Tax planning when the business value has declined
Tax planning involves managing the taxes that you, your family, and your business pay throughout your lifetimes and the life of your business. One key planning technique that private businesses and their owners usually undertake at some point in the business life cycle is an estate freeze. If you find that the value of your business has declined because of the current economic turmoil, it might be an ideal time to consider this planning idea. If you have already done an estate freeze in the past when your business had a higher value, it is an ideal time to revisit this plan to see if it needs to change.
An estate freeze is a process where you take steps to ensure that the future growth of your estate accumulates in the hands of your intended beneficiaries in a tax effective manner. By freezing the value of your estate, you will effectively lock-in the tax that will arise on your death (subject to changes in future tax rates). An effective estate freeze will allow you to pre-determine the taxes that will arise on your death so that you can ensure that cash will be available to pay that tax (for example, by taking out sufficient life insurance). An estate freeze completed when the value of the business is depressed will minimize the tax that will arise on the death of the business owner, with future increases in value accumulating in the hands of your beneficiaries.
A holding company freeze can also provide additional benefits that are well suited for a depressed economic environment. If your business corporation has funds that are not currently needed in the business, these funds can be paid by the business corporation to a holding company on a tax-free basis. This will help ensure the funds will be isolated from future business risks that may arise in the business corporation without a tax cost. It may even be possible to take this planning one step further by borrowing to pay a larger dividend to the holding company and loaning the funds back to the business corporation on a secured basis to pay off this loan.
If you have already undertaken an estate freeze, but the value of your business has declined in the current environment, it is worth considering whether the freeze could be undone and you should re-freeze your business at the current value of your business. This could make sense if the value of your business is less than its value at the time the original freeze was undertaken, and therefore the fixed value shares you took back on the original freeze is more than the value of the business. A re-freeze would allow you to reset the freeze at the value of your business today and further reduce the amount of taxes your estate would have to pay on your death.
You may also decide that you want to undo an estate freeze done in the past due to the decline in value. Known as an estate thaw, this would be possible if you and/or your spouse are beneficiaries of the family trust that own the common shares of your business. Implementing a thaw would mean that you would transfer the common shares out of the trust to you and/or your spouse. Whether this makes sense depends on your own situation, and the interests of the other intended beneficiaries.
There are many things to think about. The uncertainty in the world today is likely creating challenging times for you, your family, and your business. You can still effectively manage your taxes by being proactive.
Your BDO Tax advisor is ready to help