Managing your assets
Kurt Oelschlagel
The Milk Producer
March 2010
Used in the right circumstances, a family trust can yield many benefits for your family
What are family trusts? How are they used? Would I benefit from having a family trust? These are just some of the questions my clients ask when they are considering estate planning.
A trust lets you separate the control and management of an asset from its ownership. It is a legal relationship between three parties: the settlor, the trustee and the beneficiary. The person who creates or settles a trust is called the settlor. They contribute property to the trust for the intended beneficiaries. They also set out instructions, known as a trust agreement, on how the assets are to be used or managed and who will benefit from them.
The settlor appoints trustees to manage and control assets according to the settlor’s instructions. Once the trust has been settled, the trustee will hold the trust property in trust for the beneficiary. The trust agreement will either specifically name the beneficiaries or state they will come from a certain group, such as the settlor’s children or grandchildren. They can include individuals not yet born.
The same individual can be the settlor, a trustee and the a beneficiary in the same trust. However, there can be adverse tax consequences if the settlor is also the trustee or beneficiary.
There are several tax advantages when using a trust in estate planning, including income splitting and completing an estate freeze. A family trust also offers farmers flexibility when planning for business succession. Inter vivos trusts A living trust, or inter vivos trust, is created during a person’s lifetime. Trusts created upon death, through the use of wills for example, are called testamentary trusts.
Income earned by an inter vivos trust and not paid or allocated to a beneficiary is taxed at the highest tax rate. You can use an inter vivos trust to split income. Income splitting involves the transfer of assets, such as cash, from someone in a high tax bracket to someone in a lower tax bracket. Income earned on those assets is taxed at a lower rate. As such, income on assets owned in a trust allocated to the beneficiaries may be subject to lower income taxes.
Certain rules, however, can negate income-splitting benefits. For example, dividends earned by a trust from shares in a family corporation allocated to minor family members are subject to the income-splitting, tax or kiddie tax as it is well known, at the highest personal tax rate.
When the children are no longer subject to the kiddie tax, the dividends can be paid to the trust and then paid or allocated to these children. A child with little or no income can receive a fairly substantial dividend with very little income tax. This can be quite beneficial, especially if the child has significant tax credits for post-secondary education and little income.
Other uses
Family trusts are often used in a standard corporate estate freeze. A corporation’s shareholders have their common shares exchanged for fixed value preference or special shares on a tax-deferred basis. The new common shares, which grow in value, are issued to a family trust. The parents are usually the trustees and control the corporation and the trust. The beneficiaries may include the parents, their children and spouses, and grandchildren.
Consider tax consequences
The tax and legal requirements to establish and administer a trust must be rigorously adhered to if you want to avoid any adverse income tax consequences. Used in the right circumstances, a family trust can benefit both you and your family members now and in the future.
Consider this
Let’s imagine your family farm corporation shares are owned by a family trust. There are five beneficiaries, including you, your wife and three children. Each of you potentially has a $750,000 maximum capital gains exemption available.
You find out after selling the corporation’s shares there is significant capital gain in the trust, in this case exceeding $3,750,000 (five beneficiaries multiplied by $750,000 capital gains exemption).
The taxable portion of the capital gain, which is 50 per cent of the capital gain, is either paid equally or made legally payable to each beneficiary. As such, each of you can claim your full capital gains exemption. Therefore, the $3,750,000 capital gain you’ve earned is not subject to income tax. As an added benefit, a trust can also be used to acquire other farm assets that qualify for the exemption.
Keep in mind, though, when you report a large capital gain on a tax return, it could trigger a tax known as the alternative minimum tax. This could result in loss of some non-refundable and refundable income tax credits.
Kurt Oelschlagel is a partner with BDO in Hanover, Ont. He can be reached at koelschlagel@bdo.ca or visit the website at www.bdo.ca. For further information regarding trusts, see the BDO tax bulletin “Understanding Trusts” at www.bdo.ca.
