Family trusts are one of the least understood aspects of tax and estate planning. Introducing a family trust as part of a corporate structure may offer huge benefits but its merits should be evaluated on a case-by-case basis.
Unlike a corporation, a trust is not considered to be a legal entity and does not have separate existence. Simply put, a trust is a relationship between certain parties. One party (the settlor) gives assets to another (the trustee) who then manages such assets for the benefit of the third party (the beneficiaries).
Benefits for family trusts include:
- Tax minimization. Ownership of shares of an operating company via a family trust enables income allocation to adult beneficiaries in lower income brackets thereby minimizing overall taxes.
- Other services. It is common for ancillary services provided by professionals (such as CPAs, doctors, dentists, and lawyers), to be performed in a separate corporation, such being a corporation owned by a family trust, which then offers income splitting opportunities.
- Multiplication of the capital gains exemption. Upon the sale of shares of a Canadian-controlled private corporation carrying on an active business, an individual owner can reduce the tax impact by utilizing their capital gains exemption of $824,000. If instead, a trust owns the shares, this exemption can be multiplied by allocating the gain between the discretionary beneficiaries. E.g. If there were four beneficiaries, each would potentially qualify for the $824,000 exemption.
- Reduction of probate fees. Since a family trust does not die, a settlor may transfer assets to a family trust which would eventually pass on to the beneficiaries. Such assets do not form part of the estate of the settlor and would not be subject to probate fees upon the death of the settlor. Note that when such assets are conveyed to a family trust, there would be a deemed disposition at the time of transfer at the fair market value, and any accrued gains would incur tax.
- Minimization of capital gains. A portfolio of shares or the shares of an operating company (appreciating assets) may be transferred to a family holding company on a tax-deferred basis. The family holding company would be owned by a family trust and the beneficiaries would be the adult children of the transferor. The transferor would receive fixed value shares and retain voting control of the holding company. Future growth in the holding company would accrue to the benefit of the beneficiaries through common share ownership by the family trust. This results in lower capital gains upon the death of the transferor.
The taxation of trusts is not covered in this article however, it’s important to note that new rules enacted in 2016 now see certain trusts taxed at the highest federal tax rate where previously all trusts were taxed at graduated rates similar to individuals. The setup and taxation of trusts is complex and requires careful planning and professional assistance to determine and maximize the value of this type of structure.