FAMILY TRUSTS – TO TRUST OR NOT TO TRUST THAT IS THE QUESTION

A Family Trust, sure my family trust one another.? You probably heard that one before.? The topic of this article relates to the other Family Trust used in estate planning and some higher-level planning concepts. ?

To start off with, it is recommended that you consult with a qualified tax and estate advisor before you implement any Trust. This article has been written in the context of a Canadian taxpayer.

If you are reading this article, I’m assuming that you started to have some estate planning discussions regarding Trusts with your advisors. ?

So, what is a Trust?? Well, we know that a Trust is not a separate legal entity or person for most legal purposes, however a Trust under the Income Tax Act (“ITA”) is deemed to be an individual and taxpayer as it relates to tax reporting.

Who are the main players in a Trust? Well, you have an individual who establishes the Trust, by contributing property to the Trust, often referred to as the “Settlor”.?? The legal owner of the property held in a Trust, is referred to as the “Trustee”. ?The actual equitable or beneficial owner of the property is referred to as the “Beneficiary”.

So, to sum it up, you have property that is contributed by a Settlor to an entity deemed under the ITA to be a taxpayer, however for all other purpose not a legal entity.? The property contributed to this entity is legally owned and controlled by the Trustees for the benefit of the Beneficiaries.? The Trustees even though they have legal ownership are not the actual beneficial owners of the transferred property.? The Trustees are required to act in the best interest of the Beneficiaries and in accordance with the terms established in the Trust agreement. Simple enough?

There are many different types of Trusts which are beyond the scope of this article.? For the purposes of this article, I’m assuming a Family Trust, where Mom or Dad set up a Trust during their lifetime for the benefit of their children and/or spouse.

A Trust seems fairly complicated and costly to set up. So, what are the benefits? Well, a couple of the more significant benefits of a Trust include:

Reducing and deferring your estate tax liability

If you are planning on transferring certain growth taxable assets to your beneficiaries (in particular your children) on death, you may want to do this during your lifetime.? As you may recall from my previous article on estate tax liability, when assets pass on death to your children, there is usually a deemed disposition of these assets (depending on the asset) at fair market value, and any gains accrued over your lifetime in these taxable assets is taxed on your death and usually at unfavourable personal tax rates.?

By transferring these growth taxable assets to a Family Trust during your lifetime, any growth in value from the date of transfer of these taxable assets is attributed to the Family Trust and its Beneficiaries.? Upon your death the assets held by the Family Trust are not included in your estate for estate tax purposes. Thereby reducing and deferring your estate tax liability. ?

Splitting income with the Beneficiaries of the Family Trust

This aspect of Trust planning is particularly advantageous to a business owner.? If you are a business owner, your advisors may have introduced the concept of an estate freeze to you.?? An estate freeze simply put is just that, freezing the value of your Company at a current valuation.?

Well, how do you do that? To start off with, you engage qualified tax, legal and valuation professionals.?? Then, you the business owner will exchange your growth shares for fixed value shares.? Newly issued growth shares will then either be issued directly to your beneficiaries or you may consider issuing the shares to a Family Trust.

Why would I do that?? Well, remember with a Family Trust you the owner can be a Trustee of the Trust, therefore, you will be in a position to control the Company with the added benefit that any value increase in the Company from the date of the estate freeze will be attributed to the Beneficiaries of the Family Trust.? The Beneficiaries of the Family Trust, would typically include your children, your spouse, yourself or another corporation.

This structure is usually favourable in those circumstances where you have a Company, its growing in value and you plan on selling the Company in your lifetime.? With any living Family Trust, if you don’t dispose of the property or transfer the property to the Beneficiaries within 21 years from the date when the Trust was created, there is a deemed disposition of the property held in the Trust and any accrued gains are taxed in the Trust at unfavourable tax rates.

As Trustee of a Family Trust, you can indirectly control the Company and when you decide to sell the Company, the shares held in the Family Trust will trigger a taxable capital gain.? This taxable capital gain can then be allocated out from the Family Trust to the Beneficiaries, which then becomes taxable in the Beneficiaries’ hands.?

The main advantage of allocating out these taxable capital gains is that each Beneficiary will be able to utilize their lifetime capital gains exemption (LCGE) which is available on the disposition of qualified small business corporation shares and/or qualified farm and fishing property.?? The LCGE in the recent federal budget was increased to $1.25 million for each individual for dispositions occurring on or after June 25th, 2024. So simply put, potentially the LCGE and its use can be multiplied by the number of Beneficiaries you have.

It is important to reiterate that a Family Trust is a separate reporting entity from a tax perspective.? That is any income retained in a living (intervivos) Family Trust is taxed at a high marginal tax rate.

There are advantages of allocating other sources of income such as interest and dividends from a Family Trust to the Beneficiaries.? The main benefit is to take advantage of the Beneficiaries’ lower personal graduated income tax rates, rather than having the income taxed at the high marginal tax rates.? However, you should consult with a qualified tax advisor to ensure that the allocations are appropriately structured to avoid negative tax consequences.

Yes, there are certainly costs to set up a Trust and there are ongoing administration costs.? Though, in the right circumstances, the benefits of establishing a Family Trust far outweigh the costs.

The timely incorporation of Trusts in your estate planning can be an effective tool.? Starting early on in your estate planning by consulting with a qualified tax and estate professional as well as a qualified business valuator is a prudent step which will inevitably yield significant dividends.

“Knowledge is of two kinds.? We know a subject ourselves or we know where we can find information upon it”.? Samuel Johnson

Andrea Pontoni holds an Honours Bachelor of Commerce Degree, is a Chartered Professional Accountant (CPA), Chartered Accountant (CA), Chartered Business Valuator (CBV) with the Canadian Institute of Chartered Business Valuators (CBV Institute), Accredited Senior Appraiser (ASA) in business valuations with the American Society of Appraisers and Certified in Financial Forensics (CFF) with CPA Canada and the American Institute of Certified Public Accountants.? Andrea has also completed the three parts Chartered Professional Accountants of Canada’s in-depth tax specialty program.? Andrea has over 30 years of experience with 17 of those years at two National Firms where he held senior positions including that of a partner.? His practice includes providing advice on business valuation, succession and estate planning, personal and corporate taxation, economic loss quantifications, financial investigations, accounting advice, financial forecasts, business planning and corporate finance matters to clients varying in size and industry. For more information on his background visit his website at www.pontonifinancialsolutions.com.? He can be reached at 519-890-6288 or by email at [email protected]