ESTATE FREEZE - Proactive Tax Planning
Contact Neufeld Legal for your corporate legal work at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
An estate freeze is a proactive tax-planning strategy primarily used by business owners and individuals with significant assets to manage future tax liabilities. The core objective is to "freeze" the current value of an individual’s interest in a company or asset at its present-day fair market value. By doing so, any future appreciation in the value of the asset is diverted to the next generation, typically children or a family trust. This process effectively caps the capital gains tax that the original owner will eventually owe upon their death or when they dispose of the assets. It is a cornerstone of succession planning that balances the owner's current financial security with the long-term goal of preserving family wealth.
The mechanics of an estate freeze usually involve a corporate reorganization, often structured as a section 85 rollover pursuant to the provision in the Income Tax Act (Canada). The original owner exchanges their common shares, which carry the potential for unlimited growth, for fixed-value preferred shares. These new preferred shares are issued with a redemption value equal to the fair market value of the company at the time of the exchange. Simultaneously, new common shares are issued to the owner’s heirs or a family trust for a nominal amount. Because the preferred shares represent the entire current value of the company, the new common shares start with no initial value but capture all future growth.
Control and income stability are critical components that make this strategy attractive to founders who are not yet ready to fully retire. Even though the future growth is transferred to the heirs, the original owner can retain control over the corporation by holding a specific class of voting shares. These shares allow the founder to continue making executive decisions and managing the company’s direction while the equity growth sits with the next generation. Furthermore, the preferred shares can be structured to pay out dividends, providing the owner with a steady stream of retirement income. This ensures that the founder’s lifestyle is maintained even as the legal ownership of the company's future value shifts.
From a tax perspective, an estate freeze is an essential tool for minimizing the "tax bite" that occurs at the time of a deemed disposition. When an individual passes away, many tax jurisdictions treat their assets as if they were sold at fair market value, triggering significant capital gains taxes. By freezing the value of their shares today, the owner ensures that their terminal tax bill is based on a fixed, known quantity rather than a much larger future value. This prevents the necessity of a "fire sale" where heirs might be forced to sell the family business just to pay the tax authorities. Additionally, it allows the family to utilize multiple capital gains exemptions if the shares qualify as small business corporation shares.
Despite the significant benefits, an estate freeze requires meticulous execution and ongoing maintenance to be successful. Professional valuations establish the "frozen" value, as an incorrect valuation could lead to unintended tax penalties or the failure of the freeze in the eyes of tax authorities. It is also important to consider the timing; freezing too early might leave the founder with insufficient assets if the business underperforms, while freezing too late results in a higher tax bill. Changes in family dynamics, such as a child’s divorce or a change in career path, must also be managed through robust shareholder agreements or trust provisions. When executed correctly, however, it remains one of the most effective ways to ensure a smooth and affordable transition of a family legacy.
So when the corporation's business is advancing such that it requires the incorporation of a holding company, and are looking to undertake the associated structuring and transactional legal work to realize its commercial objectives, contact our law firm at 403-400-4092 [Alberta], 905-616-8864 [Ontario] or via email at Chris@NeufeldLegal.com.
