The Family Trust has proved to be an effective way to move taxable income out of the hands of a high income earner and into the hands of lower taxed family members. The Trust can be established in the lifetime of a settlor, or upon death through the settlor's Last Will and Testament.
Every Trust has a settlor, a trustee, and one or more beneficiaries. In a Trust established by Will, for example, the person making the Will is the settlor and the executor is the trustee. In most cases, the Trust is discretionary - meaning the trustee can decide what amount each beneficiary should receive so that the trustee can allocate income to low income beneficiaries.
Family Trusts Created by Will
The advantage of a Family Trust created by Will is that if an investment is left in the Trust, the Trust can take advantage of the lower, marginal rates of taxation of investment income for a limited time, instead of the beneficiaries' higher rate of taxation. In many cases, if the spouse of the deceased is a beneficiary, this may not only lower the tax liability, but also prevent the clawback of Old Age Security or other income-based benefits, such as the GST credit. In cases whereDiscretionary Trusts are established for children, the child is made the trustee and given the discretion to allocate income to himself, to his spouse, and to his children (i.e., grandchildren of the settlor), who may not be taxed at all!Testamentary Trusts are especially valuable if you feel sure your child would use the inheritance to earn investment income.
Family Trusts Created During a Lifetime
Family Trusts are frequently established to hold shares of a corporation owned and controlled by a taxpayer. The Trust is established by a parent giving to the Trust an object of value, such as a gold coin, and appointing the taxpayer as trustee. The Trust is always discretionary in nature, meaning the income earned by the Trust can be divided or sprinkled among several beneficiaries as the trustee, in his/her sole discretion, decides. The beneficiaries are invariably the trustee and spouse and children of the taxpayer trustee. The Trust is used to purchase shares of a company owned by the taxpayer, which must be an active business. Because the taxpayer is actively involved in the business, he knows the venture is a profitable one.
Family Trusts are also used to protect mines and minerals titles. On death, mineral titles are frequently left in estates or divided among numerous beneficiaries. As unanimous consent or a court order is required to lease out oil and gas interests. Numerous beneficiaries cause unproducing titles to become burdensome and uneconomic to retain or even lease out. Trusts can grant the authority to maintain mineral titles in the name of one or more beneficiaries so that it can be dealt with without unanimous consent.
Upon death, the full value of an oil and gas interest becomes 100% taxable unless given to a spouse. When drilling is very likely, mineral titles are frequently transferred to mineral trusts to ensure that this tax liability is postponed for a further 21 years.
When Mineral Trusts are established, they can be established so that the taxable income from future production can be spread among several beneficiaries through a discretionary trust. This allows the oil and gas interest to be taxed at much lower marginal rates than the person establishing the trust.
Taxation of Family Trust Income
Unlike Testamentary Trusts, (a trust created by Will), the income of inter vivos Trusts (a trust created during the settlor's lifetime) are taxed at the maximum tax rates unless income is allocated, paid or earmarked as payable to beneficiaries. Accordingly, all income is normally paid or allocated to beneficiaries at year-end in such a manner as the trustee sees as being most advantageous.
Adult Dependent Children
Family Trusts are especially advantageous for parents of adult dependent children. While the income of a Family Trust must be paid or made payable to beneficiaries if any income is allocated at all, it is possible to make allocations of income to an adult dependent child and not pay it to the child. This is called a Preferred Beneficiary Election and is one of the best tax breaks of all for parents of adult dependent children.
Family Trusts have been the target of many legislative changes over the years - but, tellingly, never totally abolished. The fact that the Canadian Customs & Revenue Agency has reviewed the process and never attempted to totally abolish the process bodes well for the near future. Like all legislative tax planning ideas, the taxpayers are entitled to arrange their affairs to minimize taxes. With taxes taking an ever larger portion of disposable income, financial success depends upon careful tax planning and utilization of those plans that work for you.