An estate freeze is a tax planning technique used to limit the taxes payable on death by the estate.
On death, there is a deemed disposition of capital property, such as shares held in a private corporation. What this means is that any increase in the value of the shares since they were acquired by the deceased is subject to tax on the capital gain (generally 1/2 of the capital gain is included as taxable income). In the case of a private corporation, this increase could be close to the fair market value of the shares.
An estate freeze is a transaction carried out by the owner of a business to freeze the value of his or her shares. This freezes the tax liability arising on death. Any increase in the value of the corporation from the date of the freeze will accrue in shares held by other individuals, typically the freezor's children.
In general, the following are the main elements of an estate freeze:
- the owner of the business ("Freezor") transfers their common shares to the corporation in exchange for freeze shares;
- common shares are issued to others, generally the Freezor's children;
- the freeze shares generally include the following rights:
- redemption and/or retraction rights - where the freeze shares can be exchanged for proceeds equal to their fair market value; and
- a maximum dividend, generally calculated as an annual percentage of teh fair value of the freeze shares; and
- as the freeze shares do not share the corporation's profits or to share in the property of the corporation upon dissolution, their fair market value does not increase along with the corporation's - any future increase in the value of the corporation flows to the common shares.
The estate freeze is a complex legal restructuring that is specific to the particular circumstances. For instance, it can also include a holding company or family trust. An estate freeze should always be carried out by a lawyer and accounting.