Over our collective careers, we have advised on numerous estate freezes to the extent we could almost template the transaction. But that would be wrong because there are so many issues and concerns that go into a freeze, such as what the new shares should look like, standard trust terms, etc. (those, and other questions, will be answered later in this series).
With that in mind, the purpose of this blog series is to:
- Outline the purpose and outcome of a freeze,
- Identify a number of issues in determining if a freeze is appropriate for you,
- Once the decision is made to proceed, what the mechanics are to put the freeze in place, and
- What you should do “post freeze”.
So, let’s get started.
Purpose and outcome of a freeze
Quite simply, the purpose of a freeze is to lock down or freeze the current fair market value of your shares in your company (“Opco”). All new Opco share value growth will be for the benefit of those you froze to, say your family. So, if Opco has a fair market value of $10M when you undertake the freeze, and has a fair market value of $15M at a future event date (as an example, sale or demise), $10M is yours and $5M is for the benefit of your family.
If the event is a sale, $10M of sale proceeds is yours and $5M is theirs. If the event is demise, your tax liability is only on $10M and their tax liability is only when they themselves have an event. Using these numbers, the freeze will defer (or potentially even eliminate) tax of approximately $1.2M. However, if Opco decreases in value from $10M, you get the reduced value and they get nothing.
Something additional to ponder: you will also have new Opco shareholders. Directly or indirectly, your family will be shareholders with all of the related responsibilities and more importantly, rights. Is this appropriate for your situation?
If this still sounds like a plan, here are a few other things that you should consider:
How rich do I need to be?
Remember the 90’s, when businesses and real estate were cheap? It is possible that a freeze done back then could have the outcome of your children being wealthier than you are today. What visceral reaction would you have if you froze your value at $10M and the family is now enjoying a value that is multiples of yours? The tax result may be great, but the estate outcome may not be what you had envisioned.
The question to ask yourself is “how rich do I need to be?” Going back to the $10M example, ask yourself if this is enough to live off during your lifetime (remember, you can also draw a salary from Opco for additional funds). Note: depending on how the freeze is carried out, it may be difficult and expensive to undo. A trial lawyer recently told me that family related litigation is now second only to personal injury litigation.
When should I freeze?
As part of the “am I rich enough” question, you should also consider what the right age is to conduct a freeze. Unfortunately, there is no clear cut answer. Think about:
- What are the future growth plans for Opco and how much of that do you want to pass on to your family?
- If you are currently working hard and want to continue for a number of years, you may want to personally enjoy the benefit of your hard work – defer the freeze to a later time. For now, it’s yours, not theirs.
- How old are your family members? Are they are responsible enough? If they are minors, you likely can’t answer this question.
- If family members are married, how stable are their marriages (see our Feb. 22 post ‘Matrimonial agreements within a shareholder agreement’). The thought of an “ex” at a shareholders meeting may not bode well.
By now you may have concluded that you are of the right age, you are rich enough, and your family seems to be ready. In addition, you have determined that both the tax and family benefits outweigh any risk of the freeze going sideways. Ready for the next step?
We’ll now start to go through the mechanics of a freeze, and we’ll expand on the evolution and advances involving this strategy…stay tuned!
Our estate planning posts consider estate planning issues at a high level. Before you commence any form of estate planning, please consult with tax and legal advisors.