The COVID-19 economic downturn presents tax planning opportunities to business in light of depressed asset values and business losses. In particular, Estate Freezes and “Re-Freezes”, and using losses on portfolio investments are common strategies available to generate immediate cash flow and reduce taxes payable on death.
But beware of inappropriate tax advice. Besides inherent tax traps, COVID will not last forever, and if you implement the wrong tax plan, you may regret it when COVID has passed or you need money in the future.
What is a “Freeze” and “Re-Freeze”?
Freezes are the basics of estate planning and business transition to family members or key employees.
In an (Estate) Freeze”, the value of a business is “Frozen” by transferring the current value of the business to redeemable preferred shares. As a result of the Freeze, the common shares, which now have a nominal value, may be purchased by new shareholders at a nominal cost. The future growth of the business is hereby transferred to the new common shareholders while the value up to the time of the Freeze belongs current business owner.
If a Freeze was previously implemented, and the current value of the business is now less than the business owner’s preferred shares (the original “Freeze” value), a “Re-Freeze” can be implemented to decrease the value of the preferred shares. This will result in more future value of the business transferred to family members, and as a result, lower the taxes payable on the death of the preferred shareholder (if there are any unredeemed shares at that time to death).
Don’t be left empty-handed when you need money
Perhaps the most critical error that business owners make is “freezing” too early and without taking into account other sources of income that will be available to them on retirement.
Without other tax planning, the amount of Freeze sets the upper-limit that will be available to draw from their business, on retirement, for example. A subsequent Re-Freeze will lower the previous limit to the current (depressed) fair market value of the business.
Underestimating and limiting the amount of current or future cash needs of a business owner may lead to cash shortages when they are needed most.
The Right Advice
Under the right circumstances, significant long-term tax savings can be achieved using Estate Freezes, and its one of the basics of good tax planning. Fortunately, Freezes (and Re-Freezes) can be implemented in a way to provide “upside” to business owners on retirement or business transitions.
Before freezing or re-freezing, every business owner must ask themselves the following questions:
- Will my business bounce back to pre-COVID and to what level?
- When do I want to retire and how much will I need for my retirement?
- Is the current value of my business sufficient to fund my future cash needs?
- What other sources of income will I have in the future?
The right answers to these questions will allow for the right tax advice
At Sloan Partners, we are experts at tax advisory and estate planning. We work directly with business owners as well as small and medium accounting Firms to implement strategies and achieve the most favorable tax results for small business owners and their families.
Roman Belenky CPA, CGA is a Tax Specialist at Sloan Partners LLP specializing in tax planning and advisory for business owners and their families. You can reach Roman by email or by phone at 416-665-7735 ex.227
Disclaimer: This article is intended for educational and informational purposes only. It is not intended in any way whatsoever to provide tax advice. The reader should be aware that legislation and administrative policy are subject to change at any time. None of the persons involved in the preparation of this article accepts any responsibility for its contents or the consequences that arise from its use.