Financial Post – The warm and fuzzy feeling of an estate freeze



David A. Altro was recently interviewed by Drew Hasselback for an article which appeared in the Financial Post section of the National Post. In the article, Drew asks David about the benefits of an estate freeze for family owned businesses, and what special considerations may be required when owners of a Canadian company, or those who will inherit it, are American. The article can be found below or at this link.

The warm and fuzzy feeling of an estate freeze

Drew Hasselback
Financial Post
March 24, 2014


Spring officially arrived on Thursday, and not a moment too soon for many of us fed up with a long, exceptionally cold winter.

Yet at least when it comes to estate planning and your business, don’t fear the freeze.

I’m thinking about a potentially tax-saving move called an estate freeze. This is a technique in which a company reorganizes itself in a way that “freezes” or locks down a company’s value, thereby minimizing the capital gains taxes that would be payable on the founder’s death. This is something successful entrepreneurs might wish to consider, particularly if they want to pass the business to their children without triggering a boatload of tax liabilities.

Some entrepreneurs are reluctant to consider an estate freeze. The concept requires a reorganization, and they worry this will lead to a shake up in which they might loose control of the company. That shouldn’t be a problem if the freeze is correctly put in place.

“Where people have companies, sometimes it’s appropriate to freeze the exposure to the accrued capital gains,” says David Altro of Altro Levy LLP, a firm that specializes in tax law. “It’s very effective.”

An estate freeze isn’t perfect for every estate. It might not fit cases where the adult children want to have an active, decision-making role in the business. They’re probably not needed in situations where the family owners aren’t keeping a lot of capital in the business, and therefore not piling up capital gains.

There are also some red flags. Be very careful if you have any sort of cross-border scenario, such as a situation in which a business founder or a prospective heir is a U.S. resident for tax purposes. You also have to watch that the reorganization doesn’t involve a transfer of property to a non-arms length individual, such as your spouse or another close family member.

Point is, this isn’t something you can pull off on your own by downloading a couple of forms from the Internet. You need to talk to a lawyer or an accountant to make sure you don’t walk into a tax trap.

The first thing you need is a shareholders agreement. Regular readers will know that I think these are a must for any business — including those in which the owners and founders are convinced they all get along fine. The agreement is basically a rulebook for shareholders. It defines the rights and powers that flow with each class of shares, and it sets out the conditions that allow those shares to be sold or transferred.

Before getting into the mechanics of the freeze, Mr. Altro tells me he will determine whether it’s possible to whittle down the value of the company before the reorganization. The freeze will lock in whatever gain has accrued since the company was founded, so the point is to see whether it’s possible to reduce that number. He looks to see whether it’s possible for the company founder to take capital out of the business by way of a “redemption.” Those capital withdrawals are taxable, but at the same rate as dividends.

Now for the actual freeze. In the reorganization, the company issues two types of shares: common and preferred. The company founder swaps his or her original shares in the corporation for a class of preference shares that grant the shareholder voting control and the right to receive dividends or redemptions. That’s how the founder keeps control over the company.

The new common shares issued in the organization have no current value. These go to a trust that is set up with the eventual heirs as beneficiaries.

Now for the magic of the estate freeze. Assuming your company grows in value after the freeze — and one certainly hopes it does — the growth attaches to those common shares that are in that trust. On your death (and sorry — even the cleverest lawyer can’t get you out of that one), your estate will be liable only for the capital gains tax that was locked down on the date of the freeze. Your heirs, meanwhile, won’t be liable for any capital gains tax on their stake until they sell or transfer their holdings.

Tax deferred is tax saved. And doesn’t that warm your heart?