After an estate freeze, who should inherit the frozen shares?

From time to time, I talk about estate freezes here on this blog, as they are a very popular method of transferring a family business to the next generation of entrepreneurs. After an estate freeze, the former business owner usually owns preferred ("frozen") shares in the value of the common shares that were transferred to the new owner. So the question then becomes: who should inherit those frozen shares?

I'm attaching a link to an article from http://www.capitalmagazine.ca/ that compares the tax and business effects of leaving those frozen shares to various beneficiaries, such as a spouse, a trust, or children. Click here to read this very informative article. It's essential reading for business owners who have gone through an estate freeze or are contemplating doing so.

The attached photo is also from http://www.capitalmagazine.ca/

An estate freeze is not a mid-winter funeral

I've blogged about estate freezes before, but this article is written by a "tax guy" at Canadian Tax Resource Blog who will have a slightly different slant on the topic. In case you're the kind of person whose eyes glaze over at the very thought of reading about taxes, be assured that this article is actually readable. Click here to read it.

Small business capital gains exemption

Taxation is a big factor in any business succession plan. It's important that someone selling or otherwise transferring a business understands how the tax arising from the transaction will affect everyone involved. I've found an article by Mark Borkowski that discusses how a seller can use the lifetime capital gains deduction. Click here to read it. This is really well-explained and readable, so I suggest that any business owners who are contemplating an estate freeze or who want to know more about taxation in business succession planning should read this article.

Tax effects of estate freeze

Isn't it great when you go online looking for something and you find that exact thing? I'm always on the lookout for Canadian tax experts who can explain estate-planning concepts and solutions in a way that you and I can actually read and understand. I lose interest when tax explanations are so complicated my eyes glaze over. In any event, I've found a website by Simpson Wigle Law LLP that seems to be what I was looking for. I'm attaching their article here about the tax effects of an estate freeze, so please check it out.

How an estate freeze can help you minimize tax

Here is a good article from the Financial Post about small business owners and estate freeze. This is a really popular form of tax planning that many business owners find to be exactly what they need. Click here to read the article.

(Attached photo by Caroline Blumberg is also from that article).

Wall street journal story about estate freeze

I was interviewed recently for a story in the Wall Street Journal about using an estate freeze to hand a business on to the next generation of a family. The story appeared on Thursday; here is the link to the online edition. I believe you have to be a subscriber to read the whole article. It's entitled "Getting Personal Canada: A Cool Way to Reduce Estate Taxes". It also appeared in the print edition as far as I know.

What is an estate freeze?

An estate freeze is a way of transferring ownership of a privately held corporation, often between family members, by reorganizing the company. The freeze has two purposes. One is to transfer ownership of the company from one owner to another. The second is to limit the capital gains tax for the business owner who is transferring his or her shares to someone else. Both of these things happen at the same time.

Before the freeze, the business owner usually holds common shares of his or her business. Common shares give the share owner a stake in the profits and direction of a company. Usually a common share does not give the owner a right to receive a dividend but instead represents a share of the overall value of the company itself. As the value of the corporation grows, the value of the common share also grows. Another important feature of a common share is that it almost always gives its owner a vote in the running of the corporation.

On th day agreed on for the estate freeze, the business owner exchanges those common shares for preferred shares that have a fixed monetary value. At this point, the old owner is owed a specified sum of money for the ownership of the business. That sum of money is reprsented by the new preferred shares. The sum of money might also be secured by putting a promissory note into place in addition to the preferred shares.

The new preferred shares can either be shares of the operating business itself or can be shares of a holding company. They will never increase in value even if the common shares increase in value. The new preferred shares can be voting shares or non-voting shares, depending on what the business owner and the successor have agreed, although it would be more common for the old owner to receive non-voting shares.

The outgoing business owner is liable for capital gains tax on the increase in value of the business from the day he acquired it to the day of the freeze. The new owner is liable for the tax from the day of the freeze onward.

Business owners might discuss the possibility of an estate freeze with their estate planning lawyers, corporate lawyers and accountants. For a detailed background discussion of estate freezes, see my book "Succession Planning Kit for Canadian Business."

Business succession doesn't just mean leaving your business to your children

When we hear the phrase "succession planning", many of us think of royal princes and princesses in succession for the throne now held by their parents. So when we think of "business succession planning", many people automatically assume this means planning to pass your business down to your children.

Passing the business on to your kids is certainly an option for some people, but there are plenty of other ways of passing on your business that have nothing to do with your children. The words "business succession planning" refer to any planned way for a business owner to exit his or her business, when the business owner sells the business, retires or passes away.

If you are thinking about how you might one day sell or transfer your business to someone else, some options you might consider are:

- Selling the business to a group of managers or key employees at your business, known as a management buyout. This might involve your being paid for your shares in the business over time from the future profits of the business.

- Estate freeze, in which your business is reorganized to transfer ownership to someone else and your payment is secured by preferred shares in the business which are redeemed over time on an agreed-upon schedule. This is often done for the purpose of limiting your tax liability.

- Selling the business on the open market. You can decide whether you want to sell the whole thing as a going concern, in which you sell not only the assets of the company but the corporate shares as well. As an alternative, you could sell only the assets of the business (or some of them) and keep the shares of the business for yourself.

- Rolling your shares of a farm or fishing operation over to someone in the next generation. This doesn't have to be your child; it can be (among others) a step-child, son-in-law or daughter-in-law, grandchild or greatgrandchild. The fact that this transaction is a "rollover" means that no tax is payable at the time the farm changes hands from you to your successor, as the transaction is tax-deferred.

Deciding how to sell or transfer your business is not always an easy decision. The right choice will depend on how much time you have, the economic outlook for your business, whether or not you have an appropriate successor within your family, whether you plan to fund your retirement through the sale of the business, and many other factors. You should invest some time and energy into finding out what is available to you. Make sure you talk to an accountant and/or a lawyer before starting the transaction to make sure that you understand the tax and legal implications of what you are about to do.

My new book, called "Succession Planning Kit for Canadian Business" talks about all of these options and more in detail. I also talk about using an interim manager, developing your successor to take over, family dynamics, shareholders agreements, sources of funding and much more. I also explain how to make sure that your personal planning and your business planning work together.

The book also includes worksheets to develop your succession plan. The book is due to be available on October 1, but you can pre-order it now at Chaptersonline at http://www.chapters.indigo.ca