Chapter 21 Trusts And Estate Planning 2008 Clarence

What is a Trust? Property Settlor Benefits Trustee Beneficiaries Legal Ownership © 2008 Clarence

Legal Vs. Tax A trust is not a separate legal entity © 2008 Clarence

Trust Vs. Estate In general, the term estate refers to the property and possessions

Trust Vs. Estate ITA 104(1) In this Act, a reference to a trust or

Establishing a Trust Requires three certainties – Certainty of intention – Certainty of property

Establishing a Trust Who Cares? If a trust is not clearly established, there may

Non-Tax Uses Of Trusts Administration of assets Creditor proofing Privacy (wills require probate, trusts

Classification of Personal Trusts Testamentary Inter Vivos Spousal or common-law partner Other beneficiaries Alter

Taxation of Trusts Property At FMV Property At Trust’s Cost Trust Property Settlor Capital

Rollovers to a Trust In general: Contributions are a disposition at fair market value

Rollovers to a Trust Spouse or Common-Law Partner Inter Vivos ITA 73(1. 01)(c)(i) The

Spouse or Common-Law Partner Testamentary ITA 70(6)(b) A trust, created by the taxpayer's will,

Alter Ego Only Inter Vivos ITA 73(1. 01)(c)(ii) The individual is entitled to receive

Joint Spousal or Common-Law Partner ITA 73(1. 01)(c)(iii) either – the individual or the

Rollovers to a Capital Beneficiary General Rule: Transfer at trust’s tax cost Exceptions for

21 Year Deemed Disposition Deemed disposition/acquisition every 21 years Limits the deferral of capital

Net Income of a Trust In general: Follows the ITA 3 rules as applied

Net Income Adjustments Deductions available for: – Amounts paid or payable to beneficiaries –

Net Income Adjustments Preferred Beneficiary Election – Income retained in trust, taxed in hands

Net Income Adjustments Amounts deemed not to be paid – A distribution that is

Net Income Adjustments Amounts retained for a beneficiary under 21 years of age –

Taxable Income of a Trust Same deductions as those available to individuals Net Income

Income Allocations to Beneficiaries To be deductible, amounts must be paid or payable Not

Determination of Distributions Discretionary – Amounts at the discretion of trustee – Timing at

Flow Through Provisions Dividends distributed – Beneficiary will gross up – Beneficiary will get

Flow Through Provisions Capital Gains – If distributed One-half tax free – If retained

Flow Through Provisions Tax on split income – A tax on specified types of

Flow Through Provisions Business Income – Must be calculated at trust level – Will

Flow Through Provisions Principal Residence Exemption – Owned by trust – Ordinarily inhabited by

Trust Tax Payable Testamentary Trusts Taxed the progressive rates applicable to individuals Multiple testamentary

Trust Tax Payable Inter Vivos Trusts Undistributed income taxed at maximum rate of 29

Tax Credits Many not available (e. g. , medical expenses) Available – Donation tax

Alternative Minimum Tax Applicable To Trusts The $40, 000 exemption is only available to

Income Attribution Applicable to spouses, common-law partners and related minors Applicable to transfers to

Reversionary Trusts Attribution to settlor: – If the transferred property can revert to settlor

Purchase or Sale of an Interest in a Trust Income Interest – Cost usually

Tax Planning Family Trust established for family members Can be used to enforce behaviour

Tax Planning Spousal Trusts Can provide for management of assets Can ensure appropriate distribution

Tax Planning Alter Ego and Joint Avoidance of Probate – Costly – Time consuming

Estate Planning Non-Tax Considerations – Intent of testator – Preparation of final will –

Estate Planning Tax considerations – Pre-death planning – Planning in the year of death

Estate Freeze Objectives – Transfer income to low tax beneficiaries – Freeze value of

Estate Freeze Techniques Gifts – Transfers growth and income – Generates current income unless

Estate Freeze Techniques Instalment sales – Could use capital gains reserves – Would require

Estate Freeze Techniques Establishing an inter vivos trust – Transfers income and future growth

Estate Freeze Techniques Holding company – Can accomplish most objectives – Without rollover, will

Estate Freeze Techniques Rollover under ITA 85 or ITA 86 – Can accomplish all

GST and Trusts A trust is a person under the Excise Tax Act Distributions

Slides: 50

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Trust Vs. Estate ITA 104(1) In this Act, a reference to a trust or estate (in this subdivision referred to as a "trust") shall, . . . ITA views “estate” as the property of a deceased individual prior to its distribution ITA requires a “trust” return for the income of an individual’s estate © 2008 Clarence Byrd Inc. 5

Establishing a Trust Who Cares? If a trust is not clearly established, there may be unexpected tax consequence (e. g. , income taxed in hands of settlor rather than beneficiaries). © 2008 Clarence Byrd Inc. 7

Taxation of Trusts Property At FMV Property At Trust’s Cost Trust Property Settlor Capital Beneficiaries Trust Income Retained Income (taxed in trust) © 2008 Clarence Byrd Inc. Distributed Income (beneficiaries taxed) Income Beneficiaries 10

Rollovers to a Trust In general: Contributions are a disposition at fair market value Exceptions – Spouse or common-law partner – Alter ego – Joint spouse or common-law partner © 2008 Clarence Byrd Inc. 11

Rollovers to a Trust Spouse or Common-Law Partner Inter Vivos ITA 73(1. 01)(c)(i) The individual's spouse or common-law partner is entitled to receive all of the income of the trust that arises before the spouse's or common-law partner's death and no person except the spouse or common-law partner may, before the spouse's or common-law partner's death, receive or otherwise obtain the use of any of the income or capital of the trust. © 2008 Clarence Byrd Inc. 12

Spouse or Common-Law Partner Testamentary ITA 70(6)(b) A trust, created by the taxpayer's will, that was resident in Canada immediately after the time the property vested indefeasibly in the trust and under which (i) the taxpayer's spouse or common-law partner is entitled to receive all of the income of the trust that arises before the spouse's or common-law partner's death, and (ii) no person except the spouse or common-law partner may, before the spouse's or common-law partner's death, receive or otherwise obtain the use of any of the income or capital of the trust. © 2008 Clarence Byrd Inc. 13

Alter Ego Only Inter Vivos ITA 73(1. 01)(c)(ii) The individual is entitled to receive all of the income of the trust that arises before the individual's death and no person except the individual may, before the individual's death, receive or otherwise obtain the use of any of the income or capital of the trust. © 2008 Clarence Byrd Inc. 14

Joint Spousal or Common-Law Partner ITA 73(1. 01)(c)(iii) either – the individual or the individual's spouse is, in combination with the other, entitled to receive all of the income of the trust that arises before the later of the death of the individual and the death of the spouse and no other person may, before the later of those deaths, receive or otherwise obtain the use of any of the income or capital of the trust, or – the individual or the individual's common-law partner is, in combination with the other, entitled to receive all of the income of the trust that arises before the later of the death of the individual and the death of the common-law partner and no other person may, before the later of those deaths, receive or otherwise obtain the use of any of the income or capital of the trust. © 2008 Clarence Byrd Inc. 15

Rollovers to a Capital Beneficiary General Rule: Transfer at trust’s tax cost Exceptions for transfers out of: – Spouse or common-law partner trust – Alter ego trust – Joint spouse or common-law partner trust © 2008 Clarence Byrd Inc. 16

Net Income Adjustments Deductions available for: – Amounts paid or payable to beneficiaries – Trustee’s or executor’s fees – Amounts paid by the trust on behalf of beneficiaries © 2008 Clarence Byrd Inc. 19

Net Income Adjustments Preferred Beneficiary Election – Income retained in trust, taxed in hands of beneficiary – Only applicable to beneficiaries Who are eligible for the disability tax credit; or Can be claimed as an infirm dependant over 17 © 2008 Clarence Byrd Inc. 20

Net Income Adjustments Amounts deemed not to be paid – A distribution that is taxed in the trust rather than in the hands of the recipient beneficiary – Reasons for using Lower rates Avoidance of instalments Use of trust losses © 2008 Clarence Byrd Inc. 21

Net Income Adjustments Amounts retained for a beneficiary under 21 years of age – Retained in the trust but taxed in the hands of the beneficiary – Beneficiary must be under 21 during the year – Amounts must vest irrevocably with the beneficiary. © 2008 Clarence Byrd Inc. 22

Income Allocations to Beneficiaries To be deductible, amounts must be paid or payable Not considered payable if: – A beneficiary can only enforce payment of an amount of income by forcing the trustee to wind up the trust. – The beneficiary’s right to income is subject to the approval of a third party. – Payment of income is at the trustee’s discretion. – The beneficiary has the power to amend the trust deed and must do so to cause the income to be payable. © 2008 Clarence Byrd Inc. 24

Determination of Distributions Discretionary – Amounts at the discretion of trustee – Timing at the discretion of trustee Non-Discretionary – Amounts and their timing specified in trust agreement © 2008 Clarence Byrd Inc. 25

Flow Through Provisions Dividends distributed – Beneficiary will gross up – Beneficiary will get credit Retained in trust – Trust will gross up – Trust will get credit Will retain eligible/noneligible status © 2008 Clarence Byrd Inc. 26

Flow Through Provisions Tax on split income – A tax on specified types of income – Applicable to those under 18 If specified income earned in trust: – It will be subject to this tax if beneficiary is under 18 © 2008 Clarence Byrd Inc. 28

Trust Tax Payable Testamentary Trusts Taxed the progressive rates applicable to individuals Multiple testamentary trusts – If same beneficiaries – May be taxed as one trust Tainting – May lose testamentary status if contributions by living person © 2008 Clarence Byrd Inc. 31

Tax Credits Many not available (e. g. , medical expenses) Available – Donation tax credits – Dividend tax credits – Foreign tax credits – Investment tax credits – Political contributions tax credit © 2008 Clarence Byrd Inc. 33

Income Attribution Applicable to spouses, common-law partners and related minors Applicable to transfers to a trust where the beneficiary is a spouse, common-law partner, or related minor Occurs when income is allocated to such individuals © 2008 Clarence Byrd Inc. 35

Reversionary Trusts Attribution to settlor: – If the transferred property can revert to settlor – If the settlor can determine the persons that will receive the transferred property – The transferred property cannot be disposed of except with transferor’s consent © 2008 Clarence Byrd Inc. 36

Purchase or Sale of an Interest in a Trust Income Interest – Cost usually nil – Gain will be property income Capital Interest – May have a cost – Gain or loss will be capital © 2008 Clarence Byrd Inc. 37

Tax Planning Spousal Trusts Can provide for management of assets Can ensure appropriate distribution of assets subsequent to death of spouse (settlor’s children in the event of spouse re-marriage) © 2008 Clarence Byrd Inc. 39

Tax Planning Alter Ego and Joint Avoidance of Probate – Costly – Time consuming – Multiple jurisdictions – Probate in public domain Establishment in low tax jurisdiction (e. g. , Alberta) © 2008 Clarence Byrd Inc. 40

Estate Planning Non-Tax Considerations – Intent of testator – Preparation of final will – Preparation of living will – Ensuring liquidity – Avoiding family disputes – Expediting the transition © 2008 Clarence Byrd Inc. 41

Estate Freeze Objectives – Transfer income to low tax beneficiaries – Freeze value of assets – Avoid immediate taxation – Transfer future growth – Retain control of assets Not always possible to achieve all of these goals © 2008 Clarence Byrd Inc. 43

Estate Freeze Techniques Gifts – Transfers growth and income – Generates current income unless transferee is a spouse or common-law partner – Attribution rules could apply – Tax on split income could apply – Transferor loses control over assets © 2008 Clarence Byrd Inc. 44

Estate Freeze Techniques Establishing an inter vivos trust – Transfers income and future growth – Will attract immediate taxation unless it is a spousal trust – Can result in income attribution and tax on split income © 2008 Clarence Byrd Inc. 46

Estate Freeze Techniques Rollover under ITA 85 or ITA 86 – Can accomplish all objectives – ITA 86 requires an existing corporation – ITA 86 is simpler in that is does not require an election © 2008 Clarence Byrd Inc. 48