RRIFs - How they Work and Tax Planning

By the end of the year in which you turn 71, you are required to terminate your RRSP. You have three viable options at that point.

1. You can transfer your RRSP savings into a Registered Retirement Income Fund (“RRIF”).
2. You can transfer your funds into an annuity.
3. You can blend the RRIF and annuity option.

There is a fourth option, which is to withdraw the full value of your RRSP; however, unless you have a very small RRSP, this option is a non-starter.

Today, I am going to discuss the RRIF option. I will likely write about annuities at some point in the future. Many investment advisors suggest that you consider using some portion of your RRSP to purchase an annuity to provide a fixed stream of income in retirement, especially if you don’t have a company pension upon retirement. Rob Carrick wrote this article last week on how you can use annuities in your retirement.

The RRIF Rules

RRIFs are subject to an annual minimum withdrawal, which commences the year after you open your RRIF account. The minimum withdrawal amounts are based on a percentage of the value of your RRIF. The standard percentages are noted below.

Age*	RRIFs established after 1992	Age*	RRIFs established after 1992
71	7.38%	83	9.58%
72	7.48%	84	9.93%
73	7.59%	85	10.33%
74	7.71%	86	10.79%
75	7.85%	87	11.33%
76	7.99%	88	11.96%
77	8.15%	89	12.71%
78	8.33%	90	13.62%
79	8.53%	91	14.73%
80	8.75%	92	16.12%
81	8.99%	93	17.92%
82	9.27%	94 or older	20.00%
* On January 1 of the year for which the minimum amount is being calculated.

 

The minimum withdrawal rates may force you to withdraw more funds than you need to live and push you into a higher income tax bracket. Fortunately, you can elect to have the withdrawal minimums based on the age of a younger spouse or common-law partner. This election cannot be changed once you select the spousal age option.

If you have a spouse under the age of 71 the minimum percentage is calculated as 1 divided by (90 minus your spouse's age). As per this article by Preet Banerjee, if your spouse is only 50, you would only have to withdraw 2.5% [1/(90-50)].

The website RetirementAdvisor.ca has this excellent RRIF calculator to help you determine your minimum withdrawal rates and whether you should use your age or your spouses. 

Income Tax Planning for RRSPs & RRIFs before Age 71

It may make sense to withdraw funds from your RRSP before you convert it to a RRIF at age 71. You would do this only where your marginal income tax rate will be lower in the years between retirement and when you convert your RRIF at age 71. For example, assume you will have $40,000 of pension and investment income when you retire at age 65. At this level of income, the next $4,000 you earn will be taxed at approximately 24% and the following $27,000 will be taxed at 31%. Thus, you may want to cash in $4,000 and possibly more, since when you must withdraw funds from your RRIF at age 72, you will at minimum be taxed at 31% and possibly higher (depending upon your minimum RRIF withdrawal and your ability to pension split with your spouse).

You also want to manage your total net income so that you will not have to pay back your old age security. The 2014 clawback threshold starts at $71,592 with your OAS being completely clawed-back once your total net income reaches $115,716.

To some, the above may seem simplistic and fairly standard advice. In fact, I was taken to task by a reader for similar advice during my 6 part series on retirement. The reader commented that they "have seen very few models that give a detailed picture of how to manage the drawdown of your RRSP and take into account the minimum RRIF withdrawals". As I like a challenge, I actually attempted to create such a model. Alas, after a couple hours and a brief discussion with Michael James who is a math whiz, I realized this is a herculean task, in which I have little interest in attempting to conquer. Thus, I suggest the only way to deal with this issue is to have your financial planner consider your RRSP drawdown in context of your retirement plan.

As RRIF withdrawals at age 65 and beyond qualify as pension income, they will be eligible for the $2,000 pension income tax credit. Many advisors suggest converting a small portion of your RRSP into a RRIF so that you can claim the pension credit. The pension credit is worth approximately $400 on a $2,000 RRIF withdrawal. Keep in mind you may have to pay an administration fee for your RRIF that could offset some of this benefit.

If you will have earned income in the year of retirement, say 2014, you can make a RRSP over-contribution in December, 2014 (equal to 18% of your 2014 earned income). This will allow you to claim a 2015 RRSP deduction. You will pay a one month over-contribution penalty of 1% for your December over-contribution; however, your RRSP over-contribution will cease January 1, 2015 (i.e. If your 2014 earned income is $100,000, you can make a $18,000 over-contribution in December, 2014. You will owe a $180 penalty, but can deduct the $18,000 RRSP contribution on your 2015 return even though your RRSP is now a RRIF).

If you have a younger spouse and you have RRSP contribution room, you can contribute to a spousal RRSP up to and including the year in which they turn 71.

Most people know they must convert their RRSP to a RRIF by the end their 71st year, but give no heed to any planning before the year of conversion. As noted above, tax planning should begin with your RRSP/RRIF in your early to mid-sixties.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Inheriting Money - Are you a Loving Child, a Waiter or a Hoverer

In February 2012, I wrote a blog post titled “Is it Morbid or Realistic to Plan for an Inheritance?”. I knew this was a touchy subject and would elicit various reactions from my readers. In the post, I stated that to “ignore the existence of a significant future inheritance that would impact your personal financial situation may be nonsensical” from a financial and retirement planning perspective.

Whether you believe you should plan for an inheritance or not, is your own personal decision. Today I want to deal with the behaviors and actions of those who stand to inherit money from their parents. Over the last 25 years, I have dealt with the tax, financial and psychological issues surrounding numerous client estates. I have observed the actions of those who will be the recipients of an inheritance and have found their behavior anywhere from fascinating to sickening.

I have found people who will inherit money fall into 4 groups:

1. The Loving Child

2. The Pragmatic Loving Child

3. The Waiters

4. The Hoverers

The Loving Child

For this group, their parents come first and money is secondary. Typically, these children are very close to their parents throughout their life and call and see them on a consistent basis, often weekly, or even daily. They have always helped their parents with their medical needs or in some cases with their financial needs, without giving it a second thought; because, their parents are well, their parents. This group would tell you they would give back any inheritance, if it allowed them another day to be with their parents and would consider it blasphemy to plan for an inheritance.

The Pragmatic Loving Child

This group is a subset of #1. These children love their parents and just want their parents to enjoy their lives, even if it means that they spend the children's inheritance. Children in this group may consider the reality that they will likely receive an inheritance. Even so, they do not want to take it into account in their planning and it is only at the insistence of an accountant or financial planner that they would even consider such.

The Waiters

I am not sure who coined this term, but I have seen it used many times. Waiters are described as children waiting for their parents to die, so that they can benefit from their parents assets. Waiters are considered to have a warped sense of entitlement to their parent’s money. I have observed several waiters over the years, some who went into debt to live a lifestyle based on an assumed inheritance. In my limited sample size, the children have always received their inheritance. However, one day I would love to see the face of a waiter when a lawyer informs them their parent decided to leave everything to charity instead of them.

The Hoverers

Hoverers are an even lower species than the waiters. These children often pay little or no attention to their parents their whole life, but when their parents get sick or older, they start hovering around. Several years ago one of my clients was very sick and was expected to pass away any day. I received a call from one of his children. I assumed the call was going to be the bad news that my client had passed away and the child was going to provide me the details of the funeral. The call was indeed to tell me their parent had passed away, but they were not calling to tell me about the funeral arrangements; their question to me was when they could start accessing their inheritance. I just felt sick to my stomach.

Don’t ask me why I decided to write about this topic. I guess as I have stated many times in my blog, I am just fascinated by how money affects people’s behavior. Thankfully, most people fall into the first two groups. If you are a Waiter or Hoverer, consider taking a good look at yourself in the mirror.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Income Tax Resources

I know this is the best written, wittiest and most informative tax blog you could read, but I figured today I would give the other guys some notice :). Seriously now, here are some other great income tax related resources you may want to check out:

 

Blogs and Websites

Below are some excellent websites and blogs. I am sure there are many more blogs and websites with great information, however, either I am not aware of them or do not access them often; so if you are not listed below, do not send me a hate email.

Tax Tips.ca - This is probably the best tax resource in Canada. This is not a blog in the typical sense, but more of a resource centre.

Moodys Gartner Tax Law - This is one of my favourite tax blogs. Some topics may be a bit technical, but very well written and great info for any tax junkie.

Canadian Tax Resource - Written by Dean Paley, CGA, CFP, who now posts on his own site. The Canadian Tax Resource blog is really a historical resource at this point, as Dean does not blog here anymore. However, the older posts often show up when I search a tax topic.

John Loukidelis Professional Corporation – Written by tax lawyer John Loukidelis, who wrote a long-running blog at his prior law firm. His blogs tend to be a bit technical, but he has some great information for those who are willing to read technical material.

Tax Enforcement Agencies

Canada Revenue Agency - I must say, the CRA does a very good job with their site. There is lots of information and it is usually fairly easy to read. Although, keep in mind; these are the CRA views, which are not necessarily always the view of the courts.

Internal Revenue Service - This site is more technical and not as user friendly as the CRA’s site; but if you have U.S. tax issues, it is a very good resource.

Estate Planning

Estate Law Canada - The person behind this blog is Lynne Butler an estates lawyer. Very readable and informative.

Toronto Estate Law Blog - Written by the estate lawyers at Hull and Hull LLP.

E$tate Debate - Written by various experts in the estate and trust fields.

Tax Treaties

Tax treaties  - A useful site if you want to know the withholding tax rate of foreign sources of income.

Large Accounting and Law Firm Websites

 

The following are links to the tax publications by some of the "big boys' of the accounting and legal world.

BDO
PWC
Deloitte 
EY
KPMG
Dentons
Thorsteinssons LLP

Twitter

Unlike many people, I only follow a small number of people on Twitter. Here are the Twitter handles of the tax people I follow, some already noted above:

1. @moodysgartner - Moodys Gartner Canadian and US tax lawyers and Chartered Accountants discuss tax strategies and tax issues.
2. @JamieGolombek – Managing Director, Tax and Estate Planning at CIBC Private Wealth Management and well known tax columnist for the National Post writes about all things tax & estate.
3. @Xyste – Tax lawyer Greg Ducharme
4. @taxtips.ca - Canadian tax, financial and investing info, tax and other calculators, tables of tax rates/tax credits.
5. @IRSnews -IRS news and guidance for the public, the press and practitioners.
6. @CanRevAgency - Canada Revenue Agency (CRA) administers tax and benefits programs, and ensures compliance with Canada’s tax laws
7. @WayneBewick -U.S. Certified Public Accountant and Chartered Accountant specialising in U.S. and Canadian tax services.
8. @DeanPaleyCGACFP - Accountant & Financial Planner.

Newspapers

The two best known tax columnists are Jamie Golombek with the National Post and Tim Cestnik with the Globe and Mail.

Winners of the 4 CD Audio Set of Tom Deans Every Family's Business

 

The winners of the giveaway are Stephen L. and Michael G. You will be contacted to obtain your mailing information. Thanks to all who entered.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

Are Estate Freezes the Wrong Solution for Family Business Succession? - Part 2 and Giveaway

On Monday I discussed why an estate freeze may not be the right solution for a family’s business succession plan and why Tom Deans considers an estate freeze to generally be the absolute wrong way to go about transferring a family business.

Today, I discuss my interpretation of Tom’s thoughts based on a panel discussion I participated in with him, my reading of his book and a review of interviews he has given. To be absolutely clear, these are my interpretations and Tom has not reviewed or commented in any way. Finally, I have a 4 CD audio set giveaway of Tom's book Every Family's Business.

Buy the Business, Are You Kidding Me?

In the postscript to Tom’s book Every Family's Business: 12 Common Sense Questions to Protect Your Wealth, he says the one part of his presentation that always elicits an uneasy response is when he says ‘in this room there are children who believe their parents will gift their business to them and parents who believe their children will purchase their business”. He goes on to say “this lack of clarity over the future ownership of the business is the greatest source of conflict and wealth destruction in a business".

What Tom is poignantly noting is the lack of communication between parents and their children and the unspoken assumptions that are often far from the truth. A parent needs to be honest with their child(ren) if their expectation is that their child(ren) will have to purchase the family business. Children need to be honest with their parent(s) about whether or not they are willing to purchase shares in the business or if they even have an interest in carrying on the business. The best business families are able to talk openly, honestly and frankly about money, business and family succession.

Just Sell the Damn Thing

Tom says “The legacy is not the business. The legacy is the family”. Many business owners believe their greatest legacy is their company and their job as entrepreneurs is to transition that business into their children’s hands. Tom suggests that owners need to grant themselves permission to take care of themselves first by selling for cash and looking at their business as an instrument of wealth creation. Although the business will typically be sold to competitors, Tom has no problem offering the business to children, as long as they purchase it on commercial terms and take on the risk of ownership (children may get preferential payment terms).

Tom says that when children find out they will not be gifted the business (through an estate freeze) they are often perturbed, however, when it is explained to them that someone is paying mom or dad millions of dollars, some of which may be allocated to them immediately or will ensure a significant inheritance for them in the future, they suddenly change their tune. Essentially, Tom is saying that the equity in your business does not have to be passed down as shares in the business, but can be passed as liquid wealth to your children down the road. To deal with the liquid wealth created by a sale, Tom wrote a second book entitled Willing Wisdom: 7 Questions to Ask Before You Die.

Transitioning Your Business to Your 65 Year Old Child

If a parent decides against selling the business and undertakes an estate freeze, often the parent becomes their own worst enemy. Tom half-jokingly noted during our panel discussion that when your parent has a heart attack at 71, twenty years ago they died. Now doctors put in a coronary stent and your parent is good for another 20 years. So when parents tell a child it will all be yours one day, that one day could be when you turn 65 and up until you obtain control of the company, your parent(s) may keep their thumb(s) on you (since they often maintain voting control as per my estate freeze discussion last week). Parents; skipping a generation is not succession planning! 

Find the End Before it Finds You

Tom says that in many cases your succession plan as an owner is no plan and until you suffer a health event, there is no urgency to plan. He suggests that it is important to start planning from day one, while you are healthy and clear of mind. Determine if there is a buyer in the house (family member) and as noted above, do not assume your children will be the buyer. He feels that if your children will not put up their own money (or obtain their own bank financing) to buy some or all of your shares, you should look elsewhere. If a child is not willing to risk their own capital, Tom feels that means they are either not committed to the business or they truly feel the business is old and past its freshness date.

Whether you want your business to be enticing to your children or an arms-length buyer, you must ensure your business adapts to changes and risks in the market place and that you continuously strive to improve operations and efficiency. By doing such, you make your company more valuable to an outside party and more attractive for a child to risk their own capital and carry on the business.

If you own a business, I strongly suggest you buy Tom’s book. In the end, he boils family succession planning down to 12 commons sense questions that start the family succession conversation but also cleverly have the ability to end the conversation quickly. I hope the two posts this week and last week’s blog on estate freezes, has given you plenty of food for thought.

Every Family's Business 4 CD Set Giveaway

I have two copies of a 4 CD audio set of Every Family's Business narrated by Tom. If you would like a copy, email Lynda@cunninghamca.com and I will randomly select the two winners and announce them on June 16th.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Are Estate Freezes the Wrong Solution for Family Business Succession?

Last week I discussed how an estate freeze provides an efficient income tax solution for the succession of your family business by allowing you to lock in the value of your business and pass the ownership tax-free to your children. However, a freeze does not provide you with immediate liquidity, nor does it require your children to risk their own capital. Some family succession experts believe an estate freeze is a misplaced income tax solution; when what is really required, is a business

solution.

A few months ago, I was one of the “experts” on a panel that discussed family succession. The guest speaker and main attraction for the night was Tom Deans (yes, believe it or not, I was not the draw). Tom is the author of Every Family's Business: 12 Common Sense Questions to Protect Your Wealth, the best-selling family business book of all-time with more than 300,000 copies in circulation. Tom is an outspoken advocate of parents taking care of themselves, which often means selling their business, whether to a competitor, their own child or management, rather than just handing it over to their children for free (via an estate freeze). 

Tom's suggestion to monetize your business, rather than hand it over to your children, runs counter to the commonly held belief that your business is your legacy and that the ultimate family business is multigenerational. For many business owners, I would suggest that Tom’s advice to sell and safeguard your retirement is often the prudent decision.

Tom says an “estate freeze usually sets the stage for what I like to describe as the beginning of the ‘perpetuity project.’ This is when a family shifts its thinking away from the business as a money-making asset and toward the business as a legacy, with the goal of ‘longevity’ trumping all other strategic options for creating value.”

With statistics suggesting that only 30% of family businesses transition successfully to the 2nd generation and a meager 10% to a third generation, Tom may be correct that many parents are compliant in destroying their business by trying to ensure its perpetuity.

Why Parents May Choose to Undertake an Estate Freeze

In my experience, parents often cite three reasons for preferring an estate freeze over an outright sale to an arms-length party or to one of their children.

1. They see the family business as an annuity, so why sell for $4,000,000 ($3,200,000 or so after-tax) when it will make $4,000,000 every 4 to 5 years indefinitely if the business continues as it is or grows.

2. They feel they can easily redeem enough of their frozen shares each year to cover their living expenses so why burden the children with additional debt.

3. What is the point in selling shares to their children, if their children need to borrow from the bank to purchase the shares; especially since if the business goes sour, the parents figure they may need to step-up and cover the default anyways?

What Is so Bad About an Estate Freeze?

As many accountants can attest to, often a well- intentioned estate freeze that has saved the family thousands or even hundreds of thousands of dollars in tax ends up being the catalyst to family conflict and/or the ruin of the families business. Here are some of the downsides to an estate freeze:

1. In undertaking a freeze, shares are issued for no consideration. The children have no risk capital invested in the company, which can alter their commitment to the business. (More on this on Wednesday.)

2. Whether a company’s share value increases due to market forces or because of the children’s efforts or non-efforts is irrelevant; your children may end up making far more than you ever did, despite you handing them a turnkey operation (that may be fine with you).

3. An estate freeze requires decisions regarding which child(ren) will work in the business, how they will be compensated and which of them get shares and what percentage of the shares. All these decisions can blow-up. For example, let’s say you undertake an estate freeze and give your daughter who will work in the business all the shares of the business (which are in theory worthless at the date of the freeze, since you have all the current value in your special shares, say your shares are worth $2,000,000 in this example). You leave your other two children say $100,000 each in your will to “compensate” them for not being involved in the freeze. Imagine the sibling conflict if the business grows to $3,000,000 in value. The child working the business has benefited to the tune of one million dollars ($3,000,000- $2,000,000 freeze value) plus a full-time job, compared to the $100k the other children will receive in the will.

4. Parents often like the concept of freezes because it locks in the maximum amount of income tax they will owe on death, however, the freeze is also often viewed as a way for them to slow down and move away from the business. If the child who takes over the business makes a mess of the family company, mom or dad or both are often forced to step back in to save the company – not exactly the stress-free retirement they imagined.

5. In a blog posting by Tom, he states that an estate freeze “magnifies family genius – and incompetence – precisely because the market rules of ownership were violated through gifting, all in the name of saving tax. Families pay the highest price when they lose their mutual trust and respect for one another when gifting goes bad. And when trust is lost, family members resorting to litigation is the saddest progression of a family business in decline”.

The Benefits of Estate Freezes

My personal experience with estate freezes has been good. While the overwhelming majority of my clients over the years have sold their businesses, there have been several that have frozen their companies and everything worked out. I would say that is because most of these clients were able to distinguish which child(ren) deserved to work in the business and were committed to the business (in most cases, the children have been uniformly intelligent and often academically brighter than their parents, though not necessarily as street smart). The parents also gave significant thought to how they would compensate the children both involved in the business and those excluded from involvement. Finally and probably most import, the parents tried to understand the sibling dynamic within their families and whether a freeze made sense within these family dynamics.

When I spoke to Tom about this before his speech, he asked me “If all these children were so committed to the business and so bright, why would they not have agreed to purchase shares from their parents?”

After reading this post, you may be thinking to yourself that an estate free may not be the succession planning panacea it is marketed as; at least from the non-tax perspective. On Wednesday in part two of this post, I will discuss the issues Tom considers vital in regards to selling or transitioning your family business. In addition, I will give away two copies of a 4 CD set of Every Family's Business narrated by Tom.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

Estate Freeze – A Tax Solution for the Succession of a Small Business

Winston Churchill once said, “Let our advance worrying, become advance thinking and planning.” Small business owners often worry about their exit strategy and/or succession plan. They may also be concerned about what would happen to their business if they have a health scare or receive an ultimatum from a child working in their business. Often a small business owner’s worry becomes their anxiety, instead of their advanced planning.

As a small business owner, at the end of the day, there are essentially only two exit strategy/succession options you need to plan and/or consider:

(1) A sale of your business, typically to a competitor, sometimes to current management or very infrequently, an actual sale to a child or other family member; or

(2) A transfer of the business to your children without a sale (for purposes of this article I will refer to this option as an “estate freeze”).

My blog today discusses estate freezes. How you can transfer your business tax-free to a successor (typically your children, sometimes to existing management) while continuing to control and receive remuneration from your business.

Next week I’ll discuss Tom Dean’s thoughts on this matter. Tom who is the author of Every Family's Business (the bestselling family business book of all-time) believes a business should in most cases be sold and never handed over to the next generation (such as done with an estate freeze) without the parent(s) adequately being compensated for the business.

What is an Estate Freeze?

The most tax efficient manner to transfer your business to your children is to undertake an estate freeze. An estate freeze allows your child(ren) to carry on your business, while at the same time you receive shares worth the current value of your business. In addition, once your share value is locked-in, your future income tax liability in respect of your company’s shares is fixed and can only decrease. Keep in mind that when you freeze the value of your company you are not receiving any monies for your shares at that time. There may be ways to monetize that value in the future, but on an estate freeze, you typically only receive shares of value, not cash.

The key risk in any estate freeze is that your children may partially or fully devalue these shares and your company. So while an estate freeze may be the most tax efficient way to transfer your business, it may not be the best decision from an economic or monetization perspective. 

In a typical estate freeze, you exchange your common shares of your corporation on a tax-free basis for preferred shares that have a permanent value (“frozen value”) equal to the common shares’ fair market value (“FMV”) at the time of the freeze. Subsequently, a successor or successors, say your children or family trust can subscribe for new common shares of the corporation for a nominal amount.

This concept is best explained with an example. Assume Mr. A has an incorporated business worth $3,000,000 and wants to undertake an estate freeze. In the course of the freeze, Mr. A is issued new preferred shares worth $3,000,000 and his children or a family trust subscribes for new common shares for nominal consideration. Mr. A’s tax liability in relation to these shares on death, is now fixed at approximately $750,000 in Ontario ($3,000,000 x capital gains rate). Often, a key aspect of an estate freeze is a plan to reduce the tax liability by redeeming the preferred shares on a year by year basis as discussed below.

If you have access to your lifetime capital gains exemption (currently at $800,000 but indexed beginning in 2015 for inflation), your income tax liability may be reduced when the shares are eventually sold or upon your death if you still own them at that time. Finally, you may choose to crystallize your exemption when you freeze the shares.

The preferred shares received on the freeze can be created such that they allow you to maintain voting control of your corporation until you are satisfied your child(ren), is(are) running the company in the manner you desire. This maybe a double-edged sword, as you may tend to hold onto control long after your successors have proven themselves. This may become a contentious issue.

Preferred shares can also serve as a source of retirement income. Typically what is done is that your preferred shares are redeemed gradually. So, for example, if you need $100,000 before tax a year to live, you can redeem $100,000 of your preferred shares each year. Let’s say you live 20 years and redeem a $100,000 a year. By the time of your death, you will have redeemed $2,000,000 ($100,000 x 20 years) of your preferred shares and they will now only be worth $1,000,000 ($3,000,000 original value less $2,000,000) at your death. Your income tax liability on these shares at the time of your death will now only be approximately $250,000.

The Benefits of an Estate Freeze

1. On death (something we should all be planning for), an individual is subject to a deemed disposition (i.e. a sale) on all of his/her assets at FMV, which would include his/her shares of the business. An estate freeze sets your maximum income tax liability upon this deemed sale and as discussed above, this liability can be lowered over the years by redeeming the shares.

2. Family members will be able to become shareholders of the business at a minimal cost and be motivated to build the business (although Tom Dean's would dispute this assertion).

3. Instead of having children directly subscribe for new common shares, you can create a discretionary family trust to hold the common shares. Every year, the corporation can pay dividends to the family trust which can then allocate the dividends to family members with lower marginal tax rates. This mechanism allows for great income splitting opportunities.

4. On the eventual sale of the business, the children or family trust may realize a significant capital gain. Assuming that the business qualifies for the capital gains exemption, the family trust can allocate this capital gain to each beneficiary who may be able to use his/her own lifetime capital gains exemption limit to shield $800,000 or more of capital gains from income tax.

One of the more critical aspects of an estate freeze is the determination of the fair market value ("FMV") of your business. In order to ensure that an estate freeze proceeds as smoothly as possible, the FMV of the company must be calculated. In the event that the FMV determined is challenged by the Canada Revenue Agency (the “CRA”) the attributes of the preferred shares will have a purchase price adjustment clause that will let the freezer reset the FMV. The CRA has stated in the past that they will generally accept the use of a purchase price adjustment clause if a “reasonable attempt” has been made in valuing the company. Engaging a third party independent Chartered Business Valuator to prepare a valuation report is generally accepted as a “reasonable attempt” in estimating the FMV.

Issues to Consider Before Implementing an Estate Freeze

An estate freeze does not make sense for all business owners. While the above benefits do sound very enticing, it depends on each owner’s personal circumstances. Issues to be considered include:

1. Are you relying on the value of the company to fund your retirement? If so, it may be best to sell and ensure you have a secure retirement.

2. Do you have an identified successor, i.e. child, able and willing to work in your business?

3. Can you bring one child into the business without creating a dispute amongst your children?

4. Are your children married and how may a divorce or separation impact the business?

Long-time readers of my blog will know that I am a proponent of family discussions and getting over the money taboo. I cannot overstate the importance of having a detailed discussion with your family if you plan to hand your business over to one or more of your children. If you pass that hurdle, you must speak with your accountant and lawyer to ensure you understand the implications of the freeze and how to properly implement the corporate restructuring. Finally, your tax advisor will want to structure the freeze such that it can be “thawed” if the business suffers a setback due to the economy, or your child(ren) prove incapable of running the company.

As noted above, next week I will discuss Tom Dean’s views. Tom feels an estate freeze is not a succession plan or the best way to liquidate or sell a business.

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