When it comes to estate planning, there is no one-size-fits-all formula. As a small business owner, you must have seriously considered your estate planning requirements and contemplated setting up a family trust to take care of your firm’s and family’s future. Family trusts have been a popular means of protecting small businesses and estates and effectively deferring taxes.
What is a Family Trust?
A Family Trust is a legally-recognized relationship between three parties – the settlor, the trustee(s) and the beneficiaries. A trust is set up to facilitate the transfer of property or assets (including company’s shares, real estate, and physical assets) from the settlor to the beneficiaries through the trustee, who acts as the manager and caretaker of the assets for a stipulated period.
A family trust can either be testamentary or “inter vivos” (living). A testamentary trust is attached to the settlor’s will and comes into effect on their death. A living trust can be established while the settlor is alive.
Both these trusts have their merits and demerits, and a lot depends on the objective and reason behind setting up the trust.
The Pros of a Family Trust:
- Securing your family financially: Concerned about how your family can be protected financially if you aren’t around to look after them? You could set up a trust for them by transferring a portion of your company shares and property to the trust and making your spouse or children nominees.
- Clarity on property distribution: This is especially true for larger estates with several beneficiaries where property disputes are more likely to happen. To avoid such clashes and protect your loved ones from being deprived of their fair share of your well-earned wealth, you can entrust independent, unbiased trustees to supervise the upkeep and distribution of your business and estate.
You can also set up a family trust for specific goals, such as the higher education of your children. For instance, you can set up a trust for your 3-year-old grandchild by transferring a portion of your company’s shares to the trust and making him the beneficiary. The trust deed can then instruct the trustee to transfer the shares to your grandchild at the specified time (maybe his/her 18th birthday) and are to be used solely for educational purposes.
- Protection of assets: All assets transferred to a trust cease to be your property and come under the care of the trust. The trust manages the estate on behalf of the beneficiaries. In an unfortunate situation like a lawsuit or bankruptcy of an individual beneficiary, creditors will not be allowed to seize the trust’s assets.
- Taxation: A trust comes with certain tax benefits as well –
Reduction in tax through estate freeze
As a small business owner, you can freeze your company’s shares and transfer it to the family trust. At this point, you cease to be the owner. The assets and shares will grow in value within the trust but won’t incur any tax liability unless they are disposed of, and a capital gain is realized. For instance, Jerry transferred his company’s shares worth $1 million to his daughter Amy. After Jerry passed away, shares were worth $3 million, and Amy faced a significant tax on a capital gain of $2 million. Had Jerry transferred the shares to a family trust, Amy wouldn’t have incurred the capital gain tax bill in one blow. The tax would incur as and when the trust sells these shares.
Capital gain tax exemption
A family trust uses every beneficiary’s lifetime capital gains exemption (LCGE) to sell a qualified small business corporation. In 2022, every individual had an LCGE limit of $913,630. In the above example, Amy can reduce her taxable gain to over $1 million ($2,000,000 – $913,630). But suppose Jeremy had created a trust and added three beneficiaries. In that case, the trust could sell all shares ($3 million) and use the $913,630 LCGE limit of all three beneficiaries, resulting in zero capital gain tax.
Probate in common law provinces
When an estate of a deceased is transferred, the beneficiary is required to pay a probate fee, an estate administration tax paid to a province. But when the property is transferred to a family trust (inter vivos), it is no longer subject to probate with the deceased’s estate. Depending on the deceased’s province of residence, the savings may run up to several thousand dollars.
The Cons of a Family Trust:
Administrative Challenges of Family Trusts
Setting up a trust, identifying reliable trustees, maintaining records, filing the T3 return and meeting other CRA requirements is a costly affair. Also, the trustee has to be carefully selected as it will be their sole responsibility to smoothly manage the trust and ensure the terms of the trust deed are executed satisfactorily.
Taxation hassles of Trust Income
While trusts come with their own set of taxation benefits, recent changes in taxation laws have managed to ruin the party. The T3 Trust Income Tax and Information Return mandate every trust in Canada to file its return yearly, irrespective of whether it has made any income or capital gains. Moreover, the 2018 tax on split income (TOSI) rule has removed the benefit of income splitting and charges such income at the highest marginal tax rate.
21-year rule with Family Trusts
The life of a family trust is 21 years. It means after the completion of 21 years, all the assets held by the trust would be deemed to be sold, and the unrealized gains would be taxed at the highest marginal tax rate. A trust can defer your capital gains tax for a later date and give you time to accumulate the amount for tax. But it cannot make you avoid the tax forever. A trust should determine what it wants to do with its assets and whom and when it wants to distribute the assets or sales proceeds.
While establishing a family trust is not uncommon in Canada, whether or not it is the answer to your estate and succession planning is a question that will require considerable thought and expert advice.
Contact Ford Keast Wealth Management For Further Assistance on Family Trust and Tax Solutions
If you have queries regarding estate planning, taxation benefits, and family trust-related assistance, we are here to help you. At Ford Keast LLP, our professional tax consultants and wealth advisors can guide you on family trust creation, its tax considerations and CRA’s requirements. You may also contact us online or on (519) 679-9330 for assistance with estate planning and accounting services.