What You Need To Know About Estate Freezes In Alberta
For many Canadian business owners, passing the family business onto future generations may have crossed your mind – whether it be to children or key employees who wish to take over the business. In Alberta’s current economic downturn, your business may be undergoing financial trouble. Some of the most heavily impacted investments include securities portfolios, holding companies, and trusts. BUT, it may not be all bad. Now may be a good time to start planning your beneficiaries’ tax liability on growing assets. An Alberta estate freeze is a mechanism that may help you and your business save tax and money when transitioning to new ownership.
An estate freeze can be a strategic tool for financial planning and wealth preservation. Business owners considering an estate freeze should consider whether they wish to maintain a financial interest in the business, and the amount of cash flow they require in the future. Keep reading to find out the top ten things you should know about estate freezes.
What Is An Estate Freeze?
An “estate freeze” is a tax planning strategy commonly used when business owners pass on shares in the family business to their children. It is a way of transferring ownership of a privately owned company, usually between family members, by reorganizing the business. Capital assets, if continued to grow, accrue increased taxes, which can lead to succession planning issues (transferring ownership of the business). In a basic estate freeze, owners exchange the common shares held for preferred shares that are equal to fair market value on the date of the business freeze. Estate freezes are organized to comply with the Income Tax Act of Canada.
What Happens To The Family Business After Death?
When someone passes away, all capital property owned by the individual is taxable in the year of the death. This could create huge tax consequences for the business owner’s beneficiaries if no planning is undertaken in advance.
How Do I Minimize Tax Liability On My Business With an Estate Freeze?
After an estate freeze, the payment of taxes on capital gains (profits resulting from the sale of your business) is delayed until it is taxed through your beneficiaries’ estates.
Once a tax freeze is triggered, the current value of the business’ shares are frozen. The taxation on any increases in the shares’ value enjoys a deferral to the next generation. As the current value of the frozen shares is known, business owners know exactly how much they owe in taxes in advance.
How Is An Estate Freeze Implemented?
Usually, the business owner (freezor) transfers his/her assets to a holding company and exchanges it with preferred shares of that company. The value of the preferred shares are the same as the original assets at the time of the transfer. There is no increase in value of the preferred shares in the future.
Non-voting shares from the holding company will be issued to the new shareholders chosen by the freezor. If the company grows, the increased value will accrue in these common shares. By owning the preferred shares, the owner can continue to retain control of the holding company.
What Is The Difference Between Common Shares & Preference Shares?
Common Shares In An Estate Freeze
Typically, before an estate freeze takes place, the freezor holds common shares of his or her business. This gives the freezor the ability to control the company and have a stake in the profits. Usually, the owner of a common share can vote on how the company is run. As the business becomes more profitable, the value of each common share grows too.
Preferred Shares In An Estate Freeze
Preferred shares have a fixed monetary value. Even if the value of the common shares increase, the preferred shares of the holding company never goes up in value.
What Are The Income Tax Advantages After Implementing An Estate Freeze?
An estate freeze has numerous tax benefits. For example, these include such things as:
- Tax Efficient Ownership Transition: if there was no estate freeze, the business owner would continue to own 100% of the company’s common shares. When he/she dies, the tax owed will be approximately 25% of any increase in the profitability of the business. If this is uninsured, the surviving family members may be forced to sell the equity – or even the entire company – to settle the tax bill;
- Splitting Income: income can be shared among family members, some of whom may be in lower tax brackets which enable the family to pay lower taxes;
- Future Growth of Shares: while business owners possess preferred shares that have a fixed value, future shareholders can reap the benefits of any growth in the company; And lastly
- Retain Control: although business owners possess preferred shares, they can still guide the direction of the company.
What If My Business Loses Value After The Estate Freeze?
If the company decreases in value after the estate freeze, there is no tax relief available. In this case, the value of the preferred shares may be less than how much the company is valued at. This is why it is important to ensure that assets transferred to your children are likely to go up in value. Common examples of appreciating assets include land and buildings, whereas companies that rely on human capital are at a greater risk of value depreciation.
Can I Re-Freeze My Shares If The Value Of My Business Declines?
Yes! If your business declines in value after an estate freeze is triggered, this may be a good time to implement an estate re-freeze. The preferred shares are exchanged for new preferred shares at a fixed lower value. This allows for your tax liability to be lower than it otherwise would have been without the re-freeze.
When Should I Implement An Estate Freeze On My Business?
Implementing an estate freeze is not always advantageous. Before doing so, it is important to take into account other non-tax considerations such as:
- Family dynamics: the personal impact of putting large assets in your children’s hands should be carefully considered;
- Length of time frozen assets are held for: Are the shares worth enough to justify a freeze?
- Family law: Parents who own their own business. They may feel reluctant to transfer shares to a child who is married due to the potential of the child’s spouse taking away that asset should the marriage not work out; and lastly
- If you are expecting the assets to appreciate.
Are There Other Ways That I Can Use To Minimize My Tax Liability On My Business?
Instead of an estate freeze, you can make an inter vivos gift. This occurs by distributing your assets to your children/beneficiaries as gifts while still alive.
Note: if you are gifting assets located in the United States, gifts over a certain value will be taxed.
You can also put your assets into a trust where the income of the trust will be distributed among your beneficiaries. If you would like to maintain control of your business, you can specify terms in your trust that allow you to do so.
Note: income received by the beneficiaries of your trust is taxable.
Need Legal Help With Estate Freezing In Alberta?
Start planning for the future of your business today. For more information on how to conduct an estate freeze on your business, consult Kahane Law Office. Give us a call at 403-225-8810 or email us directly here.