If Your Company Has Declined In Value, An Estate Freeze Can Reduce Future Taxes
WITH PARTS OF the economy in tatters, and the near-term economic prospects dim, business owners who have experienced a significant decline in the value of their companies may wish to consider implementing an "estate freeze" this year. An estate freeze is a corporate transaction that allows the business owner to essentially "freeze" the value of his or her ownership in the corporation, and have the future growth in the value of the company accrue to someone else, such as the owner's children or trusted employees. The result: The tax liability of the owner can be fixed at today's fair market value, and the tax liability on any future growth can be transferred to the new owners, such as family members or employees.
A freeze, which can be done on a tax-free basis currently, is often accomplished by exchanging the common shares of the corporation for new fixed-value preferred shares, which are redeemable at the current fair market value of the corporation. New common shares are then issued to whoever may one day take over the company. In the case of continuing family involvement in the business, new common shares can then be issued to the kids either directly or through a family trust.
The new fixed-value preferred shares, referred to as the "freeze shares" that have been issued to the owner, can have voting rights. This allows the owner to maintain control of the company, while not necessarily continuing to be involved in the daily operations of the business. That can be left to the kids or employees, who now own the new common shares, to which the future value will accrue.
Given the current economic conditions, doing a freeze when your company's value is depressed can permit you to significantly reduce your estate's tax exposure at death, assuming the value of the shares ultimately appreciates again. You must, however, ensure that the value associated with your freeze shares today will be sufficient to support your future needs.
But what if you've already implemented an estate freeze? In that case, you may wish to consider a "refreeze." For example, if you froze the company in 2005 when the value was worth $5 million, and today the company is worth only $3 million, you would refreeze by exchanging your old $5-million redeemable preferred shares for new preferred shares redeemable at $3 million (assuming you are comfortable with this reduced amount). Should market conditions recover and the business go back up in value, that future gain can be taxed in the common shareholders' hands instead of your estate.