Compare an estate tax freeze to a gifting strategy…an estate freeze is a legal estate-planning technique used in Canada to lock in the current value (and tax liability) of a capital property for one person, while attributing the value of future growth of that capital property to another person…its a trust.
My Q is- when & how does the tax occur on the estate tax freeze? We freeze our estate, & gift shares of the newly made LLC to kids, correct? And we pay taxes ont he gains of those shares?
Just trying to kind of create a real-world scenario to help me remember. We have a large estate, we want to freeze its growth & pass the remaining growth to our kids. Makes sense. But again what exactly do we do other than create an LLC & gift shares, and how does the tax work on that?
If you expect that the gift exceeds tax exempt gift limits, the long winded/complicated “estate tax freeze” strategy is worth the while
Estate freeze =freezes tax when the company has low valuations (t=0) currently and is expecting a super growth over a generation’s time; the goal is to transfer the potential high-value asset with out incurring tax over its appreciation
t=0; Incorporate LLC; Create preferred, voting and common non-voting shares. 100% company is controlled by preferred. The common shares are worth nominal or minimal at this time. Gift these shares to kids
t=T; Company’s value multiplies in the past 30 years. Parents/preferred/voting shares have deceased or can no longer control; convert the common/non-voting to preferred/voting at NO TAX event
Ownership is passed; no/little tax paid
Gifting, however has an allowance per annum/ per lifetime/per kid etc. Beyond which it is taxed progressively.
An estate tax freeze transfers the growth of an asset to the future generation. Here’s a real world example:
I own 100% of XYZ co., a private business that is currently valued at $5m and the cost base on my shares is zero. Consequently, I have a $5m unrealized capital gain. If I assume my company will grow at 5%/yr for the next 20 years (the time of my death), my shares will be worth $13,266,488.
Let’s assume I’m a single parent. At the time of my death, Canada’s tax regime will deem me to have sold all my assets at FMV - thereby triggering the unrealized gain on my XYZ shares, which is now $13,266,488. Assuming 25% tax, my child will receive $9,949,866.
Now instead, I enact an estate freeze today. I convert my common shares ($5m) to fixed value voting preferred shares that will not grow in value. I then issue new non-voting common shares to a discretionary trust, of which I am the trustee and my child is the beneficiary. All the future growth of XYZ co. will accumulate to the new common shares. In 20 years when I die, I will be taxed on my $5m preferred shares, leaving $3,750,000 after-tax to my child. The child will also be the owner of the common shares in the trust, which are now valued at $8,266,488. In total the child receives $12,016,488 – an increase of ~$2m.
Ultimately my child will pay tax on the common shares in the trust when he/she disposes of them. The result is a significant tax deferral and a capping of my own estate tax. Moreover there are strategies that I could employ to redeem my $5m preferred shares over my lifetime, reducing the estate tax further. But that is a story for another day.
Estate freeze is to let your next generation decide what they want to do with the tax the may be imposed on the extra value that may be accumulated in the future.
For the part that is already accumulated, there is no way to avoid tax upon death.