Estate Freezing in Challenging Times

These are challenging times for business owners. Companies are facing uncertainty, and market values are down. While tax planning might not be your top priority right now, if you believe conditions will eventually improve, this could be an excellent opportunity to make strategic financial decisions for the future. One powerful strategy to consider is an Estate Freeze.

What is an Estate Freeze?

An estate freeze is a tax planning strategy that allows you to "lock in" the current value of your assets. Here's how it works: any future growth in your assets' value will be transferred to your family members—such as your spouse, children, or grandchildren—rather than being subject to tax in your hands.

By freezing your assets at today's value, you can achieve several important benefits:

• Predict your future tax liability and plan accordingly

• Reduce your overall tax burden over time

• Lower probate fees and other estate settlement costs

• Enable family members to use tax benefits like the Lifetime Capital Gains Exemption (LCGE)

• Create an organized plan for transferring assets to the next generation

An estate freeze can also help distribute income among family members, which may reduce your family's total tax bill. However, keep in mind that new Tax on Split Income (TOSI) rules now limit some of these benefits.

How Does an Estate Freeze Work?

Let me illustrate with a practical example:

Mrs. Jones launched her small business, JonesCo, in 2000. Today, her company is worth $2 million. If she were to sell the business, gift it to family members, or pass away, she would face significant taxes on the capital gain. In Ontario, the top tax rate on capital gains is approximately 26.76%, meaning she could owe around $535,200 in taxes.

If Mrs. Jones takes no action and her business grows to $5 million, her tax liability would jump to $1,338,000. However, with an estate freeze, she can lock in her current share value at $2 million and allow any future growth to benefit her children, significantly reducing her personal tax burden.

Understanding the Lifetime Capital Gains Exemption (LCGE) 

The LCGE is a valuable tax benefit that allows business owners to avoid paying taxes on a portion of their capital gains when selling shares in a Qualified Small Business Corporation. Currently, this exemption allows individuals to shelter $1,250,000 of capital gains from taxation.

When shares are held in a family trust, the capital gain can be distributed among family members, allowing each person to claim their own LCGE. This strategy can result in substantial tax savings across the family.

At current tax rates, the LCGE can save up to $334,500 per person on eligible capital gains.

Who Qualifies for the LCGE?

To be eligible for the LCGE, your company must meet specific criteria:

• At the time of sale: At least 90% of the business's assets must be actively used in business operations

• For the 24 months before sale: At least 50% of the assets must be used in active business

• Ownership requirement: Shares must be owned by an individual (or family trust, but not another corporation)

• Lifetime limit: Each person can only claim up to $1,250,000 over their entire lifetime

The Importance of Family Trusts

Many business owners incorporate family trusts into their estate freeze strategy. A trust can hold business shares on behalf of children or other family members, enabling income to be distributed among them and potentially taxed at lower rates. However, be aware that Tax on Split Income (TOSI) rules may apply and could limit these advantages.

What Happens If Business Values Decline?

Sometimes after implementing an estate freeze, business values may drop below the frozen amount. This situation could leave you with an unnecessarily high tax liability. Fortunately, you can implement a re-freeze to adjust the locked-in value to the lower current amount, reducing your future tax obligations.

The Canada Revenue Agency (CRA) generally permits this strategy without additional tax consequences, provided the decline in value results from normal business conditions rather than intentional asset removal.

Why Now is an Ideal Time for an Estate Freeze

Current economic challenges have depressed many business valuations. As economic conditions improve—which they historically do—business values will likely recover and grow. This timing creates an exceptional opportunity to lock in lower values and maximize future tax savings.

I recall one of the most successful estate freezes I ever witnessed occurred in 1976 for a Quebec business. The freeze was implemented immediately the Parti Quebecois came to power. The company involved was an Anglophone company whose largest customer, by far, was the Quebec Government. As conditions improved and the business flourished, that freeze ultimately saved the owner substantial tax costs.

Moving Forward

If you own a business, current market conditions may present the ideal time to consider implementing an estate freeze or re-freeze. I would be pleased to collaborate with your financial advisors to explore the options available to you and determine the best strategy for your specific situation.

As always, I would be happy to work with you are your other advisors to ensure that you take advantage of all legitimate tax saving opportunities.

--Chuck