What is Estate Freeze? Why I have to do it?

…BIG TAX SAVINGS…

Estate planning is an essential part of wealth management.  It is particularly important for business owner to implement this strategy ahead of time.  The idea of an estate freeze for a business is driven by fixing the value of tax on death and transfer the future appreciation in value to next generation or 3rd generation, combined with remuneration strategy; the potential tax savings and deferrals could be gigantic.  An illustrate of this with an example would provide a clearer picture:

Example:

  • A company is 50/50 owned by the parents;
  • The current fair market value (“FMV”) of the business is $8.5 million;
  • The original cost is nominal;
  • It is expected the FMV will increase to $12M in 10 years; and
  • We will use the top marginal tax rate for this calculation purposes.

If Nothing is done, there will be a deemed disposition at death for the parents, resulting in personal income taxes of about $2.2 million (based on current FMV).   Furthermore, there will be additional taxes (commonly referred to as double taxation) which the company will have to pay when assets are liquidated and again when funds are distributed to the estate.   These additional taxes can be avoided by implementing a post mortem plan. 

Alternatively, if an Estate freeze was implemented and combined with redeeming the frozen shares over 15 years, the combined taxes for the parents are approximately $1.8 million, which is $400,000 less than the “Nothing is done” strategy.   The ability to transfer future growth to next generation would provide further benefits of tax deferral (i.e. another $500k+) and opportunity to split income and multiple the capital gains exemption if the shares of the corporation is qualified for the Lifetime Capital Gains Exemption.

It is common that the reasons for the parents to delay the implementation of estate freeze are (i) not in a stage to give up control or (ii) need more time to decide how their estate to be distributed amongst family members.  However, these are not good reasons for such a delay to sacrifice the opportunities for tax saving and deferral.  There are strategies in the estate freeze processes which allows the parents to maintain control of the business as well as provide flexibility to decide later how the shares of the corporation to be distributed to whom and when, but freeze the value at current fair market value to cap the taxes on death and transfer the future appreciation of next generation to maximize wealth for the family.  

This article is intended for general information purposes only and does not constitute professional advice.  Income tax law and regulation change frequently and the content on this article may no longer reflect the current state of the law. If you have any specific questions, you should consult a professional services advisor or email leo@awkcpa.com for further advice.