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Freezing
Your Tax Bill? - Volume 19
by David Chong Yen (Apr. 2005) |
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An estate freeze is a tool that is used
as part of your estate planning and to reduce your estate's
taxes. Estate planning is essential to minimize taxes payable
when you die. An estate freezing is used to fix or freeze
the value of your estate and therefore your tax bill at a
particular point in time so that future growth or appreciation
is taxed in the hands of your children, grandchildren, spouse
or a family trust. So why have the gains taxed in someone's
hands other than your own? Because they are hopefully in a
lower tax bracket and should pay less taxes than yourself.
A typical application for a dentist involves the hygiene and/or
technical service corporation shares (H/TSC). If you freeze
the value of your H/TSC shares prior to their appreciation,
you may substantially reduce your tax bill when you sell the
practice. So, what if I never sell my practice? Why do I have
to worry about taxes payable on the sale of my practice? Well,
the government will deem there to be a sale upon your death,
i.e., death triggers a deemed sale to your estate. The selling
price from the tax department's perspective will be the fair
market value prevailing on the date of your death.
Why do you need an estate freeze? By fixing the value of your
shares, you can fix or freeze your tax bill. The estate freeze
may also provide you with retirement income in the form of
dividends. Hence, you know your tax bill well advance of your
death. This advance notice enables you to plan your affairs
including finding cost efficient ways to pay for the taxes
upon death. Example, insurance is sometimes used to pay for
the tax bill arising on death. An estate freeze can also reduce
the probate fees payable upon death, as the value of your
estate is reduced.
In the estate freeze process one should consider utilizing
any unused portion of your $500,000 lifetime capital gains
exemption.
Estate freezing will also facilitate creditor proofing and
income splitting with children who are 18 and older in addition
to multiplying the $500,000 lifetime capital gains exemption.
By effectively transferring all future growth to other family
members, you are keeping this future growth away from your
own creditors.
An estate freeze can be structured so that you, the dentist,
and/or your spouse effectively control the H/TSC after the
freeze has been implemented. To maximize creditor proofing
of the dentist, it is recommended that the dentist does not
directly control the H/TSC. In fact, he/she should also consider
transferring all of his/her initial investment in the H/TSC
to his/her spouse at fair market value. At the very least
this will allow him/her to use the funds generated from this
sale for personal living expenses, and then hopefully be unavailable
to his/her creditors.
All taxpayers, including children have a $500,000 lifetime
capital gains exemption. Because these children now own (via
a family trust) the H/TSC shares, any capital gains realized
in the future will be taxed in their hands. The capital gains
may be "sheltered" or offset with their $500,000
lifetime capital gains exemption i.e., they pay little or
no tax on the future gains. Attribution rules were designed
to tax capital gains, income or dividends in the richer persons'
hands, typically the dentist's hands as opposed to the spouse
and children's hands. However, attribution rules do not apply
to capital gains realized by children, regardless of their
age.
One should consider an estate freeze if they want to leave
more for their loved ones and less to the government. It is
an essential tax and estate planning tool for those who are
fifty and better.
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