Estate Freeze

Peter R Welsh Law Estate FreezeWhat is an Estate Freeze? In short, it is a technique to limit and defer capital gains tax on a shareholder. As we know, upon the sale of shares of a corporation giving rise to a capital gain ( which is the difference between the acquisition cost or the “Adjusted Cost Base” and the selling price), one half of the difference is added to the other income of the seller in the year of sale (there are some income tax provisions which soften the capital gains tax exposure, but for the purposes of this brief introduction, we are ignoring those alternatives).

Upon the death of a shareholder, there is a deemed disposition (or sale) of shares and the capital gains is then calculated and included in the terminal year income tax return of the deceased shareholder. It is advantageous to a shareholder to defer or delay the calculation and payment of that capital gains tax or, better still, to limit its potential growth.

Accordingly, an Estate Freeze is frequently employed in family-owned businesses where the expectation is that the children or grandchildren will continue to operate and receive the benefits of the family business into the future. In those circumstances, it is advantageous for the aging shareholders of a family business to “cap” their capital gains tax exposure and transfer the “growth” shares (which usually means the common shares) to the children or grandchildren. With an Estate Freeze the patriarch limits his capital gains exposure as the company grows before his death.

The usual technique is either the creation of a holding company into which the patriarch transfers his common shares (which continue to grow in value over time) and receives in return preferred shares in the holding company (which do not grow in value over time) or alternatively to convert the common shares the patriarch owns in the operating company into preferred shares in the operating company.

Of course, with the transfer out of the common shares also goes the voting control of the company. In most instances the partriarch wishes to retain control over the company rather than have the children or grandchildren achieve that control simply as the result of the patriarch’s desire to benefit his progeny. In that circumstance, a “control block” of voting shares is frequently provided to the patriarch at the time of the conversion. There are some pluses and minuses: if the control block is held by the patriarch who suffers geriatric issues, the company’s operations may be impeded. On the other hand, the use of a control block retained by the patriarch allows for more effective and broader distribution of common shares to younger children, without concern for reckless decision making.

An Estate Freeze can significantly contribute to the beneficiaries of the patriarch’s initiatives, the desire to perpetuate the family business and to defer or delay or even reduce the obligations for taxes.

We would be pleased to assist you in your consideration of an Estate Freeze. The income tax advantages are significant and as referenced above, there are several other considerations which should be addressed. Please let us know if we can be of any assistance.

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