What is an Estate Freeze?

What is an Estate Freeze?

estate freeze

Do you have a farm or business that you’re looking at transferring ownership to management or your children? If yes, you should consider some of the benefits of a classic estate freeze. This strategy can help you manage your estate tax bill. For tax purposes, an estate freeze locks in the current value of the asset while passing on future growth to a transferee.

Typically an estate freeze fixes the existing shareholder’s interest while allowing the new shareholder to effectively come into an ownership position paying only a nominal amount.  Typically, you would consider estate freezes when your company is worth at least $1 million. Freezes aren’t necessary if your tax on disposition can be covered by the $824,176 lifetime capital gains exemption.

How much does it cost? A simple estate freeze can costs a minimum of $15,000 in legal, business valuation and accounting fees. Costs will increase if your succession plan becomes more complicated, such as giving the company to children with varying business involvement.

How it works: A freeze locks a business’s current value into preferred shares for the original owner, and transfers growth to new owners through new common shares.

You exchange your existing shares for preferred shares. These preferred shares can either be in the operating company or a holding company that owns the operating company. In both cases, your preferred shares should have a fixed value equal to the company’s present fair market value. The company then issues common shares, bought by your successors for a nominal amount such as $1 per share. Any further increase in the company’s value accumulates in their hands.

You may want to crystallize your capital gains at the time of the freeze. This strategy was popular more than a decade ago, when business owners were worried the government might repeal the lifetime capital gains exemption.

As we know, tax legislation can change at any time, so it is best to be prepared. To crystallize the gain, your shares must be either qualified small business corporation shares or in a farm or fishery. You would report your capital gain and offset them on her personal return using the lifetime capital gains exemption.

Once the freeze is done, you must complete T2SCH50 Shareholder Information as part of your corporate tax return. It must be updated to include the new shareholders and ownership arrangement.

Common Pitfalls: Remember that you need to notify lenders of a planned estate freeze. If you’ve given a bank a personal guarantee, there is potential that a debt covenant may be voided or reconsidered when a new shareholder is introduced.

In addition, you should confirm that your company’s articles of incorporation include the types of shares needed for an estate freeze. If not, you’ll need to file articles of amendment with the federal or provincial government to create the types of shares needed for a freeze.

Bonus strategy: If your spouse and children are issued shares, they may have their own lifetime capital gains exemptions. This would multiply your family’s net tax savings.

To qualify for this capital gains exemption, your company must be a qualified small business corporation. Your spouse and children must be Canadian residents, and they or a related party or partnership must have owned the shares for 24 months.

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