BMO Nesbitt Burns
First Canadian Place
100 King St. W, 38th Floor
Many Canadians are concerned about their financial security in retirement and preserving the value of their estates for the next generation. It’s a common and understandable situation.
What’s surprising is that so few have taken the time to create an estate plan that can help organize their assets, minimize taxes and pass along their estate in the manner they intend.
The predictable result: excess tax can be paid on retirement assets. When the time comes to settle the estate the value may be substantially diminished. Many people simply have not made estate Preservation a priority.
Just getting started is often the most difficult step you’ll take. Once you’ve made the commitment to get started, you’ll find it’s far easier than you think. Please consider the following questions.
With proper planning you can ensure that your estate is managed according to your objectives. We will help you to develop answers to these questions - answers which will result in a plan for now and the future.
The following requirements must all be satisfied in order to be considered qualifying small business corporation shares and qualify for the $750,000 capital gains deduction.
There are also tests which must be met at various times concerning the value of the assets of the corporation that are used in the active business. For example:
The Capital Gains Deduction provides Canadian small business owners with an opportunity to shelter up to $750,000 of capital gains on the sale of shares of a qualifying small business corporation. The potential tax savings from accessing this deduction represents one of the most compelling tax planning opportunities for Canadian small business owners.
Entrepreneurs who have built successful companies often want to see their business passed on effectively to the next generation. However, a sale or transfer of ownership of the business will generally trigger capital gains tax. If the value of the shares of your business has increased, you or your estate may be burdened with a substantial tax bill. The business may even have to be sold to cover the liability.
A potential strategy used to transfer wealth or implement a succession plan and to manage the tax liabilities on a transfer is to freeze the value
of your shares during your lifetime. An "estate freeze” allows you to fix the value of all or part of the capital gains accrued to date on the shares of your business. The future growth in the business is transferred to the eventual owners, typically your children. A depressed value of your business resulting from the current economic slowdown may make this an opportune time to consider a freeze.
By limiting the tax liability on an appreciating asset in this way, your estate may avoid facing a potentially higher tax liability in the future, upon your death. Your estate’s tax liability can be limited to the fixed present value of your ‘freeze’ shares, and any future capital gains can be taxed in the hands of the new owners. Sufficient life insurance could then be obtained to cover your fixed death tax liability.
If your business is a Qualified Small Business Corporation (QSBC), an estate freeze may allow you to take advantage now of the $750,000 lifetime capital gains exemption for QSBC shares. Any future growth in the value of the shares can be divided among members of your family, increasing the number of potentially available QSBC exemptions.
There are a number of ways to accomplish a freeze, but the most common is for the owner of the small business corporation to reorganize the share structure of the existing company.
Step 1: You exchange your existing common shares in the business for voting, redeemable, retractable preferred shares of the same value. This exchange can typically be completed on a tax-deferred basis or alternatively a capital gain can be realized to use any remaining capital gains exemption on qualifying QSBC shares.
Step 2: Create a new class of common shares, to be purchased for a nominal amount by your children (or a family trust for their benefit). A trust might be used to hold the growth shares to provide flexibility and control – particularly when children are young or when direct ownership is otherwise undesirable.
The future growth in the business will accrue to the new common shares. Future capital gains tax liability will be deferred until these holders of the new common shares sell or otherwise dispose of their shares.
An estate freeze can encompass the flexibility desired to meet your particular needs. Because you receive preferred shares with voting rights, you can effectively retain control of your business. The preferred shares generally have a stated dividend rate to help provide retirement income and you can redeem the shares over time for additional income. If you also want to participate in some of your company’s future growth, you might choose to retain some of the new common shares for yourself.
The suitability of an estate freeze will depend on a number of factors, including the anticipated future health of your company, your financial position and long-term objectives. If the value of your business isn’t likely to increase significantly after the freeze, or if you will need cash and are planning to sell the business shortly afterwards, then an estate freeze may not be appropriate. Some business owners have regretted freezing their business too early in their lifetime.
You should also consider the costs associated with a freeze, such as valuation costs, accounting and legal fees and the expense of setting up and maintaining a trust. Careful assessment of your financial and lifestyle objectives, current net worth and cash needs, growth potential of your assets and your future financial needs can help determine whether an estate freeze would be beneficial in your situation.Because of the complexity of the relevant tax rules and the need to avoid any unforeseen tax pitfalls in implementing an estate freeze (such as income attribution or alternative minimum tax), professional tax advice (as well as legal and estate planning advice) in the design and implementation of an estate freeze will be required.