The Deferral Value of Estate Freezes

This article examines the deferral value of an estate freeze. To be more specific, it models the value of the deferral of tax on future growth. From this model, we * Ling Chu is of Arthur Andersen LLP, Toronto; Glenn Feltham is of the University of Saskatchewan; and Robert Mathieu is of Wilfrid Laurier University. We would like to thank seminar participants at the University of Saskatchewan, the University of Toronto, and the Canadian Association of Family Enterprise. We would also like to thank Jim Barnett, Alan Macnaughton, and Ping Zhang for their helpful comments and suggestions. Funding from CGA Canada is greatly appreciated. 346 CANADIAN TAX JOURNAL / REVUE FISCALE CANADIENNE (2001), Vol. 49, No. 2 / no 2 determine the conditions that must be met if a freeze is to have value. In general, if a freeze is to have a positive expected deferral value, the business must be expected to increase in value and the children must be expected to remain shareholders of the corporation longer than the parent would have been a shareholder in the absence of a freeze. These results are intuitive. The specific deferral value of a freeze is a function of several variables. It is a strictly increasing function of the rate of return (the growth of the firm) and of the number of years until the children sell the shares or pass them on to their own children. The value of a freeze also increases with an increase in the marginal tax rate on capital gains (over a realistic range of rates). Finally, the value of a freeze can either increase or decrease with an increase in the number of years during which the parent would retain control in the absence of a freeze; the outcome depends on how long in this case the children would then retain the company. The article also discusses the implications of the analytic models for tax planning, including the optimal timing of a freeze. We find that it is advantageous (the deferral value is greatest) if the parent performs the freeze at the earliest possible moment in which he can use his capital gains exemption in full.