As a Canadian business owner, or as the holder of shares in a company, if you’re looking for an effective strategy for tax and succession management, then an estate freeze is one option you can exercise.
Through an estate freeze, you can limit income tax on future capital gains, reduce probate fees, and pass control to the next generation of your family in a tax-efficient manner.
Today we’ll be discussing what an estate freeze exactly is, how it works, its benefits, and whether you should consider an estate freeze for your assets.
What Is An Estate Freeze?
On the face of it, you’d think you’re at a great disadvantage if any shares owned by you freeze in value, but there are many advantages to an estate freeze.
A reduction in capital gains tax is one of the biggest advantages of estate freezes. If you’re expecting your company’s value to increase and there is a clear line of succession for future owners and operators, then an estate freeze can help you in ensuring that you do not incur a large capital gains tax.
Even if you’re planning on disposing of your shares before your death, an estate freeze will still help in keeping the capital gains tax contained.
Considering you now own the preferred shares that have a fixed and frozen value, those shares will never increase in value. Hence, while disposing of the same you won’t be incurring a large capital gains tax.
Even if there is an accrual in the value of the shares held by the new shareholders, the liability to pay any tax would only apply when the new shareholders dispose of their shares or die.
Moreover, there is also a lifetime capital gain exemption in estate freezes but only for certain private shares in a “qualifying small business”. Any such shares would enjoy a tax break in an estate freeze, significantly reducing the amount of tax you or your successors would need to pay.
Probate fee is a fee paid for probates, a process whereby named executors in a will or administrators of estates are approved as such by a court of law. Probate fees vary from province to province and are calculated in accordance with the market value of the deceased’s estate.
Through an asset freeze, you can reduce the probate fee, but it would involve different techniques, such as having the company redeem the shares while you are still alive, using multiple wills, or transferring the preferred shares to another entity.
Protect Your Family
Estate freezes are a surefire way of protecting your assets, especially if it’s a family company. You could ensure that all your family members are equally and equitably given their share within your lifetime, all while retaining the preferred shares yourself, meaning you have control over the company.
Since you can also transfer the common shares to a trust, if you’re worried about showing preference or jealousy among family members, you could also just set up a trust for your family and transfer the shares there. The trust documents can outline how the shares are to be distributed among family members in the event of your death, and all the benefits of an estate freeze would still apply.
The timing all depends on your personal and financial circumstances, the structure of your family, and the type of business you run.
You also need to ensure that freezing your shares or assets at any given time leaves you with enough income or value to maintain your financial independence. Freezing at the wrong time could result in you not being able to live comfortably anymore.
While you do have the option to unfreeze assets and freeze them again if you want, there are financial and tax implications to consider. Also, unfreezing will require cooperation from the shareholders you’ve transferred the common shares to, and there’s not always a guarantee for that.
The best way of doing this is to hire a professional firm to carry out an assessment for a proper valuation. If you value your shares too low in comparison to market value, you’ll be hit with the capital gains amount (difference between your valuation and the market value) and if you value too high, then you’ve got another taxable benefit on your hands.
Therefore, ensuring a proper valuation ensures you are able to benefit from the tax advantages associated with estate freezes.
Conclusion - Should You Set Up An Estate Freeze?
There’s no doubt there are advantages to an estate freeze, but it would depend on many factors including family size, the type of business, and your overall goals for the business.
Estate freezes are better for family-owned companies that intend to stay as such, being passed from generation to generation. If you have plans on taking your company public one day or selling it to an investor, then maybe an estate freeze isn’t the right option for you.
To explore whether an estate freeze is the right option for you, it would help to speak to a professional. Estate planning in Nova Scotia can be complex and speaking to the right team like that at Eastport Financial Group, will help you in making a decision that is most beneficial for you.