What is an Estate Freeze?

An estate freeze is an estate planning approach to arranging assets in a manner that limits or even eliminates the tax consequences for beneficiaries of the estate. This usually involves transferring those assets to another entity, where they are converted and issued to the beneficiaries. In many nations, this eliminates the situation in which capital gains taxes are owed on the assets when they are transferred to beneficiaries as part of the estate settlement.

A good example of how an estate freeze works is to consider an investor who owns shares of common stock. The idea is to make sure that his or her heirs get the benefit of the value of those shares, but without having to pay capital gains taxes on gains that the heirs never really received. To do this, the investor transfers those common shares back to the issuing company, where they are exchanged for preferred shares. Since those preferred shares are considered non-growth instruments, they are usually not subject to capital gains taxes. This means the original owner does not incur any further capital gains taxes on the investment, and the beneficiaries do not owe capital gains taxes when they actually receive their inheritance from the estate.

The same general principal works when it comes to stocks owned by a business. Transferring the common shares for preferred shares helps to prevent capital gains taxes being assessed when the business owner passes away, a situation that can sometimes be crippling to a company. If the goal is to preserve the company and pass it on to children or other heirs, this approach does help improve the chances that the business will remain intact and not be forced to liquidate in order to settle a tax debt.

While beneficiaries do not have to deal with capital gains taxes when an estate freeze is utilized, this does not preclude them from owing taxes in later years, as the value of the shares appreciate. From this perspective, the freeze should be seen as a means of putting off the time when some type of taxes will be due. In addition, if the tax structure relevant to the estate calls for the payment of any type of inheritance tax, an estate freeze may or may not have any impact on the amount of that tax debt.

Depending on the structure of relevant tax laws, there are several issues to consider before proceeding with an estate freeze. In some nations, using this strategy with a business can limit the ability of the owner to vote the shares of stock. Instead, voting privileges are vested in the beneficiaries. This may be a workable 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 some potential that the beneficiary will not seek the counsel of the business owner before voting, establishing an estate freeze may not be the best solution.