Trusts - a tax planning tool
Country Routes February 1997
This is the second of a three part series by an associate of mine who is an accountant specializing in estate matters. He has written some articles for various publications including one for the Financial Post magazine in January of this year titled, "Ten Ways to Beat the Taxman". He has given me permission to reprint them here in my monthly column along with the Canadian Moneysaver magazine where they appeared earlier in the 1990s. His firm, Quinlan Quinlan are located at 8 King Street in Toronto. Quinlan merged with Lawless in October 1996 to bring the firm under the Campbell Lawless banner.
There has been a great deal of coverage in the financial press on the uses of a trust. Why have trusts become popular?
- personal income tax rates continue to rise. The top tax rates in Canada range from 44.4% to 52.9%. Trusts can lessen the tax burden.
- the capital gains exemption. Where sufficient capital gains exemption is available, assets can be transferred to a trust without incurring any tax on the accrued gain. A trust permits one to use the capital gains exemption without losing control of the asset. This is often referred to as "crystallizing" a capital gain.
- fear the capital gains exemption will be taken away by the new government. Again, using a trust to "crystallize" now removes this fear.
- restrictions on the use of the capital gains exemption with respect to real estate properties such as cottages. Each month since February 1992 the tax payable on the sale of a non-principal residence cottage increases even where the value of the cottage remains constant. People are "triggering" a sale to a trust to stop future tax bleeding.
- avoid probate fees on death. Given the high rate, this is especially important if you live in Ontario.
A trust is not:
- solely for the old,
- solely for the rich,
- overly complex,
- a tax scam,
- exorbitantly expensive to set up and maintain.
Uses of a trust
This article concentrates on using a trust to minimize your taxes. However, a trust is used for many non-tax reasons such as:
- avoiding family disputes,
- assisting in managing another's financial affairs,
- controlling children's money,
- providing for orderly succession of a family business.
What is a trust?
A trust is an arrangement which merely separates control and registered ownership of a property from its actual beneficial ownership. For tax purposes, a trust is a separate taxpayer. A trust must file its own special tax return if it has income and may or may not be required to pay income taxes. A trust involves three people:
i) the settlor the person who sells or gives assets (i.e. Investments, cottage, money) to a trust. The sale or gift is a disposition at the current value for income tax purposes. If the asset has an accrual gain and the settlor does not have sufficient capital gains exemption available, the settlor will pay tax on the gain. However, this tax may be less than the future tax liability that will arise. A settlor of a trust can be a parent who wishes to eventually pass assets to children.
ii) the beneficiaries the individual who will reap the rewards from the trust assets as "beneficial owners". Often, children are beneficiaries of a trust especially if they are under 18. The future appreciation in the trust assets will be taxed in the trust or beneficiaries' hands and not the settlor's. This is of great advantage where the settlor is at a higher tax rate than the beneficiaries.
iii) the trustees trustees manage or control the trust on behalf of the beneficiaries. The trustees are often the settlors. This permits a parent to minimize a potential tax liability without giving assets directly to a child who may not act responsibly.
A trust can be created with a trust agreement while the settlor is alive (a living or inter-vivos trust) or created on a settlor's death by way of a will (a testamentary trust). A trust can be discretionary (trustees have significant freedom in administering the trust) or non-discretionary (trustees' responsibilities are laid out in the trust agreement/will). A settlor can structure a trust to permit significant flexibility. Common trusts include: Family cottage trust, Income splitting trust, Spousal trust and Multiple testamentary non-spousal trusts.
If you have any questions about a more in-depth explanation of trusts, please call Reg Borrow at (519) 855-6639. He is an Independent Financial Consultant for Regal Capital Planners Ltd.
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