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Introduction to Estate Freeze
From tax expert Gerry Vittoratos
May 27, 2020
Estate freezes are a powerful tool in the tax arsenal of a family corporation. They allow for the tax-efficient transfer of a corporation from the originator to the next generation. What are they, and why should they be considered? This article will explain.
Estate Freeze Defined
Although there is no official definition, the process of an estate freeze aims to “crystallize” (lock in or freeze) the fair market value (FMV) of an individual's assets on a given date so that the future capital gains of the assets they hold before the transfer will not be incurred in their hands but in the hands of their chosen successors.
The process is usually done through an exchange of shares under various methods (explained in the next instalment). The individual exchanges the growth shares (common shares) which he/she holds at the time of the transfer for shares (preferred shares) whose value will remain stable in the future. This way, any future increase in the value of the shares exchanged benefits people chosen by the author of the freeze rather than himself/herself. The freeze can be partial or total.
When to Trigger an Estate Freeze
There is no set date to trigger an estate freeze. This date can depend on certain factors, many of them subjective, such as the desired retirement date of the principal owner, or the readiness of the potential successors.
There is, however, one factor that is much less subjective and can tip the scales on the timing of an estate freeze. The factor is when the increase of value of the shares of the corporation starts nearing the capital gains deduction limit (https://www.canada.ca/en/revenue-agency/services/tax/individuals/topics/about-your-tax-return/tax-return/completing-a-tax-return/deductions-credits-expenses/line-25400-capital-gains-deduction/what-deduction-limit.html). In that case, if the author of the freeze does not want to trigger any personal taxes from performing an estate freeze (assuming Alternative Minimum Tax or AMT is not applicable), they would have to execute the crystallization when the value reaches the deduction limit.
Why Trigger an Estate Freeze?
Reduction in Taxes
By freezing the assets that are more susceptible to increase in value, the author of the freeze can determine ahead of time what the likely tax liability would be, should he/she wait to transfer the estate to the successors. By triggering the freeze now, the author can mitigate the taxes his/her estate would have to pay at the time of death; the value of the assets transferred upon death will no longer be subject to taxation.
Take Advantage of Current Legislation
By triggering an estate freeze, the author takes advantage of current tax legislation before any change occurs. For example, potential changes to the capital gains deduction rules (https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4037/capital-gains.html#P428_42672) might have a negative impact on estate planning such as this. By freezing the assets today, the author of the freeze protects himself/herself from such a change.
Orderly and Gradual Integration
By integrating the next generation while he/she still has control, the author of the freeze can guide the successors and train them to eventually take over.
Protection of Assets
By setting up a family trust in the corporate structure as the principal shareholder of the family corporation, with the family members as beneficiaries, the author can add a layer of protection against creditors ( https://www.nbc.ca/personal/advice/taxes-and-income/family-trust-everything-you-need-to-know.html) on the assets held personally. This is due to the fact that the trust is a distinct entity from its beneficiaries, and therefore the only assets that creditors can go after are only the ones within the trust.
In the second instalment, we will see how to perform estate freezes through several techniques.
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