Family trusts have the potential to provide important benefits for you and your family. One of the main incentives is tax-efficient transfer of wealth. If a family trust is right in your situation, how do you go about establishing one? The first step is speaking with a tax professional who can advise you about the Income Tax Act and assess if a family trust would be beneficial in your situation.
If your tax professional determines that you and your family would benefit from a family trust, the next steps are to draft and settle the trust, based on your tax professional’s instructions. It’s technically possible to set up a trust without a lawyer, but it’s not recommended. Trusts are complex legal instruments. If not properly structured, the trust may trigger unintended tax consequences and fail to achieve your goals.
At Onyx Law Group, we specialize in estates planning, trusts and family law, so you can be certain that your family trust is appropriately drafted and settled. If you want to know more about our estate planning services or wish to discuss your unique circumstances, we welcome you to reach out to us to arrange a consultation.
Setting up a family trust involves several key steps, including creating a formal trust deed, appointing a trustee, and transferring assets to the trust. In this post, we’ll discuss those steps in detail, provide additional information about potential tax benefits, and answer some family trust FAQs.
Key Parties in a Trust in Canada
A trust is a legal arrangement that is used to hold, manage, and distribute property and assets. Trust assets can be money, real estate, a cottage or vacation property, business interests, investments, etc.
A person (the “settlor”) creates the trust. The settlor transfers legal title to property to another person (the “trustee”) to hold for the benefit of another person or people (the “beneficiaries”). The trustee is the legal owner of the trust property, while the trust’s beneficiaries maintain a beneficial interest in the trust property.
Trust Deed is the Controlling Legal Document
The trustee(s) must manage the trust assets in accordance with the terms of the trust document; a legal document sets out details, including the objective of the trust, trustee responsibilities, and beneficiary rights. The trust document specifies what the beneficiaries of the trust are entitled to receive (only the trust’s income; both income and capital, etc.).
The trust document can give discretion to the trustee to determine how trust assets are to be used or distributed to beneficiaries, or it can be non-discretionary (the trustee is required to make distributions from the trust in accordance with specific instructions). Family trusts are usually discretionary.
How is Trust Treated for Tax Purposes?
A trust is not a legal entity but is treated as a separate legal entity for tax purposes. T3 tax returns are required for each year of the trust’s existence. There will be tax payable on undistributed income, and you’ll need to budget for related accountant fees to prepare annual tax filings.
What Is a Family Trust and Why Set One Up?
Family trusts are a specific type of irrevocable trust in which a person settles specific assets—usually shares in a corporation or a portfolio of investments—with a trustee to hold for the benefit of one or more beneficiaries such as a spouse, children, or grandchildren.
If a family trust is right for you, it will likely be to take advantage of income tax benefits. In addition to reducing your family’s overall income tax burden, the benefits of a family trust can also include:
- Reducing taxes payable at death
- Asset protection
- Preservation of wealth for future generations
- Protecting beneficiaries
- Increased confidentiality/privacy
- Transferring ownership while retaining control over assets until retirement (business succession/retirement planning)
Family trusts can also be used to reduce family conflicts and ensure the smooth transfer of wealth within your family as part of your overall estate plan.
Common Types of Family Trusts in Canada
Trusts can be established in several different ways. The two main categories of trusts are:
- Inter vivos trust (established during the settlor’s lifetime)
- Testamentary trusts (created in a person’s will)
Within those two categories, there are many options, such as an alter ego trust, a joint partner trust (for seniors), and a qualified disability trust (for beneficiaries with disabilities). A family trust is a type of inter vivos trust.
When Should You Consider a Family Trust?
You should consider the pros and cons of establishing a family trust as part of your overall estate plan. This is particularly true for private business owners and those who own substantial capital property that’s expected to appreciate in value. Family trusts have the potential to reduce taxes in a number of ways (income splitting, ability to distribute income to those in lower tax brackets, multiplying the lifetime capital gains exemption on the sale of shares of a qualified small business corporation, etc.). Tax considerations for family trusts are discussed in more detail below.
Family trusts are often used as part of an estate freeze to address succession of a family business and transfer wealth to future generations on a tax-deferred basis. An estate freeze works by “freezing” the current value of private company shares you hold. New growth shares are issued to the family trust.
If done correctly, an estate freeze lowers your income tax bill and caps probate fees and taxes payable at your death. Future growth accrues to the new shareholders (e.g., your children, your grandchildren). You, as the “freezor” can retain control of the company as a trustee of the family trust and/or by attaching special voting rights to your shares.
Step-by-Step: How to Set Up a Family Trust in Canada
A family trust must be properly settled to maximize benefits and manage risks.
Step 1 – Define Your Objectives
The first step is to clarify the objectives you hope to achieve (tax savings, protecting assets, deferring capital gains, confidentiality/privacy, avoiding probate fees, succession planning, etc). We recommend first speaking with a tax professional (accountant, tax lawyer) who can advise you about applicable tax laws and evaluate whether a family trust would be of benefit in your situation.
Once your tax professional has determined that you would benefit from a family trust, our Vancouver estate lawyers will work with you and your tax professional to draft and settle the family trust, based on their instructions.
Step 2 – Choose Your Trustee and Beneficiaries
A family trust can have multiple trustees and multiple beneficiaries. Trustees are often the parents, grandparents, or other senior family members, but a trusted financial advisor or professional trustee can also be named.
Beneficiaries are family members such as children, grandchildren, parents, or a spouse, for example. It’s also possible to include a corporation as a beneficiary, provided the company is owned entirely by one or more of the beneficiaries of the trust.
Step 3 – Draft the Trust Agreement
You should work with tax and estate professionals to prepare the trust document. The trust deed specifies the trust’s purpose and outlines the trust’s terms and conditions. This important legal document should encompass directives on trustee authority/discretion, how to manage and distribute income from the trust, whether capital gains can be allocated to beneficiaries, etc.
Step 4 – Make an Initial Gift or Contribution
Once the structure is in place, an initial gift is made to the trust. You should speak to your legal and tax professionals to get advice on the implications arising from the type of property that is gifted to the family trust. Capital gains and/or property transfer tax can be triggered. Attribution rules—which are intended to prevent tax avoidance in certain situations—must be carefully considered and well-understood. Trust income may be attributed back to the settlor in certain circumstances and may prevent income splitting with lower tax bracket beneficiaries, such as a minor child.
Step 5 – Open a Trust Account and Fund the Trust
It may be necessary to open a bank account or bank accounts in the name of the family trust. A separate bank account makes it easier to monitor trust income and expenses directly associated with the functioning of the trust.
You can then fund the trust by transferring additional trust assets, such as private company shares, real estate, or other holdings. Transferring assets and property into a family trust takes them out of your personal portfolio. Proper documentation is essential to ensure transfers are legally valid.
When property is transferred to the family trust, it can trigger immediate tax consequences (e.g., disposition at current fair market value, making you responsible for the capital gains tax in the year of the transfer). Seek legal and financial advice before transferring assets to ensure you understand possible tax implications.
Step 6 – Register the Trust With the CRA (If Applicable)
Family trusts must be registered in some provinces. It’s crucial to speak with legal or tax experts to find out if registration is required in your province.
Tax Considerations for Family Trusts in Canada
The tax considerations and potential family trust tax benefits discussed in this post are general and not advice. You’ll need to consult with a tax lawyer or accountant about tax implications in your particular situation.
Income Splitting and Tax Deferral
One of the biggest potential tax advantages is that the trust’s income can be allocated to beneficiaries in lower tax brackets, minimizing the amount of tax payable (subject to attribution rules).
Tax deferral is another potential advantage. It may be possible to defer the triggering of capital gains until the trust assets are sold or distributed to beneficiaries (subject to the 21-year rule, discussed below).
Capital Gains and Lifetime Exemption
Capital gains can be allocated to beneficiaries in a lower tax bracket. That can significantly reduce capital gains tax payable, especially when trust distributions are strategically timed.
In addition, it may be possible to multiply the Lifetime Capital Gains Exemption when shares in a qualified small business corporation are held in a family trust. If specific criteria are met, future sale of shares can be sheltered from personal income tax on capital gains, up to set maximums.
Tax Credits
The dividend tax credit and personal tax credit may be claimed by family trust beneficiaries with little or no other income (e.g., students), allowing them to receive dividends tax-free.
The 21-Year Rule and CRA Deemed Disposition
Intended to prevent indefinite tax deferral, this rule deems a trust to have disposed of all of its assets at fair market value on the 21st anniversary of its creation, and every 21 years thereafter, so that any capital gains accruing on the trust assets are crystallized and taxed. It has the potential to cause a sizeable tax bill.
Annual Filing and Compliance
As discussed, a family trust is considered a separate taxpayer. A family trust must file its own T3 tax return, report its income, and pay its own income tax bill in accordance with annual tax filings. Income earned within the trust that’s not allocated to beneficiaries will be taxable to the trust at the highest marginal tax rate.
Securing Your Family’s Financial Future With a Trust
A family trust can be a versatile, powerful tool to protect and manage assets, provide financial security, avoid probate, and ultimately distribute wealth in a way you see fit.
Setting up a family trust in Canada requires careful consideration and expert guidance to ensure it aligns with your financial and personal goals. There are cost considerations and other potential drawbacks that you must carefully weigh before deciding if a family trust is right for you and your family members. Customized legal and tax advice is critical to ensure your family trust complies with Canadian tax laws and meets your goals.
At Onyx Law Group, we take care to understand our clients’ unique needs, goals, and circumstances to ensure their wealth and assets are effectively and efficiently managed. Contact the experienced team of British Columbia estate planning lawyers by calling (604) 200-8492.
Family Trust FAQs
What Documents Are Needed to Set Up a Family Trust in Canada?
Documents typically include the trust deed, bank account information, title/ownership documents, and asset transfer documents. Trustee and beneficiary information is also needed (legal names, addresses, SINs, etc.)
Can a Family Trust Be Changed Later?
It depends on the type of trust. Revocable trusts can be modified or revoked by the settlor. Unfortunately, most family trusts are irrevocable. This means they cannot be undone once established.
How Long Does It Take to Set Up a Family Trust?
The process typically takes 2–6 weeks, but it will depend on factors such as asset complexity and involvement of a notary or tax lawyer.
How Much Does a Family Trust Cost?
On average, the cost of setting up a family trust falls between $2,500 and $10,000, but it’s best to consult professionals for a tailored estimate. See here for our blog post on set-up costs and annual/ongoing costs associated with maintaining a family trust.
How Long Can a Family Trust Last?
A family trust can last for generations (but not exceeding 80 years in BC), can end at a set date, or can end when the settlor dies. A final division date can be drafted into the trust deed.
Most trust drafters will require a family trust to fully distribute its assets on the death of the person who desired to settle the trust, or on the 21-year anniversary of the trust’s settlement (unless the trustee is given the power to extend), because of the “21-year rule” under Canada’s Income Tax Act.
What Is the 21-Year Rule?
This is the “deemed disposition” rule. It deems a trust to have disposed of all capital property at fair market value every 21 years. Capital gains are crystallized and tax, which can trigger a large income tax bill.
Family Trust vs. Will: Which Is Better?
The answer depends on your goals, wishes, and the needs of you and your family members. Inter vivos family trusts aren’t subject to probate, which makes them more private and can reduce the probate tax burden on your estate. Family trusts aren’t subject to wills variation claims, which can help avoid will disputes. Wills, on the other hand, become public, and probate fees must be paid on estate assets if probate is necessary. Wills are typically much less expensive to prepare and relatively easier to change.
An estate planning lawyer can help you decide which offers greater benefits in your situation. In fact, you may want to have both, as they serve different purposes and achieve different goals.