Effective Estate Planning: Estate Freezes

At Kutner Law LLP we try to provide useful information on a variety of topics including estate planning. In this blog entry we are going to discuss a useful estate planning tool called an estate freeze. We have found that estate freezes are useful for many of our dentist, doctor and small business clients.

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What is an estate freeze?

An estate freeze involves the reorganization of your property (including shares of your professional corporation) in order that the value of your interest in the property/shares is frozen as of the date of the reorganization and the appreciation is passed on to your family members.

Let’s take for example a dentist who has shares in a Dentistry Professional Corporation (“DPC”). As of the date of reorganization for example, the value of the DPC is $1,000,000.00. To effect the estate freeze the dentist would exchange his common shares for new preferred shares that are frozen in value (this is done on a tax exempt basis on the date of the exchange). These preferred shares don’t appreciate in value and will always be worth the original $1,000,000.00. The second step is that on the date of the reorganization common shares in the DPC are issued to family members with the intent that future growth will accrue to the family members rather than to the professional. The growth in the DPC will accrue to the common shares which would be owned by the family members.

You could also use an estate freeze if you own property. For example, let’s say you have an investment property worth $1,000,000.00 and you feel that the property will appreciate in the future. Your first step would be to incorporate a holding company (“Holdco”). Next you would transfer the property into Holdco in exchange for preferred shares worth $1,000,000.00. The value of the preferred shares will never exceed the $1,000,000.00. Like the example with the DPC, common shares of Holdco will be issued to your children and/or spouse and the growth of Holdco will accrue to the common shares benefitting your family members.Why should you freeze your assets?

Tax Deferral

The main benefit to an estate freeze is to pass the tax liability on the assets to your family members. The value of the common shares that are held by your family members will not be subject to taxes at the time of your death. You should note that the tax is not eliminated but is only deferred until your children dispose of the common shares. Your tax will be limited to the value of the frozen shares.

Capital Gains Exemption

Another advantage is multiplying the capital gains exemption among several family members – this would apply to the example of the DPC but not to the holdco (the capital gains exemption only applies to an active company and not to a passive holding company). If the preferred shares are sold during your lifetime or at death you will be taxed only on the gain realized on the preferred shares. The growth interest attaching to the common shares will be taxed to your family members who hold the common shares when the family members dispose of the common shares. If the corporation qualifies as a Qualified Small Business Corporation (such as your DPC), each of your family members may also be able to use the $800,000.00 capital gain exemption.

What are the negatives of Estate Freezes?

By doing an estate freeze you give up the growth to your family members. The preferred shares that you retain will, most likely, be multi voting shares to ensure that you continue to control the property/shares – in the case of a freeze of your DPC, voting control is less of a problem as only the professional can own voting shares. However, once you issue common shares to family members it is very difficult to get them back in the event of a family dispute, death of the family member, etc.

Summary

In summary there may be many instances where an estate freeze will become part of your overall estate planning. However, it is complicated and must be done properly in order to avoid adverse tax or family dispute consequences. We would strongly recommend that you discuss all of the positive and negative aspects of an estate freeze with your accountant and lawyer. It can be a beneficial estate planning tool that should be considered in the appropriate circumstances.

If you have any questions please do not hesitate to contact us.