How does a family trust work with an estate freeze for a private corporation in Ontario?

In a typical estate freeze for a private corporation, the business owner exchanges their common shares for fixed-value preferred shares (locking in today's value), and new common shares are issued to a family trust. The family trust is the vehicle through which future growth in the business is held and eventually passed to the next generation.

The family trust names the business owner's children, grandchildren, and often the owner themselves as discretionary beneficiaries. The trustee — usually the owner or a trusted advisor — has discretion over how to allocate income and capital among the beneficiaries. This discretion allows income to be distributed to beneficiaries in lower tax brackets in years when the business is profitable, subject to the federal "tax on split income" (TOSI) rules that limit income splitting with certain family members who are not actively involved in the business.

On a future sale of the business, capital gains on the new common shares held in the trust can potentially be allocated to beneficiaries who each have access to their own capital gains exemption. This multiplies the available exemption within the family, which can result in significant tax savings on a business sale.

Family trusts must have a limited lifespan — generally 21 years under the deemed disposition rules — so proper planning is needed for what happens at that 21-year mark if the trust has not already wound up.