What is a Family Trust anyway and why do you need one? We have compiled some of the most common questions that our team receives regarding trusts to fully explain the intricacies of the Inter vivos (Family Trust) world.
Q: What is a Family Trust anyway?
The industry term is “Inter vivos trust” but it is often referred to as a Family Trust. This trust is created for the benefit of either a portion or the entirety of a family and is created during the lifetime of the “settlor”, or the person settling the trust. In it’s basic form, a trust is an obligation that binds a designated person(s), known as the “trustee(s),” to deal with the “trust property” for the benefit of specified persons, known as the “beneficiaries”. When establishing a trust, a person (the settlor), transfers legal ownership of the property through a legally binding trust agreement to the trustee(s) and provides instructions as to how the property is to be used for the benefit of the beneficiaries.
Q: Why should I establish a Family Trust?
Choosing to establish a Family Trust is often a personal choice. Some things to consider are:
- Flexibility when choosing beneficiaries
- Ability to place a variety of assets into a trust
- Tax Planning/Benefits
- Income Splitting
- Estate Freezes
- Trusts for Charitable giving
- Family Planning (children from a previous marriage, beneficiaries with financial difficulties, elderly parents that require financial support, etc.)
- Personal peace of mind
Q: How are Family Trusts Taxed?
A Family Trust is considered to be a separate taxpayer. Because of this, they are required to file annual income tax returns. All inter vivos trusts adopt a year-end date of December 31st, and the deadline for filing these returns is 90 days after the year-end. This typically lands on March 31st or on March 30th in a leap year. The trust can deduct income and capital gains that are paid or payable to the beneficiaries during the year. It is the responsibility of the beneficiaries to include these amounts in filing their own tax returns using the T3 slips issued to them by the trust.
Trusts are often part of a larger tax planning strategy. The dividends and capital gains that are received by a trust will retain their identity when paid out to the beneficiaries.
Capital gains received by a trust and paid to a beneficiary will continue to be considered capital gains in the hands of the beneficiary for income tax purposes. This means only 50% of the capital gain received by the beneficiary would be taxable, which is another benefit.
Dividends that are received by a trust and distributed to a beneficiary would retain its character as a dividend and would still be taxed as a dividend in the hands of the beneficiary.
Since Family Trusts are lifetime trusts, the total taxable income of the trust is taxed at the highest marginal tax bracket. Trusts are not allowed to claim personal tax credits, and because of that, the trustees typically ensure that all income/capital gains earned by the Family Trust are paid or made payable to the beneficiaries and subsequently taxed in the hands of the beneficiaries.
An Inter vivos or Family Trust is treated as having disposed of its capital property at fair market value every twenty-one years. This “twenty-one year rule” could trigger a capital gain (or loss) taxable within the trust. Planning for the “twenty-one year rule” should commence at least 2-3 years prior to the event.
Q: What is a Promissory Note?
When a trust distributes income to a beneficiary, the income then can either be paid in cash to them or made payable. An amount is only considered “payable” in a year if the beneficiary is able to legally enforce payment through a Promissory Note. Expenses paid on behalf of the beneficiary may be recouped from the income payable to the beneficiary and therefore reduce the net Promissory Note payable. The current position of the Canada Revenue Agency (“CRA”) is that an expense may be considered only if it was made for the beneficiary’s benefit. For example, an amount paid out of the trust for the support, maintenance, care, education, enjoyment and advancement of the beneficiary. It is vital that proper documentation is kept in order to demonstrate the money was used for the benefit of the beneficiary.
Q: Why is there “Interest Paid” from the Trust?
A trust can borrow funds to acquire investments such as shares in a private company, a vacation home, securities or other assets. For this to work, the loan must have the CRA prescribed rate of interest charged on the principal. This interest must be paid each year no later than 30 days after year end. For example, if the trust year end is Dec 31st, 2023, the interest must be paid by Jan 30th, 2024. This interest is used as an expense on the trust’s tax return to reduce the income payable, and the interest that is paid to the lender must be included on the lenders T1 return as income.
Q: What are Trustee resolutions and minutes, and why do we need them?
A resolution is a decision of the trustee(s) that was made with reference to the powers available to them under the trust agreement. Minutes are the notes and written records of the resolution which is signed by the trustees. The minutes should be prepared when the trust allocated income to beneficiaries, has a promissory note payable, and or expenses paid on behalf of a beneficiary.
Please feel free to contact an RLB trusted advisor to discuss reviewing your individual situation and how establishing an Inter vivos or Family Trust may benefit you.