The Estate Freeze Explained

How to Pass the Torch Without Getting Burned by the Tax Bill

In Canada, death is a taxable event. The moment you pass away, the CRA deems you to have sold everything you own at fair market value. For a successful business owner, this often triggers a massive capital gains tax bill:sometimes requiring the family to sell the business just to pay the CRA.

The Estate Freeze is the single most powerful tool to stop this liability in its tracks. It locks in your tax bill at today's value and passes all future growth (and future tax liability) to the next generation. It is the bridge between "Success" and "Significance."

Part 1: The Mechanics of the Freeze (Stopping the Clock)

Imagine your business is a tree. You planted it, and it has grown to be worth $5 Million. If you die today, you pay tax on that $5M gain. But you expect the tree to grow to $20 Million over the next decade.

If you do nothing, your estate will eventually pay tax on $20M.

An Estate Freeze allows you to say to the CRA: "I will accept the tax liability on the $5M I have built so far. But the next $15M of growth belongs to my children."

How It Works (The Section 85/86 Exchange)

1. Valuation: We determine the company is worth exactly $5M today.
2. Exchange: You trade your Common Shares (which grow in value) for Preferred Shares (which have a fixed value of $5M).
   • Note: These Preferred Shares usually come with "Voting Control," so you remain the boss.
3. New Issuance: The company issues new Common Shares at a nominal price (e.g., $10) to your heirs (or a Family Trust).
4. Result: If the company grows to $20M, your shares are still worth $5M. The new shares are worth $15M. You have successfully transferred $15M of wealth tax-free.

Part 2: The "Wasting" Freeze (Funding Your Retirement)

Many owners worry: "If I freeze my shares, how do I get money out?"

This is where the strategy turns into a lifestyle engine. Your "Frozen" Preferred Shares are essentially an IOU from the company to you. You can demand the company buy them back over time.

Example: You have $5M of Preferred Shares. You need $250,000/year to live.

• The Mechanism: The company redeems (buys back) $250,000 of your shares annually.
• The Benefit: This provides your retirement cash flow. But more importantly, every dollar you redeem reduces your death tax liability. If you live for 20 more years, you might redeem the entire $5M, leaving your estate with zero capital gains tax on the business.

Dynasty Principle: "Consume the capital that has the highest tax liability attached to it first."

Part 3: The Role of the Family Trust

Referring back to our "HoldCo" article: rarely do we issue the new Growth Shares directly to children. What if they are 18? What if they marry the wrong person?

Instead, the new Common Shares are owned by a Discretionary Family Trust.

• Flexibility: You (the Trustee) decide if and when the children get the shares.
• Protection: Since the children don't legally own the shares yet, creditors and ex-spouses generally cannot touch them.
• The 21-Year Rule: Note that trusts have a "best before" date. In Canada, a trust is deemed to sell its assets every 21 years. You must plan to distribute the shares to the beneficiaries before this deadline (a "thaw").

Part 4: Quebec vs. Ontario Nuances

The tax math is federal, but the legal execution changes heavily depending on which side of the Ottawa River you reside.

Ontario: The Probate "Tax" (EAT)

Ontario charges roughly 1.5% in Estate Administration Tax (Probate) on assets passing through a will. On a $10M company, that is $150,000 in unnecessary fees.

The Fix: Ontario business owners use "Dual Wills" (Primary and Secondary Wills). The frozen shares are dealt with in the Secondary Will, which does not go through probate, saving the 1.5% fee.

Quebec: The Civil Code Advantage

Quebec does not have a "probate fee" based on percentage of value (only nominal court verification fees for non-notarial wills).

The Difference: "Dual Wills" are not a concept in Quebec. However, Quebec has unique rules regarding "Patrimony." When setting up a Trust (Fiducie) in Quebec, the assets constitute a separate patrimony (ownerless property). This provides incredibly strong asset protection, often stronger than common law trusts, but the administrative rules are stricter.

Part 5: The "Refreeze" (When Values Drop)

Business is not a straight line up. What if you froze your shares at $10M, but then a recession hits and the business drops to $6M?

• The Problem: You are holding Preferred Shares fixed at $10M, but the company is only worth $6M. You are "underwater."
• The Solution: We perform a "Thaw and Refreeze." We reset your preferred shares to the new, lower value ($6M).
• The Benefit: This instantly deletes $4M of future taxable capital gains from your estate. This is a common strategy during economic downturns.

Frequently Asked Questions

Q1: At what age should I do an Estate Freeze?

There is no magic age, but generally when two conditions are met:

1. The business value is significant enough that the tax bill on death would be a burden.
2. You have enough "frozen" value to sustain your lifestyle for the rest of your life. (Usually age 50-60).

Q2: Do I lose control of my company?

No. This is the biggest myth. You exchange Common Shares for Preferred Shares that carry Voting Rights. You can keep 100% of the vote until the day you die, even if you own 0% of the growth.

Q3: What if my kids don't want the business?

The Freeze is still valuable. If the kids don't want it, the Trust sells the shares to a third party. The capital gains tax is still shifted to the kids (who likely have lower tax brackets or exemptions), or the cash proceeds are distributed to them. It separates the "value" from the "job."

Q4: How much does an Estate Freeze cost?

It is a complex legal maneuver involving valuations, tax elections (T2057), and new share classes. Expect to invest $15,000 - $25,000 in legal and accounting fees. The tax savings, however, are often in the millions.

Q5: Can I reverse a freeze?

Not easily. Once you give the growth away, you can't just take it back without tax consequences. However, if the Trust owns the growth shares and you are the Trustee, you can often control the flow of benefits.

Q6: Does the "Capital Gains Inclusion Rate" increase affect this?

Yes. While the inclusion rate is currently 50%, future changes could increase the tax burden on death. Freezing now locks in the value and the tax liability based on today's rules for the frozen shares, providing certainty.

Q7: What is a "Gel" strategy?

It's another term for a Freeze. You "gel" the value.

Q8: Can I use my Lifetime Capital Gains Exemption (LCGE) during a freeze?

Yes. You can "crystallize" your exemption at the time of the freeze. This bumps up the cost base of your shares immediately, locking in your tax-free portion while you are still alive.

Q9: What happens if I spend all my "Frozen" shares?

Then you have successfully died with zero business assets and zero tax liability on the company! This is the perfect "die broke" tax efficiency scenario.

Q10: Does Life Insurance play a role here?

Huge role. Most owners buy Corporate Owned Life Insurance to cover the tax bill on the "Frozen" shares. When you die, the insurance pays out tax-free to the corp, and the corp uses that cash to redeem your shares and pay the estate tax.

Q11: What is Section 84.1 and how does it affect freezes?

Section 84.1 is an anti-avoidance rule that prevents certain types of share redemptions from being treated as tax-free capital dividends. It can affect how you structure share redemptions during a wasting freeze. Proper planning is required to navigate this rule.

Q12: Can I freeze shares in a HoldCo structure?

Yes, and it's often recommended. You can freeze at the HoldCo level, which provides additional asset protection and flexibility. The growth shares in the HoldCo can then own the OpCo, creating a multi-layered structure.

Q13: What happens if the valuation is wrong?

This is why professional valuations are critical. However, CRA allows "Price Adjustment Clauses" in certain circumstances. If CRA challenges your valuation and adjusts it upward, the clause can retroactively adjust the transaction to reflect the correct value, potentially avoiding penalties.

Q14: Does TOSI (Tax on Split Income) apply to dividends from frozen shares?

Generally, no. TOSI typically applies to dividends paid to family members who don't work in the business. However, dividends paid to you from your own frozen preferred shares are not subject to TOSI since you are the original owner.

Q15: What is the difference between a Section 85 and Section 86 freeze?

• Section 85: Used when you're transferring shares to a corporation (like a HoldCo). More common in multi-corporate structures.
• Section 86: Used when you're reorganizing shares within the same corporation. More common for single-corporation freezes.

Both achieve the same result but use different tax code provisions.

Resources & Recommended Reading

External Resources

• CRA Folio S4-F3-C1: Price Adjustment Clauses : What happens if the valuation is wrong
• CRA Guide T4037: Capital Gains : Understanding capital gains taxation
• CRA Form T2057: Election on Disposition of Property : Required form for Section 85/86 rollovers
• Government of Canada: Estate Strategies Guide : General estate strategies considerations

Related Articles

• The Fortress Strategy: Why Successful Families Use a HoldCo/OpCo Structure : Understanding corporate structures that work with Estate Freezes
• CDA 101: The Capital Dividend Account Explained : Tax-free dividend strategies that complement Estate Freezes
• Tax Optimization Services : How we help optimize corporate tax and estate strategies