Estate Freezes

As a business owner, you work hard to grow your business, but are concerned with the taxes you’ll have to pay in the future. We’ve worked with our clients and their accountants to implement estate freezes to help save on future taxes. But what is an estate freeze and why would an estate freeze help? Read further and I’ll tell you why an estate freeze could be important for your business.

Shifting future growth

An estate freeze can shift the future growth of your business and its associated tax bill to a trust or your heirs. This strategy can lead to significant tax savings by reducing the amount of money subject to capital gains tax upon your death or sale of your business. An estate freeze may also give you more options for succession planning as it provides more time and flexibility to think of who to transition your business to. Let’s work through an example of how this could work for you.

Estate Freeze in Action

Dale is the founder and owner of a successful real estate services business currently valued at $5 million. He is 54 years old, married, with two young children, and expects his business to grow significantly over the next 10 years. Dale is concerned about the potential capital gains tax that would be due on the future growth of his business when he eventually sells it or transfers it to his kids. The future value of Dale’s business in 10 years is estimated to be $15 million, his current cost base is nominal at $1- therefore his capital gain would be approximately $15 million if he sold his business 10 years from now. His estimated capital gains tax at that time would be $5.3 million.

Dale works with his accountant and financial advisor and together they recommend an estate freeze to help him save money on taxes. Dale “freezes” the current value of his business by converting his shares into preferred shares valued at $5 million. He then issues new common shares to a family trust. These new common shares represent the future growth of the business. The future value of his business is $15 million, but the value of the new common shares held by the trust are $10 million.

Tax Implications

Since the value of Dale’s new preferred shares is locked at $5 million, Dale’s capital gains tax liability is minimized to the value owing at the time of the freeze— in this case, $1.74 million. If Dale eventually disposes of his preferred shares, he will only pay taxes on the value that was locked in. If he dies while holding these shares, his estate would face tax of approx. $1.74 million on this locked-in value.

Heirs/Trust Tax Liability

The new common shares, which have grown to $10 million, are now with the trust or heirs. Any tax implications on these shares will depend on when and how they are disposed of, but they will benefit from the growth without having to pay taxes on the initial $5 million that Dale locked in.
By freezing the value at $5 million, Dale has effectively shifted the future growth and its associated tax liability to his heirs or a trust.

Summary

Without Estate Freeze: Dale’s tax liability is approximately $5.3 million on a $15 million future gain.
With Estate Freeze: Dale’s tax liability is approximately $1.74 million on the locked-in value of $5 million. Future growth ($10 million) shifts to the trust therefore deferring or spreading out tax liability. This also gives Dale more options for succession planning as it provides more time and flexibility to think of who to transition the business to.

This is a transaction that should only be implemented in consultation with experienced lawyers and tax professionals. When we build financial plans for clients, we often work together with your trusted lawyers and accountants to ensure the right strategy gets put in place. Please reach out if you think this could be of help to you.

Brent Vandekerckhove
Financial Advisor & Portfolio Manager
T 604 732 6551