FAMILY TRUST for Tax and Estate Planning

Neufeld Legal PC: Chris@NeufeldLegal.com - 403-400-4092 / 905-616-8864

A family trust in Canada is a powerful and flexible tool for tax and estate planning, allowing a family to manage wealth and transfer assets to the next generation while minimizing taxes. While recent legislative changes have made some strategies more complex, trusts remain a cornerstone of sophisticated financial planning.

What is a Family Trust?

A trust is a legal arrangement, not a separate legal entity like a corporation. It involves three key parties:

The Settlor: The individual who creates and initially funds the trust.
The Trustee: The person or people (or a corporate trustee) who legally hold and manage the assets of the trust. They have a fiduciary duty to act in the best interests of the beneficiaries.
The Beneficiaries: The individuals who benefit from the trust's income and capital.

Family trusts are typically "discretionary trusts," meaning the trustees have the power to decide which beneficiaries receive income or capital and when. This discretion is what provides much of the planning flexibility.

Key Tax Planning Strategies Using a Family Trust

A. Estate Freeze and Capital Gains Multiplication:

This is arguably the most common and powerful use of a family trust.

The Freeze: A business owner exchanges their current common shares of a company for fixed-value preferred shares. This "freezes" the value of the owner's estate at its current market value, capping the potential tax liability on death.
Future Growth: New common shares, which will receive all future growth and appreciation of the business, are issued to a family trust.
Capital Gains Multiplication: When the business is eventually sold, the capital gain on the new common shares is realized within the trust. The trustee can then "flow" this capital gain out to the beneficiaries.
The Benefit: Each beneficiary (who must be a Canadian resident and meet other criteria) can use their own Lifetime Capital Gains Exemption (LCGE) on the sale of shares of a Qualified Small Business Corporation (QSBC). By distributing the gain to multiple family members, the total tax-free amount can be multiplied significantly. For example, a business sale with a $3 million capital gain could be allocated to three family members, each using their LCGE to shelter a portion of the gain from tax.

B. Income Splitting:

This strategy involves distributing income earned by the trust to beneficiaries who are in a lower tax bracket.
A high-income earner can lend money to the trust at the CRA's prescribed interest rate. The trust invests the money, and any income earned above the interest paid back to the lender can be distributed to beneficiaries in a lower tax bracket (e.g., adult children).
This helps to reduce the family's overall tax burden. However, it's a complex area with strict rules to avoid "attribution rules" that would re-assign the income back to the original lender. Recent changes to the Tax on Split Income (TOSI) rules have also made this strategy more limited, but it can still be effective in specific situations, such as with adult children who are actively involved in the family business.

C. Asset Protection:

Once assets are legally transferred to a trust, they are no longer owned by the settlor or the beneficiaries.
This can provide a degree of protection from future creditors, lawsuits, or matrimonial disputes, provided the trust is properly structured and the transfer of assets is not made to defraud creditors.

D. Estate Planning and Probate Avoidance:

Assets held in a living (inter vivos) trust do not form part of an individual's estate upon death.
This can simplify the estate administration process and help avoid or reduce probate fees (i.e., in jurisdictions where probate costs are consequential, such as Ontario), which are essentially a tax on the value of the estate at death.
It also allows for privacy, as the details of the trust and its distributions are not part of the public probate record.

E. Flexibility and Control:

A trust allows the settlor to maintain a high degree of control over the family wealth even after it's been transferred.
The trust deed can set out specific conditions for distributions, such as providing funds for a child's education or a down payment on a house, while preventing a "spendthrift" beneficiary from receiving a lump sum.

Key Tax Rules and Considerations

The 21-Year Deemed Disposition Rule: To prevent an indefinite deferral of taxes, Canadian trusts are deemed to have disposed of all their capital property at fair market value every 21 years. This can trigger a significant capital gains tax liability. Planners must either wind up the trust or distribute the assets to beneficiaries before this 21-year anniversary to avoid this tax.
High Tax Rate: Income that is retained within the trust and not distributed to beneficiaries is taxed at the highest marginal tax rate. This is why trusts are often used as "flow-through" vehicles for income and gains.
Compliance and Reporting: Trusts are required to file an annual tax return (a T3 Return), even if they have no tax payable. There are also new, more stringent reporting requirements for trusts to disclose information about settlors, trustees, and beneficiaries.
Professional Advice: The rules governing trusts are complex and subject to change. It is crucial to work with an experienced team of professionals, including a tax lawyer and an accountant, to properly set up and administer a family trust to ensure it meets its intended purpose while complying with all tax laws.

For knowledgeable and experienced tax law representation for family trusts and other tax and estate planning strategies, contact tax lawyer Christopher R. Neufeld at Chris@NeufeldLegal.com or call 403-400-4092 (Calgary, Alberta) / 905-616-8864 (Toronto, Ontario).

Why would I implement an Estate Freeze? What are the benefits?
An estate freeze is an important estate planning strategy where you have significant appreciating assets, like businesses and/or real estate, from which you are seeking to manage and minimize the tax burden on these assets, ensuring a more efficient transfer of wealth to future generations. . . . Continue reading.

What scenarios can take advantage of an Estate Freeze?
Serious analysis and investigation should be undertaken, and consideration to the implementation of the appropriate estate freeze, where you have significant appreciating assets, like businesses and/or real estate, that you are seeking to manage and minimize the tax burden on these assets, so as to ensure a more efficient transfer of wealth to future generations, in particular in the following scenarios. . . . Continue reading..

What are Common Estate Freeze Strategies?
When contemplating the use of an estate freeze strategy, the appropriate strategy will be determined by the asset(s) that are to be frozen, your particular tax situation, the objective outcomes being sought, among other factors, such that an appropriate tax strategy and procedure might be pursued to realize optimal results. . . . Continue reading.

What are Potential Risks / Disadvantages of an Estate Freeze?
As with every legitimate tax planning strategy, it almost goes without saying, that there are potential risks and disadvantages with instituting an estate freeze. Nevertheless, it is through the recognition of the potential risks and disadvantages that you might be able to either avoid their occurrence or minimize their adverse impact, such that understanding these risks and concerns is an important facet in getting the most out of an estate freeze. . . . Continue reading.

Can an Estate Freeze be Reversed (Thawed)?
As the name implies, an estate freezes effectively freezes those assets that have been subjected to the legal procedure of an estate freeze. Nevertheless, there may well arise circumstances at a later date that you no longer benefit from having those assets effectively frozen. In those circumstances, is there a legal process to reserve your original actions, such that you are effectively thawing or defrosting particular assets that were frozen pursuant to your earlier estate freeze. . . . Continue reading.

Estate Freeze: Reasons & Benefits

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