family trust so it complements your future goals and objectives and considers any other tax rules that might apply. Your Doane Grant Thornton advisor can help you set and meet those objectives.

Talk to an advisor

^Disclaimer

^{The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Doane Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.}