A trust is an agreement between a settlor (a donor) and a trustee, in which the settlor gifts property to the trustee, who manages and controls the property for the benefit of another person, people, or other entities, the beneficiaries.
Trusts can also be used to shelter property from potential liabilities or marriage breakdowns of the beneficiaries.
There are many different types of trusts. Two common, and broad, categories of trusts are inter-vivos trusts and testamentary trusts. An inter-vivos (a living) trust is a trust set up during the settlor’s lifetime; many inter-vivos trusts are referred to as family trusts.
General Info on Trusts
Generally, income or capital gains earned within a trust may be allocated to the trust’s beneficiaries in accordance with the terms of the trust deed. For discretionary trusts, the trustee has the flexibility to allocate income and capital to the beneficiaries as it deems appropriate.
Testators may want certain beneficiaries to receive the income from their property only, and have someone else receive the capital or actual property. Some cases where this might occur are:
- There is a spendthrift beneficiary whom the testator wants to maintain but doesn’t want to give a large sum of cash all at once.
- There is a mixed family situation where the testator wants to leave the income generated from their property to their surviving spouse (generally from a second marriage) during their lifetime while retaining the capital or the residual of the trust for their children from their first marriage.
- The testator has a disabled beneficiary whom, absent the trust, would lose their provincial disability benefits if they received a large inheritance. This is commonly referred to as a Henson Trust and it is not applicable in Alberta.
The testator wants to provide for a surviving spouse or children during their lifetime but wants the capital to be donated to a charity. There are a number of ways to structure charitable giving within an estate using testamentary trusts, and in certain circumstances, life insurance, which can have beneficial tax results.
Trusts are sometimes used in family corporate structures to achieve various objectives within the family structure. For example, a business owner may want the flexibility to pay ‘tax-free’ inter-corporate dividends to holding companies to save funds for a rainy day or invest in other business ventures while protecting the funds from the liabilities of the operating company, all while preserving their family’s access to their lifetime capital gains exemptions.
If a holding company owns the shares of an operating company, this could limit the owner’s access to the lifetime capital gains exemption. The operating company may have to be sold by the holding company, and not the individual. A family (inter-vivos) trust can allow a company to retain its ability to access lifetime capital gains exemptions for individual beneficiaries and also pay tax-free inter-corporate dividends to corporate beneficiaries of the trust.
This structure allows families to take advantage of each family member’s individual tax attributes, subject to the new Tax On Split Income (TOSI) rules. The lifetime capital gains exemption can be multiplied by the number of beneficiaries who have their gains exemptions available. This can yield a more tax-efficient result on the sale of a family business than if it had a single owner.
If income is not allocated to the beneficiaries of a trust, the income is generally taxed within the trust at the highest marginal tax rates in the jurisdiction where it is resident.
Testamentary Trusts vs Inter-vivos Trusts
A testamentary trust (often referred to as or created in an estate) is created on the passing of the testator and as governed by their final will. The trust property is given or donated to the executor to be managed on behalf of the beneficiaries in the will and often distributed to the beneficiaries when the estate is finalized.
An inter-vivos trust is created during the lifetime of the settlor and is governed by a trust deed. The settlor donates some property to a trustee to be managed on behalf of the beneficiaries in the trust deed and often distributed to the beneficiaries when the trust is finalized.
Alter-ego Trusts & Joint-spousal Trusts
Alter-ego trusts are set up during the lifetime of a settlor who is 65 years of age or older. They are often used to avoid provincial probate charges (not generally applicable in Alberta) or to create some degree of privacy relating to the settlor’s property when they die.
Alter-ego trusts have two benefits. First, property contained in an alter-ego trust at death does not form part of the deceased’s estate and so does not become public record in probate on the testator’s will. Second, the settlor may wish to have another person manage their property during their lifetime in anticipation of incapacity. For an alter-ego trust to be valid, 100 per cent of the income and capital distributions from the trust during the settlor’s lifetime must go to the settlor.
A joint-spousal trust is very similar to an alter-ego trust but both spouses are entitled to the income and capital distributions during their lifetimes.
Filing Trust Tax Returns
T3 returns for all types of trusts are to be filed within 90 days of the trust’s year end, which is March 31 in most cases.
Achen Henderson has extensive experience in trust and estate planning and can help you ensure you meet your goals. In fact, two of our partners are members of the Society of Trust and Estate Practitioners. We also work with an extensive network of trust and estate lawyers to meet your specific needs.
Thinking About Setting Up a Trust?
If you would like to consult a trust and estate practitioner about setting up a trust, please contact us. Our estate and trust planning and tax services are available in our accounting and bookkeeping packages for additional fees.