If you’ve got a cottage you want to share with family or a business you plan to pass on to your children, a family trust could help protect your assets and lower your tax bill. But there are costs and enhanced reporting requirements to consider. Nicole Ewing, Director, Tax and Estate Planning, TD Wealth, joins Kim Parlee to help sort through some benefits and drawbacks.
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* If you've got a cottage you want to share with family or a business you want to pass on to your children, a family trust may be something to have on your radar. But setting one up can be pricey. So is it right for you? Nicole Ewing, Director of Tax and Estate Planning at TD Wealth, joins me now to discuss what to know about family trusts, including some of the pros and some of the potential complications to consider as well.
- Nicole, you're always the person we go to on the complicated stuff. So let's start from the beginning. What exactly is a family trust? And who does it even make sense for?
* So a trust is a relationship, essentially, between the person who's contributing property to it-- that's your settlor. They are transferring it over into the control of trustees who are going to administer this on behalf of you and the terms that you've set out for the benefit of beneficiaries that you've identified. And so a family trust, there's no defined term for that.
- You won't find that term in the Income Tax Act. But it's essentially a trust that is established for the benefit of a family. And as you mentioned, this might make sense for business owners who want to transfer the property on. Perhaps we have a minor beneficiary that we need to protect and control their assets. We might have a cottage where there's many family members that are going to own this, perhaps, for generations.
- Trusts are really useful in those circumstances. And they can be, depending on your province, used in other ways, like a will substitute, a power of attorney substitute, even a prenup or a postnup. So they are very useful.
- But they are also expensive. There are a lot of administrative things to be aware of that could potentially cost you money in order to comply with. And I caution people that their general understanding about what trusts are, if it's come from TV or the movies, that's likely referring to the US. And they are very, very different rules. So our trust world and the way that we can utilize them in Canada is a little bit more limited, I would say, than what they do in the US.
* OK. Good to know. OK, so, first off, Canadian trusts more limited than the States. Secondly, let's actually start about what the benefits are, and then we'll get into some of the potential complications. But what are the benefits?
* If we start from tax benefits, we can-- for example, if you're that business owner, you might be able to multiply the capital gains exemption, making additional tax-free money getting into the hands of your family members. There might be income-splitting strategies like prescribed rate loans that we're not seeing so much of anymore because of the high interest rate. Estate freezes are often a real benefit here, where we're freezing the value of the estate in the individual's hands and allowing that future growth and that future tax liability to go into a trust.
- But there are some limitations. So every 21 years, you must either deem all of the assets in the trust to have been sold and pay your capital gains tax-- so you could potentially be accelerating that tax-- or transfer it out into the hands of the beneficiaries, which you might not be ready to do at that point. And then, depending on who your beneficiaries and your trustees are, you might actually have additional tax filing obligations.
- To the extent that you even leave any of the income in a trust, it is going to be taxed on an annual basis at the top marginal rate. So being aware of what you're using that trust for, what type of income you're earning is going to be really critical.
* And also, the one thing I do know about trusts-- and I'm not the expert, you are-- but I do know it helps with control. So that's the other benefit with trusts.
* It helps with control. It can help with flexibility. It can allow you to maybe pause making decisions for a period of time, so transfer that future tax liability into the trust, but maybe not make a decision yet about whose hands that's going to go into. So it can provide some control. It can provide that flexibility. But there are costs to doing that.
* OK, what are the costs? That's one of the cons to this, right?
* Well, a ton of new rules over the last number of years about trusts, and trust reporting, and compliance, and the administration-- we are seeing, frankly, new rules developing all the time. So for folks who may have had the Underused Housing Tax on their radar, the trust reporting rules have expanded quite significantly. There are additional levels of complexity that we wouldn't have seen in the past.
- And so making sure that you're aware of what those are-- again, I mentioned those foreign beneficiaries-- you could potentially be having filing obligations to the IRS. You could potentially be having personal liability as a trustee of these trusts simply because of who the beneficiaries and the trustees are. So there are some pretty significant administrative burdens to be aware of and potential costs to be aware of as well.
* One of those burdens, I understand, is you have to file something called a T3 return. What is that?
* Yes. So a T3 return, this is your tax filing return for a trust. And there used to be some more restricted circumstances in which you needed to file it. But essentially, now, all of your family trusts are going to need to file this T3 return and, in addition, will likely have to file what's called a Schedule 15.
- And in that, you will, as the trustee, need to report all of the personal information-- name, date of birth, tax residency, social insurance number, tax reporting number-- of the settlor, the trustees, the beneficiaries, the contingent beneficiaries, and make best efforts to gather all of that information to provide, which, again, depending on the terms of the trust and how long ago they've been drafted-- we used to draft these to include every possible scenario of beneficiary to allow for that flexibility. But in doing so, we have now increased the burden on the trustees in order to comply with these new rules.
* I guess as I hear the somewhat exhaustive list and all the things that need to be done for this, you really need to make sure this is worthwhile. You need to make sure, I'm assuming, that the assets are substantial enough to have this all make sense. So if someone is listening going, OK, I don't know, who should they talk to figure out and to evaluate this in the right way?
* Well, whenever we're thinking about any sort of strategy or planning in this way, we need to step back and look at what our goals are and identify, what is the point? What are we trying to achieve? And not start with the solution of a trust, but start with what it is you're trying to achieve.
- And then, work with your tax advisors, your legal advisors, and your financial advisors to help create a plan that makes the most sense. So we don't want any one of those individuals to be necessarily making that plan on their own. We really do need to be working together as a team to figure out what it is we're trying to achieve and the best solution possible for getting the best result.
* Nicole, it is always a pleasure. Thanks so much, and appreciate the time today.
* My pleasure.
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- Nicole, you're always the person we go to on the complicated stuff. So let's start from the beginning. What exactly is a family trust? And who does it even make sense for?
* So a trust is a relationship, essentially, between the person who's contributing property to it-- that's your settlor. They are transferring it over into the control of trustees who are going to administer this on behalf of you and the terms that you've set out for the benefit of beneficiaries that you've identified. And so a family trust, there's no defined term for that.
- You won't find that term in the Income Tax Act. But it's essentially a trust that is established for the benefit of a family. And as you mentioned, this might make sense for business owners who want to transfer the property on. Perhaps we have a minor beneficiary that we need to protect and control their assets. We might have a cottage where there's many family members that are going to own this, perhaps, for generations.
- Trusts are really useful in those circumstances. And they can be, depending on your province, used in other ways, like a will substitute, a power of attorney substitute, even a prenup or a postnup. So they are very useful.
- But they are also expensive. There are a lot of administrative things to be aware of that could potentially cost you money in order to comply with. And I caution people that their general understanding about what trusts are, if it's come from TV or the movies, that's likely referring to the US. And they are very, very different rules. So our trust world and the way that we can utilize them in Canada is a little bit more limited, I would say, than what they do in the US.
* OK. Good to know. OK, so, first off, Canadian trusts more limited than the States. Secondly, let's actually start about what the benefits are, and then we'll get into some of the potential complications. But what are the benefits?
* If we start from tax benefits, we can-- for example, if you're that business owner, you might be able to multiply the capital gains exemption, making additional tax-free money getting into the hands of your family members. There might be income-splitting strategies like prescribed rate loans that we're not seeing so much of anymore because of the high interest rate. Estate freezes are often a real benefit here, where we're freezing the value of the estate in the individual's hands and allowing that future growth and that future tax liability to go into a trust.
- But there are some limitations. So every 21 years, you must either deem all of the assets in the trust to have been sold and pay your capital gains tax-- so you could potentially be accelerating that tax-- or transfer it out into the hands of the beneficiaries, which you might not be ready to do at that point. And then, depending on who your beneficiaries and your trustees are, you might actually have additional tax filing obligations.
- To the extent that you even leave any of the income in a trust, it is going to be taxed on an annual basis at the top marginal rate. So being aware of what you're using that trust for, what type of income you're earning is going to be really critical.
* And also, the one thing I do know about trusts-- and I'm not the expert, you are-- but I do know it helps with control. So that's the other benefit with trusts.
* It helps with control. It can help with flexibility. It can allow you to maybe pause making decisions for a period of time, so transfer that future tax liability into the trust, but maybe not make a decision yet about whose hands that's going to go into. So it can provide some control. It can provide that flexibility. But there are costs to doing that.
* OK, what are the costs? That's one of the cons to this, right?
* Well, a ton of new rules over the last number of years about trusts, and trust reporting, and compliance, and the administration-- we are seeing, frankly, new rules developing all the time. So for folks who may have had the Underused Housing Tax on their radar, the trust reporting rules have expanded quite significantly. There are additional levels of complexity that we wouldn't have seen in the past.
- And so making sure that you're aware of what those are-- again, I mentioned those foreign beneficiaries-- you could potentially be having filing obligations to the IRS. You could potentially be having personal liability as a trustee of these trusts simply because of who the beneficiaries and the trustees are. So there are some pretty significant administrative burdens to be aware of and potential costs to be aware of as well.
* One of those burdens, I understand, is you have to file something called a T3 return. What is that?
* Yes. So a T3 return, this is your tax filing return for a trust. And there used to be some more restricted circumstances in which you needed to file it. But essentially, now, all of your family trusts are going to need to file this T3 return and, in addition, will likely have to file what's called a Schedule 15.
- And in that, you will, as the trustee, need to report all of the personal information-- name, date of birth, tax residency, social insurance number, tax reporting number-- of the settlor, the trustees, the beneficiaries, the contingent beneficiaries, and make best efforts to gather all of that information to provide, which, again, depending on the terms of the trust and how long ago they've been drafted-- we used to draft these to include every possible scenario of beneficiary to allow for that flexibility. But in doing so, we have now increased the burden on the trustees in order to comply with these new rules.
* I guess as I hear the somewhat exhaustive list and all the things that need to be done for this, you really need to make sure this is worthwhile. You need to make sure, I'm assuming, that the assets are substantial enough to have this all make sense. So if someone is listening going, OK, I don't know, who should they talk to figure out and to evaluate this in the right way?
* Well, whenever we're thinking about any sort of strategy or planning in this way, we need to step back and look at what our goals are and identify, what is the point? What are we trying to achieve? And not start with the solution of a trust, but start with what it is you're trying to achieve.
- And then, work with your tax advisors, your legal advisors, and your financial advisors to help create a plan that makes the most sense. So we don't want any one of those individuals to be necessarily making that plan on their own. We really do need to be working together as a team to figure out what it is we're trying to achieve and the best solution possible for getting the best result.
* Nicole, it is always a pleasure. Thanks so much, and appreciate the time today.
* My pleasure.
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