USING AN ESTATE FREEZE TO MINIMIZE ESTATE TAXES
Under the Income Tax Act, on the date of your death you are
considered to have sold or disposed of all of your property. This is a deemed disposition
of all your property on death for purposes of income tax. Your estate must
recognize any gains made on property or investments and pay taxes subject to any
exemptions available. Estate planning permits you to arrange
your estate to minimize estate taxes on death. An estate freeze can defer the taxes payable to a later
date by limiting the taxable capital gain that has to be realized on death.
If
the taxes are deferred, then the amount remaining for your family can be
increased resulting.
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In very general terms, an estate freeze is an estate planning
technique to limit the growth of capital property held by you during your
lifetime; any future growth in the capital property is transferred to you heirs
as a result of the estate freeze. For example, if your business is incorporated,
then the shares you own in your company will increase in value. On
death, for purposes of income tax, you are deemed to have sold the shares such
that your estate must pay taxes on the capital gain. The problem is that
your estate is required to pay taxes on unrealized gains. In order
to meet the tax liability, the estate may be forced to sell the business in a
bad market.
To protect your estate, you can use an estate
freeze. Under an estate
freeze, in the above example,
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you would exchange your common shares for shares of equal
value but the new shares would not grow.
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your family members would be given preferred shares and
all the future growth would be attached to the preferred shares.
From the time of the estate
freeze, any increase in value in the capital property accrues to property held
by the heirs. The property held by the original owner, or the person who
puts the estate freeze in place, does not grow in value. For many
individuals, an estate freeze can be very effective especially if your company
will continue to grow in value.
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The main value of an estate freeze is the tax deferral. The
longer that payment of the taxes can be deferred, the higher the value. The deferral period
would be from the time your heirs acquire the new capital property until they sell the assets.
By deferring payment of taxes, the assets available to you during the deferral
period are increased; you have more cash available to use in your business for
example.
If your business is incorporated, then the estate freeze
may involve you giving up
voting control of the business. The voting shares of the company may be given to
the children. Consider the implications of this situation. The dynamics of a
modern family are very complex. Major changes, such as would result from an
estate freeze under which control of the business is given to the children, can
produce quite unexpected and dramatic changes. You must consider the dynamics of
your own family and assess the impact of an estate freeze.
It can be extremely difficult to undo an estate freeze once
it is implemented. The danger arises if you carry out the freeze to early. Over
the years, your cost of living will increase. You may encounter unexpected
expenses such as for medical treatment. The estate freeze may have limited your
income to an extent that it will not be sufficient to meet your needs.
These types of concerns can be addressed in a properly prepared estate plan that
uses an estate freeze as part of the overall plan to transfer the property to
the heirs in the most tax efficient manner.
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It is difficult to develop an understanding for these factors
in the abstract. If you are seriously interested in minimizing taxes, then the
best approach is to develop a preliminary plan as a first step. Next, the potential tax
savings must be estimated based on reasonable assumptions that reflect your
actual situation and expectations. The effect of the estate plan on the
family must be discussed and carefully considered with proper legal, accounting
and financial planning advise. This will give you some indication of whether or not an estate freeze has value
to you. If in the end you decide that there is significant value to you, the
plan can be implemented. Throughout the process you will have to work closely
with your accountant and lawyer. More importantly, you will have to involve your
children in the planning process; they must have a clear understanding of what
you are considering and be on side.
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An estate freeze can help you minimize the taxes arising from
your death. It should be part of the process to carry out a succession plan under which
the children will eventually take over the business and be ready to run it when
you want to retire. Even if in the end you decide not to do the estate freeze,
going through the process may be of value for this purpose alone.
If you have any questions on the issues discussed above, or
on estate planning in general, please
contact Sucha S. Ollek at: info@e-law.bc.ca.
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