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How an estate freeze can help you maintain control of your investments

In the midst of the COVID-19 pandemic, many things are currently outside of your control. If you’re a business owner, or have substantial investment assets, you might feel especially challenged by the current market conditions. Yet, while you can’t control what’s happening in the markets, there are tax-planning tools that can still give you some control over your financial well-being. Specifically, an estate freeze can help you take advantage of current market conditions while providing you with some financial security and greater certainty in the future.

Estate freezes establish fixed value

An estate freeze is a tool that lets you “freeze” the value of your investments for tax purposes. The main benefit of an estate freeze comes from allowing you to cap the value of the estate taxes associated with your investments when you eventually pass away. On the date of death, you are deemed to have disposed of all your assets, including your investments, at their fair market value. However, if you own these investments through a corporation, you can freeze their value at today’s market prices using an estate freeze. This provides you and your family with greater financial certainty as you can more accurately estimate, and plan for, the amount of taxes that will be owing at death.

While there are different ways to accomplish this goal, in broad terms, an estate freeze involves transferring your investments into a corporation, or exchanging the shares in your already-existing corporation which owns your investments, for new fixed-value preferred shares. These new shares would not increase in value as the markets recover, thereby locking in the taxable value of your investment at that lower value.

To illustrate the potential tax savings of this strategy, let’s say you, or a company that you own, has investments that were worth $5 million in the market a month ago. Today, you hold the same investments but they’re worth around $3.5 million. An estate freeze could capture this value in a set of preferred shares now worth $3.5 million. In certain circumstances, this could result in a reduction of estate taxes of over $400,000.

If you already own fixed-value preferred shares in your company, you can still take advantage of the reduced value of your underlying investments and lower your future tax bill through what is commonly referred to as a “thaw and re-freeze” strategy. This would essentially involve reversing the existing $5 million freeze (using the example above) and issuing new fixed-value preferred shares at today’s lower value of $3.5 million, again reducing your future estate taxes by over $400,000.

It might seem counter-intuitive, but it’s a strategy that recognizes the current economic downturn as a reality. By choosing this approach, you’re adjusting the value of your investment to reflect that reality, while enabling your tax liability to match the new—and more accurate—value of your investments.

Family trusts provide additional flexibility

An essential part of your estate freeze tax planning is maximizing your future flexibility as it relates to a market recovery. Creating a family trust in conjunction with a well-planned estate freeze can give you both control and flexibility, even though you’ve capped your estate tax liability. If, in the future, you find that you need more personal income than you currently have access to through your new preferred shares, the use of the family trust affords you the flexibility and control to make adjustments accordingly.

We’ve previously written about how family trusts remain an important tax planning tool despite changes to the tax on split income (TOSI) rules. Although TOSI implemented limits on income splitting, there are still multiple tax and non-tax advantages to using a trust.

Together, the estate freeze and family trust can help you manage the current economic headwinds. As no two businesses are the same, it’s important to properly plan and implement your estate freeze, based on market conditions and on your objectives. It’s also imperative to structure your family trust so it complements your future goals and objectives, and considers any other tax rules that might apply. Your Grant Thornton advisor can help you set and meet those objectives.

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