What is a family trust?
A family trust is a legal entity that has its own family patrimony. Like any taxpayer, it can invest, own property, and enter into contracts with other parties. The administration of a family trust is handled by the trustees, whose role is similar to the directors of a company. The trust can distribute its income to its beneficiaries, just as shareholders in a company can receive dividends from the company.
A trust must always be created during the life of an individual. However, the trust will take effect at different times, depending on the nature of the trust. A protective trust will take effect immediately, while a testamentary trust will take effect on the death of the person for whose benefit the trust was created.
Because a trust is a taxpayer, it is taxed separately and is therefore required to file its own tax returns. However, when the income of the trust is distributed to its beneficiaries, the beneficiaries are taxed on the income instead.
The purpose of this article is to provide an overview of some of the tax advantages that result from creating a family trust.
Advantages of a family trust
Multiplies the capital gains exemption
The capital gains exemption ($848,252 in 2018) on the disposition of qualified small business corporation shares (QSBCS) by the trust can be multiplied by this method. More precisely, the trust may attribute the gain resulting from the disposition of QSBCS to its beneficiaries, who may each use their capital gains exemption (representing a tax saving of approximately $200,000 per exemption).
Minimizes tax on death
A family trust will minimize and virtually eliminate the tax payable on the taxpayer’s death. The taxpayer is deemed to have disposed of all of their property at fair market value at the time of death, including the shares they held in an operating company. Assuming that the company was built up by the owner-operator and that its fair market value is substantial, this will result in significant taxes at the time of the owner-operator’s death and will thus reduce the cash available to the estate.
When a family trust is created, it results in an estate freeze, so that the participating shares of the active company are held solely by the family trust. This means that surplus value accumulates in the trust. The taxpayer will therefore not realize a gain on the shares at the time of their death. The tax on the surplus value is carried forward to the disposition of the shares by the trust.
Facilitates transfer of the family business
Using a family trust allows a family business to be more easily transferred to the children. The trust can give the shares in the family business to the beneficiaries, who are identified by the parents as the “family succession”. This avoids the significant tax burden when the parents sell the shares to their children to whom they are related.