When assessing opportunities to exit an operating business, owners must consider their personal and economic goals and the needs, objectives and capabilities of their family members. In this context, we are focusing on private corporations, the shares of which are held by related persons. The tax implications of each possible strategy are important, not just for exiting the business but also in determining what steps should be taken in preparation for the ultimate disposition of the business.
Although it is common for owners of family businesses to opt to have a family member or family members take over the business when they retire, this option assumes or is founded upon the notion that there is such a family member (usually a child or children) who is/are both interested and capable of carrying on the business successfully. At a basic level, factors to consider for this option include whether familial disharmony will result among the successors and, if the proposed successors are unable to buyout the owner’s interest in the business, how the financial needs of the successor will be satisfied.
There are several ways of transferring a business to a child or children of the owner. The most common method is by way of what is known as an estate freeze. Using this method, the value of the business is “frozen” and new shares are issued to the child(ren), entitling them to benefit from the future growth of the business. In the process, the owner receives preferred shares on a tax-deferred basis such that the owner will not have to immediately recognize the accrued capital gain regarding his or her common shares. The freeze may be combined with the capital gains exemption if the owner has not used up his or her $500,000 allotment for this exemption.
An estate freeze can also be carried out to accomplish the same benefits by transfer of the owner’s common shares to a holding corporation and the shares of that holding corporation then, in turn, transferred to the child(ren).
Other attributes or considerations of an estate freeze include:
- Owner can retain voting control
- Owner can have an income stream by having a cumulative dividend attached to their new preferred shares
- A partial freeze is possible if the timing is such that the owner does not yet have enough retirement funds
- Children who are not currently involved in the business perhaps should receive less than 51% of the common shares or non-voting shares
- It is recommended that a shareholder’s agreement be implemented, including to stipulate share purchase rights and govern share transfers to outsiders
Thus an estate freeze allows a child to become the owner of the business without any immediate cash outlay. Any funds required to redeem the owner’s new preferred shares can be generated from the profits of the business. The estate freeze also finances the owner’s retirement in such a way that applicable taxes, usually on capital gains on their common shares, can be deferred and/or minimized.
For assistance in determining whether an estate freeze is advantageous for the estate and succession plan for your business, please contact Andrea Kelly.
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Andrea Kelly, Lawyer, has extensive experience in wills, trusts, powers of attorney and estate administration matters. She provides clients with a high standard of timely professionalism and expertise, incorporating a very thorough fact finding process. This is quite often enlightening for her clients and facilitates individually tailored services. If you would like to know more, feel free to use the easy contact form or read Andrea’s bio.