THE FAMILY TRUST
The family trust is a structure worth considering for holding the stocks of a private company and other valuable family assets. With its separate patrimony, the family trust may be a valuable tool to tax the income generated by the business within the trust itself or in the hands of the beneficiaries. The after tax income subsequently becomes capital that may be distributed tax-free to the beneficiaries.
There are three types of intervenors in the creation of the family trust: the settlor, the trustee or trustees, and the beneficiaries. The role of the settlor is limited to the setting up of the trust. The trustee is the person responsible for the proper management of the trust; he also holds the legal ownership of the assets held by the trust for the benefit of other family members appointed as beneficiaries. The trustee may therefore exercise the voting right related to the stocks held by the trust. However, it should be noted that the trustee must act according to the obligations stipulated in the deed of trust and in the best interest of the beneficiaries. The beneficiaries are the individuals designated to receive the income or the capital of the trust.
A trustee that is at the same time beneficiary of the trust may not act alone. In such case, the trustee will have to be assisted by an independent co-trustee that is neither beneficiary nor settlor. Together, they may exercise a large discretion in managing the assets of the trust and in allocating its income and capital to the beneficiaries.
Once the trust is set up, it remains possible to elect new beneficiaries as long as the individuals are specifically designated in the deed of trust (i.e. ascendants and descendants of any beneficiary).
ADVANTAGES OF THE FAMILY TRUST
1- Separate Patrimony
The family trust enjoys the attribute of an autonomous patrimony distinct of that of the trust actors. Its only creditors are those with whom the trust contracted, therefore limiting its liability. In a family trust where the spouse and children are beneficiaries, as it is usually the case, it may be advantageous to transfer the family residence and other substantial assets such as secondary residences, investments or vehicles, as these will be protected from any of the family members' creditors.
DIAGRAM OF A TRUST
2- Income Splitting Strategy
Using a family trust, it is possible to take advantage of the splitting of the income generated by the trust between the beneficiaries, i.e. the spouse and children. These beneficiaries are likely to benefit from a lesser tax rate than the individual that would otherwise have held the stocks directly. Significant tax savings may thereby be realized.
However, it should be noted that dividends of private companies allocated by a trust to minors are subject to the income tax at the maximum marginal rate for individuals, which is 48%. However, this rule does not apply to the interest and capital gain generated by the trust. For this reason, it is recommended to allocate this type of income to children under the age of 18 and to distribute the dividends to other adult beneficiaries.
Moreover, there may be considerable tax savings to be made for the allocation of the trust income to a child above the age of 18 for living expenses including tuition fees and other costs related to education. This plan will enable you to reduce your overall tax liability as the trust distribution will be taxed at a lower rate of tax than if it was taxed in the parents' hands.
3- Capital Gain Exemption
Each beneficiary that has received income generated by the trust may claim, on the capital gain that has been attributed to him, an exemption of $750 000 relatively to the shares that meet the specific requirements of the tax laws. With the intent of maximizing this exemption, the trust may distribute a portion of the capital gain in the event that the shares are sold. In other words, it is possible to multiply the capital gain exemption of 750 000$ by the number of beneficiaries so that each one may receive the capital gain free of tax.
4- Tax Savings at Death
Usually, when an individual dies, there is deemed disposition of the stocks that he holds in a private company and of his other property at the fair market value, with the exception of the assets that are transferred to the spouse or to a spousal trust.
Therefore, any accrued increase of value on the stocks would be taxed at approximately 24%. Holding the stocks of a private company through a trust offers the opportunity to bypass this situation, as the trust is not subject to the deemed disposition at death.
However, it should be noted that any family trust is subject to the rule of deemed disposition applicable at the 21st anniversary of its creation. As a solution, it may be appropriate to distribute the assets to the beneficiaries before the 21 year deadline.
In conclusion, the creation of a family trust may be advantageous in many respects. Not only does it offer an autonomous patrimony for asset protection, the income splitting strategy allows important tax savings. Moreover, it can be used to multiply the capital gain exemption by the number of beneficiaries and to reduce taxation at death.
Some Tax Implications of the Family Trust
- The family trust is taxed at the maximum rate applicable to the individual. A T3 will therefore have to be produced as for an individual.
- The maximum tax rate for an individual in Quebec is 48%.
- The income may be allocated to the beneficiaries
- There are many types of trusts: alter ego trust, asset protection trust, etc.