Business & Estate Planning

How Does an Estate Freeze Work for a Canadian Business Owner?

An estate freeze is implemented by your accountant and lawyer — this page explains the mechanism conceptually, so you understand what they'll be doing and why, not so you can execute it yourself. The actual structuring involves specific tax elections and share terms that need to be built around your corporation's real numbers.

The Share Exchange, Step by Step

At a conceptual level, an estate freeze happens in three moves:

• 1. You exchange your existing common shares for new preferred shares fixed at today's value — say, your company is worth $2 million, so you receive preferred shares with a $2 million redemption value.
• 2. New common shares are issued — typically to your children directly, or to a family trust that holds them for your children's benefit — usually for a nominal amount.
• 3. All future growth in the company's value accrues to those new common shares, not to your frozen preferred shares. If the company doubles to $4 million over the next decade, that additional $2 million belongs to the new common shareholders, not to you.

The Section 85 Rollover

The share exchange in step one is usually done under a "section 85 rollover" — a tax election under the Income Tax Act that lets you exchange your common shares for the new preferred shares without immediately triggering the capital gains tax that a normal sale would create. Instead of paying tax on the exchange itself, the tax is deferred until you eventually dispose of the preferred shares — including, eventually, at your death, subject to the estate tax mechanics covered on Life Insurance for Estate Taxes. Filing this election correctly, and choosing the right elected amount, is technical work done by your accountant — getting it wrong can create unintended tax consequences.

Why the Preferred Shares Are Structured Carefully

Your new preferred shares aren't just "the old value parked somewhere" — they're typically designed with specific terms your lawyer and accountant negotiate together:

• Redemption value fixed at the frozen amount, so the corporation (or a future buyer) can eventually redeem them for that set price.
• A dividend rate, if you want ongoing income from the frozen value rather than just a future redemption.
• Voting rights, often retained on the preferred shares so you keep control of the company even though the common shares now belong to your children or the trust.

Why a Family Trust Is Often Used

Rather than issuing the new common shares directly to your children, many freezes route them through a discretionary family trust. This adds flexibility — the trust can hold the shares for the benefit of several family members without deciding exact proportions up front, and can offer some income-splitting and creditor-protection benefits depending on how it's structured (subject to current tax rules, which have tightened considerably on income splitting in recent years). Whether a trust makes sense for your freeze is a decision for your accountant and lawyer, not a default step.

A Simplified Worked Example

A business owner's company is valued at $2 million. They freeze: exchanging their common shares for preferred shares with a $2 million redemption value, and issuing new common shares to a family trust for their two children. Ten years later, the company is worth $5 million.

• The owner's preferred shares are still worth $2 million — the amount their eventual estate tax liability is calculated against, rather than the full $5 million.
• The $3 million in growth belongs to the new common shares held in trust for the children — value that has already shifted to the next generation without a separate transfer or additional tax at the time of the freeze.
• Because the frozen $2 million is now a known number, a life insurance policy can be sized against the resulting tax liability with much more confidence than trying to insure an unknown, growing figure.

This is illustrative only — actual numbers depend on a real valuation, the specific share terms chosen, and your accountant's calculation of the resulting tax position.

Where Insurance Fits

The freeze itself doesn't eliminate your estate's tax liability — it caps it at today's value and makes it predictable. That predictability is what makes it practical to fund the liability with a permanent life insurance policy, sized against the frozen amount. See Estate Freeze & Life Insurance for how that funding is typically structured.

Frequently Asked Questions