The estate freeze solution is the preferred strategy for transitioning a business to your children due to its tax efficiency and the ability for you as a business owner to maintain control.
How it works
Let’s say you own a business that’s worth $5,000,000. That $5,000,000 of value will be reflected in the value of your common shares. To do an estate freeze, all you do is exchange your common shares for new preferred shares that are worth the same amount – $5,000,000 on a tax-free basis. Afterward, your children then subscribe for new common shares and there you have it, you’ve just completed an estate freeze.
So what are the benefits?
- Your kids are able to become owners of the business without going 5 million dollars into debt
- They are motivated to grow the business because your preferred shares are frozen at a value of five million. Any future growth will increase the value of the common shares, thus incentivizing your children to grow the business.
- If the business were to be sold in the future, by having your children as owners, they’ll be able to use their capital gains exemption to shelter tax.
- The preferred shares you receive upon freezing your corporation can be created in such a way that you maintain voting control of the business for as long as you own some preferred shares. In the event your successors aren’t running the business properly, you’re able to step back in and take back control.
- From a retirement perspective, your preferred shares could serve as a retirement income. By gradually redeeming your five million dollars worth of shares from the corporation that’s enough for you to pay yourself $200,000/year for the next 25 years. Now keep in mind, the corporation would be making these payments so making sure the corporation continues to be profitable is crucial.
- As your preferred shares slowly get redeemed, your estate tax bill shrinks. Let’s say you only pay yourself $100,000/year over the next 25 years, and let’s also assume your shares have an ACB of zero, which essentially means the full five million is taxable. By reducing your preferred shares from $5 million to $2.5 million you’ve cut your estate taxes in two.
- Lastly, you can be very creative, and instead of having your children subscribe for new common shares, you could have your family trust as the new business owner
No strategy is a perfect strategy so an estate freeze comes with it’s own sets of issues for you to consider.
- Will your children love the fact you’re potentially maintaining control until you pass away?
- Will your children be motivated to run the business to its full potential if they never had to put any skin in the game?
- If you need the business to provide you with a retirement income, how confident are you in your successor’s ability to provide this for you? There may not be enough cash flow on an annual basis to provide for you, the business, and your child’s personal needs.
- And of course, we can’t forget about divorce and separations. If your children get divorced, now your company is potentially in the crosshairs.
An estate freeze works great if you’re looking for a tax-efficient way of getting the next generation involved.
It has many tax advantages, but like any strategy, make sure you weigh the pros and cons with your team of professionals before moving forward.