Corporate reorganizations can offer significant estate planning benefits
For the owners of privately-held companies, an estate freeze can serve as a highly valuable estate planning and business succession tool. When an estate freeze occurs, the current owners are transferring the future growth of the company to new recipients, most commonly children of the owners or a family trust. This action freezes the value of the current owners’ estate to the day the estate freeze takes place and therefore limits the owner’s exposure to future capital gains. This type of reorganization can also allow the company to access other family members’ lifetime capital gains exemption eligibility – $813,600 in 2015, but indexed to rise with the rate of inflation in future years.
In a typical estate freeze, the owners exchange their common shares for preferred shares that have a fixed (or frozen) value equal to the common shares exchanged. The new beneficiaries, typically the children, subscribe to a new common share for a nominal value. If properly structured, the parent will not have made a taxable disposition and no taxable benefit will have been conferred on the child, since the full present value of the corporation is represented in the preferred shares issued to the parent in the exchange.
There are several different types of estate freezes that can be used depending on the family and financial circumstance of the current owners. For example, in circumstances where there is not sufficient value in the company to provide for the owner’s full retirement needs there is the option of conducting only a partial estate freeze. This allows the current owners to still benefit from some of the future growth. There are a number of factors that need to be considered before deciding on the ideal structure of an estate freeze including:
- the parents’ life expectancy;
- lifestyle and income needs;
- the impact of expected inflation;
- the ability of the children to responsibly manage and preserve directly controlled wealth;
- whether the parents have identified which of their children are suited for taking over ownership and eventually control of the family business;
- how even-handedness in estate planning can be achieved if only one of several children is identified as the beneficiary of the freeze; and
- the ability of the company to fund orderly redemptions to finance the parents’ retirement when the time comes.
In many circumstances, the estate freeze is accompanied by the creation of a family trust. The key feature of a family trust is the power of the trustees (usually the parents, who control the family company) to appoint the capital and income of the trust to one or more beneficiaries specified by name or class. This will include an express and unfettered discretion to exclude other beneficiaries. Where the trust is constituted for the purpose of holding shares of a family corporation, it will allow the trustees to decide who among their children will receive the shares, once the children have grown up and demonstrated their interest and ability with regard to the family business. It can also be used to distribute the proceeds of the shares, should the parent decide that the shares will be sold or the corporation wound up.
Estate freezes are particularly useful for family business and aid in transferring the company to the next generation in a tax efficient manner. However, estate freezes can also be used in other circumstances such as to ease entry of key employees into partial ownership of a business, to promote loyalty and dedication, and possible succession to more full ownership in future.
In addition to the potential significant tax savings that come about from an estate freeze, the process can provide a strong incentive for the new generation to promote the success of the family corporation.
It should be noted that there are numerous technical legal and tax considerations to be weighed in the development and implementation of an estate freeze plan. These must be addressed carefully in conjunction with your lawyer and accountant.
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This article is intended to give general information only. We recommend you contact a lawyer for specific legal advice.