Family trusts will continue to be an effective tax and estate planning tool. In the past, there appears to have been much focus on the income splitting advantages of using a family trust. However, there are a wide range of other objectives that may be achieved by using a family trust. In looking at whether or not a family trust should be created or an existing trust continued, a number of factors should be considered.
Under a trust relationship, the trustees hold legal title and control over the trust assets, whereas the beneficiaries have an equitable interest in the trust property. This separation of beneficial ownership from legal control makes a trust an effective tool for allowing parents to set aside property for the use and enjoyment of their children without having to relinquish control of the property. If the property had been gifted to a family member outright, control of the property would be lost. Using a trust helps ensure that the property is used for the purpose intended. For example, an individual may wish to set aside assets for the purpose of funding their children's education.
A family trust will continue to be useful at the time of incorporation or subsequent estate freeze of a small business corporation. Using a family trust to hold the growth shares of the corporation will allow parents to include all of their children as discretionary beneficiaries. The trustees (who would generally be the parents) have the flexibility to subsequently distribute shares of the corporation to the children in such proportions as they determine. Using a trust in this situation will also allow each beneficiary to benefit from his or her $824,176 capital gains deduction in the event that the company is later sold and capital gains are attributable to the shares held in the family trust.
As a trust is a legal relationship, rather than an independent legal entity such as a corporation, there is more flexibility for the trustees to take into account the competing needs of the beneficiaries and to accommodate the changing needs of the beneficiaries. Legislation governing trusts is relatively small compared to the legislation governing corporations. In structuring a trust, the individual's spouse is often included as a beneficiary. In doing so, all or a portion of the trust property can be subsequently distributed to the individual's spouse if desired. For example, this may occur in the event the parents require additional capital to support their retirement or if it becomes undesirable to distribute property to any of the children beneficiaries.
In a discretionary family trust, the trustees have the flexibility to choose whether income should be taxed in the trust or in the hands of the beneficiaries. As a result, family trusts will continue to be an effective and legitimate tax planning tool for splitting income among family members. Tax savings can be achieved where income which would otherwise be taxed in the hands of the parents or at the trust level at the highest marginal tax rate is instead taxed in the hands of the beneficiaries who are paying tax at a lower marginal tax rate.
A good opportunity for splitting income often arises where a trust subscribes for shares of a small business corporation, either on the incorporation of the corporation or as part of an estate freeze. By using separate classes of shares, it is possible to declare and pay dividends on the class of shares owned by the trust, to the exclusion of other classes of shareholders, which generally include the parents.
Depending upon the province in which the beneficiaries reside, a beneficiary having no other income may receive dividends of approximately $33,000 per year and only pay $1,262 income tax. If an individual, with other sources of income, had the dividend taxed in the highest marginal tax bracket, he or she would pay $13,220. Depending upon the level of trust income and the number of beneficiaries who have no other sources of income, the annual tax savings can be significant and an effective means to enhance the family's standard of living.
Safeguarding family assets against the claims of creditors has become an increasingly important objective for many people. The separation of beneficial ownership from legal control makes trusts an effective tool for protecting assets from the claims of outside parties such as creditors. Assuming that an individual is currently solvent, is not subject to the claims of any creditors and is not contravening the federal Bankruptcy and Insolvency Act or any provincial fraudulent conveyance legislation, steps may be taken to preserve family assets.
Using a family trust, rather than directly transferring assets to family members, may assist an individual in avoiding the claims of creditors, while at the same time retaining control over the assets. In structuring the trust to achieve this creditor proofing objective, it will be important that the trust is irrevocable and the individual has no vested interest in the trust property either as an income or capital beneficiary. By transferring ownership to the trust, the individual no longer has any rights to which a future creditor can attach.
A family trust may also be an effective means of safeguarding assets from the claims of the beneficiaries' creditors as well. If a fully discretionary family trust is used, no beneficiary has any vested right to the trust assets. Where creditor proofing is a primary objective, consideration should be given to locating the trust in a jurisdiction with favourable legislation relating to asset protection trusts.
Keeping an Operating Company Onside for the Capital Gains Deduction
An operating company needs to ensure that non-operating assets do not exceed the required limits in order to maintain the eligibility of the shares for the capital gains deduction. A corporate beneficiary can be included as part of the trust. If set up properly, this arrangement allows the operating company to pay dividends to the trust which in turn can allocate the dividends to the corporate beneficiary free of income tax. This allows the operating company to remain onside without any current income tax implications.
Avoidance of Matrimonial Property Claims
Parents are often concerned that if they transfer assets to a child, the property or any appreciation in the value of the property may be subject to division in the event that the child's marriage subsequently breaks down. This concern can be addressed by using a family trust. By using a fully discretionary trust, the child beneficiary does not have a vested interest in the trust property and, therefore, there is no property to be divided in a matrimonial property settlement.
Using a family trust may also be useful where an individual has children from more than one marriage and wants to ensure that specific assets will go to specific children.
Avoidance of Probate Fees
Transferring assets to a family trust allows an individual to maintain control over assets and yet avoid probate fees which would otherwise be incurred at the time of death. Given the high rate of probate fees in several provinces, trusts may be used more frequently to avoid probate fees.
Minor Children or Disabled Adults
Minor children and adults who are mentally incompetent generally do not have legal authority to deal with property. Therefore, using a trust can be an effective way to overcome the legal issues otherwise present. Holding assets in a trust may also be more appropriate where the beneficiaries are unwilling or not ready to accept the responsibility of holding the assets directly.
An important feature of a trust is that there are not many requirements to disclose information which can be publicly scrutinized. Other than the requirement to file an annual trust income tax return, there are no other annual or specific filing requirements with respect to the creation or ongoing operation of the trust. There is no requirement to disclose publicly what assets are held in the trust or who the beneficiaries are.
Family trusts are an important vehicle in many estate plans for both tax and non-tax reasons. Family trusts will continue to be a significant tax and estate planning tool.
Should you require additional information please contact your Chartered Professional Account-ant.