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Benefits of an estate freeze

An estate freeze can help your family business stay robust.


October 18, 2010
By Jim Sanderson

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Most business owners understand the value of several key steps to keeping a business healthy.

Most business owners understand the value of several key steps to keeping a business healthy. These include accumulating, preserving and passing on wealth (certainly with the help of the $750,000 capital gains exception), minimizing and deferring taxes, ensuring clear and consistent communication among family members and providing funding for eventual tax liabilities.

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Many business owners will be pleasantly surprised by how much they will benefit by taking the time today to create a long-term succession plan that encompasses both a business and personal financial plan.

Enjoying the fruits of hard work
Instead of waiting to make decisions about the future of a family-owned business when the owner becomes sick or just doesn’t want to be involved any longer, planning today from a position of strength can make a significant difference. Advance succession planning can help owners enjoy the fruits of years of hard work and turn them into healthy financial futures for their family and employees. What business owner wouldn’t sleep better with that knowledge?

Control bills with an estate freeze
Establishing a family trust or doing a refreeze of a previous freeze are strategies that are also available to help mitigate taxes. For illustrative purposes, in this example we will look at the estate freeze.

An estate freeze is a fully allowable tax planning strategy under which children are given shares in a family business. It is really a way of transferring ownership of a privately held corporation, often between family members, by reorganizing the company. The freeze has two goals: 1) To transfer ownership of the company from one owner to another, and 2) To limit the capital gains tax for the business owner who is transferring his or her shares to someone else. Both events happen simultaneously. You can consider a full or partial freeze, depending on the extent to which you want to maintain a financial interest in the business, and how much cash you need in the immediate future.

In an estate freeze, capital assets, whose continued growth creates mounting tax and succession planning issues, are exchanged for similar assets that are fixed in value. A business owner may decide to freeze when he or she decides there is sufficient equity in the business to support his or her lifestyle indefinitely. This allows a business owner to literally “freeze” the value of his or her shares at current levels and to defer taxation on future business growth to the next generation. As he or she knows the precise value of the frozen shares, the owner will know exactly how much tax will be payable in the future.

How an estate freeze works
The following is a hypothetical example. Ben owns 100 per cent of his aggregate operation, Ben Aggregates. He has just turned 60 and is considering an estate freeze to defer the tax he will otherwise pay now and plan an orderly business succession. Ben wants to stay involved in the business and needs the income to pay for his winter sunshine and boating trips.

He does a partial freeze and transfers 50 per cent of the growth in Ben Aggregates to his son, Ken, and daughter, April, while maintaining 25 per cent for himself and 25 per cent for his spouse, Carrie.

He incorporates a holding company, “Aggco,” and issues 25 per cent (each) of the common shares, all with nominal value (Aggco has no assets or income), to Ken, April and Carrie.

Ben then transfers his common shares in Ben Aggregates to the holding company, in return for preferred shares.

The result: This transfer will occur tax-free (under the Rollover Provision of Section 85 of the Income Tax Act) as long as the value of Ben Aggregates preferred shares is equal to the value of the common shares of Aggco.

Ben arranges for the preferred shares he receives from Aggco to have a fair market value of $500,000 and an adjusted cost base of $500,000. Any future increase in the value of Ben Aggregates, which is owned by Aggco, will be reflected in the common shares of Aggco. This structure will allow these common shares to be divided equally among Ben and his family.

In addition to creating a holding company, Ben initiated the creation of an investment portfolio using the declared dividends generated by his share of the business. This diversified portfolio will bolster Ben and Carrie’s cash flow when they begin their transition into retirement after selling the business.

Be sure to consult your advisors to help plan and implement these strategies that will affect your and your family’s standard of living, today and through future generations.

Today is the best time to plant the tree
The sooner you sit down and plan the future of your business, the sooner you’ll be able control not only the future of your business, but also the quality of your life and the life of your family. No one can predict the future, but a well-thought-out succession plan, which takes into account everything from future ownership to tax management issues, is a great start.


Jim Sanderson is a certified financial planner and wealth manager at ScotiaMcLeod.


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