The Estate Freeze: A Multi-faceted Solution for Business and Wealth Transfers

Every business owner will eventually contemplate the transition of the family business and wealth to the next generation. A properly designed estate freeze can help an entrepreneur achieve various personal, business and tax objectives in their wealth transition planning.

How does an estate freeze work?

Typically, the business owner exchanges the common shares of their company for fixed value preferred shares. This exchange “freezes” the value of their participation in the business at that moment in time. Second generation family members or a family trust then subscribe for the new common shares of the company. This allows any future growth in value to accrue to them and not be taxed on the death of the business owner.

Take the example of a business owner who owns 100% of their company’s common shares with a current value of $1 million. An estate freeze would involve the exchange of their common shares for $1 million of fixed value preferred shares and the creation of a family trust to subscribe for the new common shares for nominal consideration, say $100. Any increase in value in the business will flow to the new common shares held by the family trust, not the business owner.

Why would a business owner consider an estate freeze?

Our experience has taught us that business owners are often concerned about (1) transitioning control, (2) properly planning for retirement needs and (3) mitigating tax on death. An estate freeze addresses all of those worries:

  • Transitioning control: a business owner can always retain full or partial voting control of the business when implementing an estate freeze. This can allow them to transition control to the next generation when deemed appropriate.
  • Financial certainty in retirement: the frozen preferred shares can provide the business owner with a source of income in retirement, either by way of dividends or by way of progressive redemptions of the shares. The frozen investment can therefore be monetized to fund lifestyle needs in retirement.
  • Certainty of value and tax on death: Canadian taxpayers are deemed to dispose of their capital assets at their fair market value immediately before death. Any accrued capital gain on these assets are realized at that time and the individual’s estate will have a corresponding tax on that capital gain. This deemed disposition applies to shares of a company. As the business owner’s shares have a fixed value, following an estate freeze, the tax liability associated with those shares can be determined with certainty. The business owner can then plan for it accordingly, with life insurance or savings, for example.
  • Minimizing tax on death: as the future growth in value of the business will accrue to the second generation or the family trust, capital gains tax on that future growth will be deferred to the next generation. The business owner will only be taxed on the capital gains on their frozen preferred shares at the time of their death.

Other benefits of an estate freeze can include creditor-proofing and the potential multiplication of the capital gain exemptions upon the eventual sale of the business.

Business owners discussing estate freezes

When should a business owner consider an estate freeze?

Choosing the right time to implement an estate freeze is dependent on a myriad of factors, including the business owner’s age, family profile, finances, and forecasting (both at the personal and business level). An estate freeze is an intricate subject that goes beyond taxes and technical matters. It is never too early broach the topic with your business advisors, as it can also be an emotional journey that forces you to confront difficult questions:

  • How do you foresee your retirement?
  • Can the current value of your business provide you with financial security in retirement?
  • Are your children ready to take control of the business? Conversely, is the business ready for you to transfer control?
  • What would happen if you die suddenly?

Richter experts can accompany you through this personal and business transition process and help alleviate the confusion and stress related to these questions. Working closely with our clients, we aim to provide the comfort and peace of mind that comes with a personalized estate plan and properly designed estate freeze. Having handled hundreds of successful business transitions and estate plans, we have encountered innumerable situations, issues, obstacles, and opportunities – it’s experience you can lean on to unburden the process.