An estate freeze is a way to limit tax consequences for beneficiaries by transferring assets to another entity, such as preferred shares, which are not subject to capital gains taxes. This approach can help preserve a business and avoid crippling tax debts. However, beneficiaries may still have to pay taxes in the future as the value of the shares appreciates, and the strategy may limit the owner’s ability to vote shares.
An estate freeze is an estate planning approach to organize assets in a way that limits or even eliminates the tax consequences for the beneficiaries of the estate. This typically involves transferring those assets to another entity, where they are converted and issued to the beneficiaries. In many nations, this eliminates the situation where capital gains taxes are due on assets when they are transferred to beneficiaries as part of the estate settlement.
A good example of how an asset freeze works is to consider an investor who owns common stock. The idea is to make sure his heirs get the benefit of the value of those shares, but without having to pay capital gains tax on the gains the heirs never actually received. To do this, the investor transfers those common shares to the issuing company, where they are exchanged for preferred shares. Since those preferred shares are considered non-growth instruments, they are generally not subject to capital gains taxes. This means that the original owner does not incur any other capital gains tax on the investment, and the beneficiaries owe no capital gains tax when they actually receive their inheritance from the estate.
The same CEO works when it comes to shares owned by a company. Transferring common stock for preferred stock helps avoid capital gains taxes being assessed when the business owner dies, a situation that can sometimes be crippling for a business. If the goal is to preserve the business and pass it on to children or other heirs, this approach helps improve the chances that the business will remain intact and not be forced into liquidation to settle a tax debt.
While beneficiaries don’t have to deal with capital gains taxes when an estate freeze is used, this doesn’t prevent them from paying taxes in later years as the value of the shares appreciates. From this perspective, the freeze should be seen as a means of postponing the time when some type of tax must be paid. Additionally, if the relevant estate tax structure requires payment of any type of inheritance tax, an estate freeze may or may not have an impact on the amount of that tax liability.
Depending on the structure of the relevant tax laws, there are various issues to consider before proceeding with an estate freeze. In some nations, using this strategy with a business may limit the owner’s ability to vote the shares. Instead, voting privileges accrue to the beneficiaries. This can be a viable situation when the relationship between the beneficiary and the owner is one that allows the owner to indirectly influence how the beneficiary votes. If there is a chance that the beneficiary will not seek the advice of the business owner before voting, establishing an asset freeze may not be the best solution.
Smart Asset.
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