What is an Estate Freeze
If you’re a business owner in Canada, this article is for you. There is one crucial element to estate planning that you need to consider. If you plan on passing your business on to your children, if you want to minimize the amount of taxes you pay in your lifetime, or, if you want your estate to be maximized by your beneficiaries, don’t overlook this estate planning technique that allows you to transfer the future growth of your assets to your children or grandchildren.
An estate freeze is a strategy used in estate planning to limit the taxable value of an estate. It involves freezing the value of assets at a specific point in time, especially for inheritance purposes.
By “freezing” the estate, you essentially lock in the current value of such an asset, allowing you to transfer it to the next generation without incurring immediate capital gains taxes.
This saves your heirs a significant amount of money when the estate is transferred. However, the major advantage here is you get to retain control of your asset, whether it’s personal property or a business.
Understanding estate freeze structure, how it works, as well as its pros and cons are essential before deciding on whether it’s the right move for you, so keep on reading this guide as we discuss everything you need to know about this concept.
When to Consider an Estate Freeze?
An estate freeze works best if you want to achieve one of the following objectives:
To minimize or defer tax
You operate a business and want to have family members take over the business after you retire or after death
You wish to income split with family members who are in a lower marginal income tax bracket than yourself
The value of the shares of your corporation is more than the lifetime capital gains exemption, or you have a spouse and/or children who have not used their exemptions and you expect your business to grow significantly in the future
If you reside in a jurisdiction with high probate fees such as BC or Ontario and want to minimize those fees
The 21-Year Rule: On the 21st anniversary of a family trust’s creation, all of the trust’s assets will be disposed of, which will trigger a capital gain.
Feel free to contact Parr Business if one or more of the above apply to you and you’d like to find out more about how toplan your estate freeze.
Estate Freeze Structure & Strategy
According to Canadian law, when a property owner dies, they're considered to have sold everything they own at fair market value right before their death.
The problem with this tax legislation is that it can trigger a large income tax bill in the year of death, taking a big chunk out of what's left for beneficiaries.
In some cases, this can be devastating for limited estates with little funds to pay the owed taxes, as it might force the sale of valuable business shares or even the liquidation of the entire asset to fund those hefty bills.
That’s where estate freezing is used, to prevent such problems. Through an estate freeze, the estate owner can exchange this increase in value for a fixed share value, which is determined according to fair market value at the time of completing the freeze.
This way, any future increase in the value of the original asset goes to the new beneficiaries as they become new shareholders of the estate.
In this case, the original owner keeps control of the estate and its current value while deferring the capital gains tax until they decide to sell their estate or when they're deemed to be sold upon death.
While this is the most common structure of an estate freeze, there are many variations of an estate freeze structure. Consulting a qualified professional will help you set the ideal plan to achieve the desired objectives while freezing assets.
What are the Benefits of an Estate Freeze?
Freezing an estate comes with a wide range of advantages, especially when done right and with the help of a qualified professional. Here’s a quick look at some of the top benefits to make you consider an estate freeze:
Estate Planning and Asset Protection
An estate freeze is one of the best strategies to ensure smooth succession and transfer of wealth to your beneficiaries, especially when you’re considering future generations, such as your children and grandchildren.
Using an estate freeze as a method to transfer income allows you to introduce your chosen successors as shareholders of the estate.
Combined with a reliable family trust, this allows you to have full control over how you want your wealth distributed.
Tax Deferral and Advantages
One of the main purposes of an estate freeze is to reduce tax burdens by deferring the capital gain tax on assets transferred to your beneficiaries through inheritance.
By freezing the value of your shares, any future growth falls directly under the ownership of your beneficiaries, which reduces the capital income taxes they need to pay and leaves more for them.
While an estate freeze doesn’t completely eliminate the taxes, it can significantly reduce its impact on their assets.
Of course, this is provided that your beneficiaries aren’t planning to sell those assets soon after inheritance, as they’ll have to pay income taxes in the case of the sale, which defeats the purpose of the estate freeze.
Reducing Probate Fees
While Canada has no inheritance taxes, it still has probate fees, which vary significantly from one province to another. These fees are determined according to the overall value of the assets you own.
By freezing your estate, you effectively reduce the probate fees that your beneficiaries have to spend.
On its own, probate fee reduction isn’t a solid reason to consider an estate freeze, but it can offer additional savings when combined with other advantages.
Keeps Business Operations Smooth
Transfer ownership of an estate, especially a business, can involve a lot of hassle and legal steps that may affect the flow of business operations.
However, by freezing your estate, you skip several major inconveniences associated with ownership transfer, and the most advantageous part is that you retain control over these assets during the transition. This can minimize business disruptions that result from these proceedings significantly.
Provides Opportunities for Income Splitting
The introduction of new shareholders through an estate freeze opens doors for major income-splitting opportunities.
For instance, through an estate freeze family trust, you can distribute shares to beneficiaries so that they remain within a lower tax bracket, which can potentially reduce the overall family tax burdens significantly.
Potential Disadvantages of Freezing Your Estate
Despite its merits, freezing your estate, whether partially or fully, comes with several drawbacks that you need to be aware of. In this section, we’ll take a closer look at some of those disadvantages:
Requires Careful Planning
Estate freeze is a complex strategy that takes a lot of factors in mind to be a worthy strategy. This includes everything from the size and type of your assets and your overall financial goals to your family dynamics and purpose of freezing the estate.
Freezing your estate while disregarding these factors can end up causing much more harm than good.
Additional Legal Costs
Implementing an effective estate freeze requires meticulous planning and the help of qualified professionals like lawyers and accountants to share their expertise.
Seeking the help of these professionals can help you make the right decision while keeping legal and tax implications in mind.
However, these services typically come at a price, which isn’t always worth it for a relatively small estate.
Attribution Rules May Apply
Canadian tax law has various laws to ensure proper tax collection and structuring. Some of these rules can impact the future growth of assets or limit the benefit of the tax deferring advantages, especially when combining an estate freeze with a family trust.
A qualified advisor will warn you when the attribution rules would apply in your situation, which is why it’s always essential to ensure you have the right type of guidance by your side while proceeding with an estate freeze.
DISCLAIMER
This information is intended for business owners in Canada and serves as general guidance only. Always consult with a qualified advisor before making any legal decision.
TL;DR
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