An estate freeze in Canada is a strategy used to lock in the current value of an individual’s estate for preserving wealth, minimizing tax consequences, lowering probate fees, and ensuring the smooth transfer of assets such as a family business to the next generation.
An estate freeze can be a highly effective planning tool, and it’s certainly a valuable strategy to consider, especially if you’re a business owner or a high-net-worth individual. However, estate freezes are complex and should only be used in certain situations, customized to your unique needs and goals.
An estate freeze must be well understood and properly structured to be effective. Our trust and estate planning lawyers can help you determine whether an estate freeze would be advantageous and recommended as part of your succession plan. If you want to know more or wish to discuss your personal circumstances, we welcome you to reach out to Onyx Law Group to schedule a consultation.
Today’s post will answer important questions such as what an estate freeze is, how an estate freeze works, why implement an estate freeze, and how to do an estate freeze. Knowing the answers to those questions will help you decide if you should further explore an estate freeze as part of your plan for the future.
Estate Freeze Meaning
An estate freeze is a transaction that “freezes” the value of assets at a specific point in time. An individual (the “freezor”) can use an estate freeze to lock in the value of appreciating assets at their current fair market value and exchange them for assets that have a fixed value (“frozen assets”).
Why Do an Estate Freeze?
The purpose of locking in the value of appreciating assets at their current value is to transfer future growth of those assets and any associated tax liabilities to others. The assets are usually transferred to your family members, such as children or grandchildren, or to a family trust set up to benefit you, your spouse, your family members, etc., depending on your needs and goals.
The general rule is that capital gains are triggered when property is transferred or disposed of (one exception is transfers to your spouse). So, if you’re planning to sell, gift, or otherwise transfer appreciating property in the future to someone other than your spouse, you may be on the hook for significant capital gains—especially if the value of that property is expected to grow significantly over time.
Remember that when a person dies in Canada, they are considered to have disposed of all their capital property at fair market value immediately before death. This is known as a “deemed disposition.” Any resulting capital gains are included in the deceased’s final tax return, and capital gains tax is calculated accordingly.
When you implement an estate freeze, any growth in value of the frozen assets accrues to the benefit of the next generation. That allows you to limit accrued capital gains, transfer future growth to your beneficiaries, and plan for income tax that will be payable when you ultimately dispose of the frozen assets (whether by way of sale, transfer, gift, or deemed disposition on death).
How Does an Estate Freeze Work in Canada?
There are many ways to implement an estate freeze, but let’s look at a common example to demonstrate how they work in real life. In a typical estate freeze, a person who owns common shares in a private corporation exchanges those shares for fixed-value preferred shares in the corporation. The corporation issues common shares to a new shareholder or shareholders (usually the freezor’s children or a family trust, but the shares could also be issued to key employees of the family business or other successors).
Example of an Estate Freeze in British Columbia
Imagine you own an incorporated family business in BC. Your children work at the family business, and they are the clear successors. Your business is expected to grow significantly in value. If there is no change in the share ownership during your lifetime, there will be a deemed disposition of your capital property, including your shares in the business, when you die. The tax consequences are expected to be substantial.
To implement an estate freeze in that example, you exchange your common shares for fixed-value preferred shares in your business. The corporation then issues common shares to new shareholders of your choosing (in this example, your children). You can have the company issue you preferred shares with special voting rights, thereby maintaining control over the business. Alternatively, your family members could receive shares that have limiting voting rights.
Your preferred shares stay frozen that the fair market value established at the time the shares are exchanged. You only realize a capital gain when you sell or are deemed to have disposed of the preferred shares, and the capital gain is calculated on the asset’s frozen value. That lowers your tax bill and allows you to plan ahead for paying off the associated tax liability.
Future growth of the business accrues to the benefit of the new shareholders (your children). They will have to pay capital gains taxes on accrued gains at a future date when they dispose of their shares or are deemed to have disposed of them. That tax deferral can be of significant benefit to your children. Additionally, if your children are in a lower income tax bracket, their tax bill will be less than what you would’ve paid, resulting in a lower tax bill for the family.
Why Implement an Estate Freeze?
We’ve touched on some of the benefits of an estate freeze, including capping capital gains tax and deferring taxes. There is a range of other tax benefits and non-tax benefits that may come with freezing an estate, particularly when the estate freeze is carefully structured and properly executed.
Benefits of An Estate Freeze Canada Explained
Here is an overview of some of the other potential benefits and advantages of an estate freeze:
- Smooth Transfer of Business Ownership and Operation: An estate freeze can be structured to transfer ownership to the next generation while retaining control until you’re ready to retire, or until the successors are ready to take over control of the business (for example, if your children or grandchildren are young when the freeze is implemented).
- Retirement Planning: If timed correctly, freezing private company shares can allow you to retire with financial independence, for example, by redeeming your fixed-value preferred shares over time.
- Asset Protection: A holding company and/or family trust to facilitate the freeze can protect certain assets from creditors, family law claims, etc.
- Income Splitting: You may be able to split income with family members in a lower tax bracket. After the freeze, your company can pay dividends to the new shareholders. If they are lower-income earners compared to you, that will reduce your family’s overall tax bill—subject to applicable attribution rules. Recent Income Tax Act amendments toughened up the attribution rules and limited some opportunities for income splitting. It’s imperative to get advice from a qualified tax professional before carrying out an estate freeze.
- Multiplying the Lifetime Capital Gains Exemption: The Lifetime Capital Gains Exemption can provide a significant tax break by sheltering capital gains resulting from the disposition of shares of qualified small business corporations. If the projected growth of your business is expected to exceed your Lifetime Capital Gains Exemption limit, an estate freeze can be used to transfer some of the growth to your beneficiaries. They, in turn, may be entitled to rely on their own Lifetime Capital Gains Exemption when they dispose of the shares.
- Reduce Probate Fees: There are no inheritance taxes in Canada, but there are probate fees, which must be paid on estate assets if probate is necessary. An estate freeze can reduce the overall value of your estate, thereby reducing probate fees that might’ve otherwise been payable on your death. It’s important to note that there are many other strategies that can be used to avoid probate, including multiple wills, alter ego trusts, and joint venture trusts.
Estate Freeze Family Trust
As discussed above, the freezor can transfer shares of a private company directly to the next generation, or the freezor can set up a discretionary family trust to be the owner of the newly issued “growth shares.”
What Is an Estate Freeze Family Trust?
It’s common for a family trust to be used when implementing an estate freeze. The family trust can be structured so that certain family members are beneficiaries of the trust (e.g., children, grandchildren). The freezor can retain control of the company as a trustee of the family trust.
Benefits of Using a Family Trust
A family trust can provide considerable flexibility. Different classes of beneficiaries can be created. The trustee(s) determine how income and capital should be allocated to beneficiaries. That can be done in a strategic manner to provide an overall tax benefit to the family.
Gradual transition of ownership and management of the business is another major benefit. When the trustee(s) decide that the next generation is ready to be actively involved in the business, the family trust can distribute shares to one or more of the beneficiaries.
A family trust can also mitigate against potential issues such as breakdown in the family and unexpected sale of shares before the freezor intended.
It’s important to mention, however, that attribution rules apply to family trusts, so they must be structured properly. Timing is also very important. A family trust is deemed to have disposed of all of its capital property on the 21st anniversary of its creation. That rule is intended to prevent indefinite tax deferral. If the family trust will be in place for longer than 21 years, a tax advisor and legal professional can help you plan for the 21-year deemed disposition rule.
How to Do an Estate Freeze
There are many ways to structure an estate freeze. In addition to identifying the assets that are suitable for freezing, you must also consider timing, factor in family dynamics, and examine your overall financial goals and retirement plans. You’ll also need to think carefully about options such as using a holding company or family trust to hold the growth shares, creating different classes of beneficiaries, and how voting rights should be allocated.
To perform an estate freeze, start by determining the current value of your estate, including assets like property, investments, and business interests. Next, transfer the future growth of these assets to a beneficiary or a trust, often by gifting or selling shares in a business or property at current market value, locking in the present value for tax purposes. You might use an instrument like a family trust or a preferred share structure to facilitate the transfer. This helps reduce future estate taxes, as the appreciation after the freeze is no longer part of your taxable estate. It’s also crucial to consult with an estate planner or tax professional to ensure all legal and tax considerations are properly addressed and to structure the freeze in a way that aligns with your financial goals.
Need an Estate Planning Lawyer for Your Estate Freeze BC?
An estate freeze can be a powerful tool to manage assets, provide financial security, reduce probate fees, and distribute assets and wealth to benefit future generations, but they must be well-understood and correctly implemented to achieve such goals.
You need the right advice to determine if an estate freeze is recommended in your situation. When preparing estate plans for our clients, our estate planning lawyers take care to understand their unique needs, goals, and circumstances to ensure their assets are effectively and efficiently managed.
Whether you’re looking to protect your wealth, plan for your retirement, provide for family members, or ensure a smooth succession plan, we welcome you to contact the experienced team of Vancouver estate planning and trust lawyers at Onyx Law Group by calling (604) 200-8492.