Your business may be increasing in value, and you may be thinking of transferring some of that value to your kids or other family members. This will allow you to minimize taxes when you sell your business or upon your death (since there’s a deemed sale of all your assets upon death at fair market value and tax on the resulting capital gain).
Tax practitioners use a transaction coined the “Estate freeze” to make this happen. We demonstrate this using a simple example.
Case Study
Suppose Leah is the owner of Leah’s Cookies a successful company that makes one of the tastiest cookies in Canada. Currently, Leah owns all the shares of the company. Leah has two ambitious adult children – Sam and Rachael – who are serious about taking over the business one day. Sam is in finance and Rachael is in marketing and want to take the expertise they developed in Bay Street Toronto to grow the family business.
The business is valued at $1 million today but expected to triple in value to $3 million in the next 5 years with Sam and Rachel’s help since they are expert business professionals. So, Leah is eager to implement an Estate Freeze to transfer the future growth in value to Sam and Rachael. However, Leah would still like to maintain voting control.
With the help of tax experts from LRK Tax, Leah exchanges her shares for fixed-value preferred shares worth $1 million, and another class of voting but non-participating shares. Sam and Rachel each subscribe for common shares. This is done tax-free! Note that there would normally be taxes but with a series of careful tax steps, LRK Tax was able to implement the Estate Freeze tax-free.
What are the Benefits?
Leah can save almost $1 Million in Taxes!
| Explanation of Taxes Saved | Taxes Saved |
| Leah can save taxes upon death. Instead of paying taxes on, say, $3M of value, the value of her shares is frozen at $1M. By the time she passes away, the value would be much lower because the corporation would redeem her shares over time to pay her “dividends.” | $500,000 |
| Since Leah’s value is frozen at $1M (instead of, say, $3M), Leah’s probate tax would be reduced. “Probate fees” or ‘probate tax’ must be paid to the government of Ontario when an estate is probated (certified) by the courts. Probate fees are: 1.5% of the value of estate assets over $50,000. | $30,000 |
| An eligible individual is entitled to a cumulative lifetime capital gains exemption (LCGE) on the sale of small business shares up to a value of approx. $900,000 (in 2022). On the future sale of the business, Leah can multiply the capital gains exemption. Suppose the business got sold for $3,000,000 by Sam and Rachael also use their lifetime capital gains exemption, Lean can realize $450,000 of permanent tax savings. | $450,000 |
| Total Tax Savings | $980,000 |
What if you don’t want to give up ownership?
If you have young children, you may not want to give us Ownership until they are mature and ready to handle it. If you’re in this situation, you can still go ahead with an Estate Freeze by using a discretionary family trust to hold the “growth” shares. If your kids never become ready, you can essentially wind up the structure and return to the status quo without tax consequences. The method of using a discretionary trust is referred to as a “flexible freeze.”
If You Need Help Give us a Shout
We do this type of tax planning – along with many others – almost daily, so we know all the ins and outs of implementing a structure while giving you peace of mind. Feel free to give us a shout!
