An estate freeze—exchanging the value of your business interests at their current value for property having a static value—is a method of passing along future growth to others while maintaining some control (ideal if you want to keep a hand in a new business strategy) and reduce your tax burden.
It usually takes place when an owner recognizes he or she will have kids or other relatives take over the business. A freeze is particularly attractive if it’s clear a business will keep growing.
Take the example of a family manufacturing business worth $10 million. The two adult children can’t afford to buy out their parents, so the parents perform an estate freeze. The parents receive preferred shares worth $10 million and new common shares are issued to children for a nominal amount, say $100, in a 50-50 split. From that point on the two children participate in the growth of the business and use its profits to pay their parents back over time.
Entitlement to future growth then passes to holders of new shares issued as part of the estate freeze. These shares have low value initially because the corporation’s entire value is reflected in the freeze shares that are owned by the parents. But the move lets new people become partners in the corporation at a minimal cost.
For the parents, the corporation’s tax bill is frozen at the value of the preferred shares at the time of sale. So the parents only pay tax on that sum, regardless of how much growth the new owners (their kids) coax out of the business.
This article was originally published on capitalmagazine.ca.