The estate freeze, without the mystique

Explainer, Ontario incorporated owners

An estate freeze is a reorganization that answers a specific problem: the shares of your company are worth something today, they will likely be worth more when you die, and the tax at death is charged on the growth. A freeze locks, or freezes, your shares at today's value, and lets the future growth land in the hands of the next generation instead. Your eventual tax bill is capped at the frozen value. Their growth starts from here.

How a freeze works, step by step

Step 1: your common shares become fixed value shares. You exchange your growth (common) shares of the corporation for new preferred shares with a fixed redemption value equal to what the company is worth today. This exchange is normally done under section 86 of the Income Tax Act, which allows it to happen without an immediate tax bill when the rules are followed.

Step 2: new growth shares are issued for a nominal amount. New common shares are subscribed for by your adult children directly, or more commonly by a family trust, for a small amount. From that day forward, growth in the company's value belongs to those new shares.

Step 3: you keep control while you want it. Freeze structures commonly give the founder voting control through the preferred shares or a separate class, so passing along future growth does not mean handing over the wheel today.

Step 4: life carries on, with new homework. Dividends on the new growth shares follow the tax on split income (TOSI) rules, which restrict income splitting with family members and need to be planned around, not discovered later. If a family trust is used, it faces a deemed disposition every 21 years, which has to be planned for well in advance. And your frozen preferred shares still carry their tax bill at your death, at the frozen value. A freeze caps the bill. It does not erase it, and many owners pair a freeze with insurance sized to that known, capped amount.

Questions worth asking before any freeze

• What is the company worth today, and who is valuing it? A freeze built on a soft valuation invites the Canada Revenue Agency to argue about it later.
• Is a price adjustment clause included, so the values can be corrected if the CRA disagrees? This is standard protection in a properly built freeze.
• Who should hold the new growth shares: children directly, or a family trust, and what does the 21 year rule mean for that choice?
• How do the TOSI income splitting rules affect dividends to family members under this structure?
• What is my frozen value, and is there a plan, usually insurance, for the tax that will still be due at my death?