An estate freeze is a tool that is used as part of your estate planning and to reduce your estate’s taxes. Estate planning is essential to minimize taxes payable when you die. An estate freezing is used to fix or freeze the value of your estate and therefore your tax bill at a particular point in time so that future growth or appreciation is taxed in the hands of your children, grandchildren, spouse or a family trust. So why have the gains taxed in someone’s hands other than your own? Because they are hopefully in a lower tax bracket and should pay less taxes than yourself.
A typical application for a dentist involves the hygiene and/or technical service corporation shares (H/TSC). If you freeze the value of your H/TSC shares prior to their appreciation, you may substantially reduce your tax bill when you sell the practice. So, what if I never sell my practice? Why do I have to worry about taxes payable on the sale of my practice? Well, the government will deem there to be a sale upon your death, i.e., death triggers a deemed sale to your estate. The selling price from the tax department’s perspective will be the fair market value prevailing on the date of your death.
Why do you need an estate freeze? By fixing the value of your shares, you can fix or freeze your tax bill. The estate freeze may also provide you with retirement income in the form of dividends. Hence, you know your tax bill well advance of your death. This advance notice enables you to plan your affairs including finding cost efficient ways to pay for the taxes upon death. Example, insurance is sometimes used to pay for the tax bill arising on death. An estate freeze can also reduce the probate fees payable upon death, as the value of your estate is reduced.
In the estate freeze process one should consider utilizing any unused portion of your $500,000 lifetime capital gains exemption.
Estate freezing will also facilitate creditor proofing and income splitting with children who are 18 and older in addition to multiplying the $500,000 lifetime capital gains exemption. By effectively transferring all future growth to other family members, you are keeping this future growth away from your own creditors.
An estate freeze can be structured so that you, the dentist, and/or your spouse effectively control the H/TSC after the freeze has been implemented. To maximize creditor proofing of the dentist, it is recommended that the dentist does not directly control the H/TSC. In fact, he/she should also consider transferring all of his/her initial investment in the H/TSC to his/her spouse at fair market value. At the very least this will allow him/her to use the funds generated from this sale for personal living expenses, and then hopefully be unavailable to his/her creditors.
All taxpayers, including children have a $500,000 lifetime capital gains exemption. Because these children now own (via a family trust) the H/TSC shares, any capital gains realized in the future will be taxed in their hands. The capital gains may be “sheltered” or offset with their $500,000 lifetime capital gains exemption i.e., they pay little or no tax on the future gains. Attribution rules were designed to tax capital gains, income or dividends in the richer persons’ hands, typically the dentist’s hands as opposed to the spouse and children’s hands. However, attribution rules do not apply to capital gains realized by children, regardless of their age.
One should consider an estate freeze if they want to leave more for their loved ones and less to the government. It is an essential tax and estate planning tool for those who are fifty and better.