Case Study

Spouses Keith and Janet had built up the retail business they founded with disciplined entrepreneurship to the point where the company and personal investments were valuable. The couple was fully satisfied with their lifestyle, and they were getting to the point where they found themselves increasingly contemplating the legacy they would bestow on their children and the community that had been so good to them.

When they brought their thoughts to the attention of their financial planner, he explained the rationale and the mechanics and then the benefits of an estate freeze.

An estate freeze is a practical and relatively simple way for a business owner to predict the tax ultimately due on his or her death, minimize that tax, and achieve various other personal goals for the benefit of survivors and beneficiaries. Any business or investment portfolio that has accumulated significant value can benefit from a full or partial estate freeze. You don't have to wait until retirement is being contemplated to entertain the idea.

In the business environment, an estate freeze is accomplished by having common shares held by the owner exchanged for preferred shares. The value of the preferred shares is fixed at the fair value of the common shares for which they were exchanged. The adult children or other beneficiaries subscribe for new common shares at a nominal amount. (Note that even though the subscription price of the new common shares can be just a nominal amount, it does not confer a benefit on the new shareholders because all the value of the corporation is held at the time in the preferred shares.)

Future increases in the value of the business accrue to the new common shares, which is why they are often referred to as "growth shares." Because the value of the preferred shares never increases, the parents' value is "frozen." With a correct designation of values by the chartered accountant, capital gains taxes may now be deferred for many years, or even for decades.

An estate freeze is also effective for fixing the value of an investment portfolio. The mechanics are much the same as freezing the value of a business. The investor and his children or other beneficiaries incorporate a company, with the parent transferring his investments into the corporation, taking back preferred shares, which will have a value equal to those investments. The children subscribe for common shares at a nominal amount, to which future growth in the value of the portfolio will accrue. Again, capital gains taxes may be deferred for a very long time.

With this large asset value now fixed, the couple's chartered accountant could now estimate the tax ultimately due on their death. Don't underestimate the value of the advance determination of that final tax amount -- it permits your affairs to be structured for eventual payment. And since it's not often that even the best planning can make tax completely "go away," part of the estate freeze plan may be to seek the advice and assistance of an insurance expert.

One of the important, and often overlooked, purposes of an insurance program is to determine a sufficient amount with which to pay the tax due on the parents' ultimate death.
But the exercise of predictability and deferral of capital gains taxes may be only one of the benefits determined during sessions with a professional adviser. Significant cash and legal protections are available by including family trust provisions in the freeze transaction.

A family trust is a method of managing a family's assets and incomes. It is created for tax, legal, and estate planning purposes, usually by a senior family member. The settlor may be a trustee and/or a beneficiary, depending on the purpose of the trust. But unlike the situations described above, instead of the children subscribing for the new common shares of the corporation at the time of the freeze, the common shares are purchased by the family trust.

The parents are still able to direct the trust to pay them as they require through their preferred shares, which they hold directly.

The family trust is tax-efficient because of its infinitely variable income-allocation ability. It is also flexible in that the annual income generated by the business or investment portfolio may be directed to one or more of the beneficiaries on an as-required basis.

The ratio of the total payout to the beneficiaries can be varied from year to year. As an additional advantage, funds paid to the beneficiaries can often be targeted to the type of income allocated.

All of this has significant implications for after-tax income - and really, it is only after-tax amounts that really count.

Death and taxes are a certainty. Just as certain is that planning can minimize the pain.

"When we first began, he thought he was going to be getting primarily income tax and wealth transfer tax advice," said Peter. "Which, of course he did, along with advice and assistance in a great many other areas. But, over the years, he began to call and ask questions about things that he was thinking of doing in the business, to ask 'How will this impact my plan? What do you think of this?' He came to see our relationship as so much more than just taxes.

Random Stuff

Money fast facts

People tip more on sunny days than they do on dreary days.

A person who drives 10 miles to buy a lottery ticket is 3 times more likely to be killed in a car accident while driving to buy the ticket... than he is to win the jackpot.

Fresh, crisp, clean bills are considered much more valuable than those which are old, wrinkled and dirty.

How long do bills last? A $1 bill or a $10 bill last for an average of eighteen months. Five dollar bills last around fifteen months, and twenties kick around for two years. The larger denomination bills can last up to eight years!

Good thing that the average coin lasts for 25 years, since new pennies cost over 1.67 cents each to make.

If your plan is to build a house, your need a blueprint and materials. The same is true for your financial plan.

Your blueprint is where you want to be in five or ten or twenty years from now. Will you be working or retired, living in the same house or somewhere else? Will your children be going to college? Will you own a different car, or a new boat? What kind of lifestyle do you want to lead? Although sometimes difficult, projecting into the future is stimulating. Visualize your goals if you want to reach them.

And feel free to call if you want more info on this month's topic or any planning or investment issue.

Share Freeze

It's no secret that financial markets are at record low levels and the economy is at a virtual standstill, while the value of many investment portfolios and operating businesses have dropped significantly. As a result, now could be the ideal time for private companies to consider an estate freeze.

An estate freeze is a tax-planning technique used to defer taxes by transferring growing wealth in private company shares from the current generation to a future generation.

In order to do that, the business owner caps or freezes the value of their interest in the company at the current value and allows all future growth to accrue for the benefit of future generations. Even if you take the economic crisis out of the equation, freezing in and of itself is a great idea, particularly if your wealth is already such that you will live comfortably for the rest of your life and you plan to give anything else you might accumulate to the next generation on your death.

Proper planning means the taxes on that growth will only be triggered if and when your children die or sell the business.