Getting Assets into and Funding your Family Trust – Part 4

Family Trusts should avoid earning active income as it could incur liability through any active income arrangements. If you want to earn income from a trust you should set up a different type of trust, such as a Limited Partnership Trust or Income Trust.

Some examples of passive income that the trust would receive are:

1. Dividends from Corporations owned by the Trust
2. Capital Gains from the sale of a Stock owned by the Trust
3. Interest from investments and promissory notes owned by the Trust
4. Rental Income from Real Estate owned by the Trust

There are many other ways to receive Passive income, however the main types of passive income you will see coming into your trust are dividends, interest, capital gains and rental income. Each form of passive income is taxed differently in the individuals’ hands, however in a trust this is not always the case. Dividends and interest income that are retained by the trust incur the highest marginal tax rate. (currently 39% in Alberta). For Capital Gains, 50% of the Gain that is retained by the Trust is taxed at the highest marginal tax rate. Rental income gets the rental expenses deducted from it, and any net income that is retained by the trust is taxed at the highest marginal tax rate.

So you must be wondering “Why I would retain income in the trust if I am going to pay the highest marginal tax rate?” Before answering this question you must have the knowledge of what marginal tax rate you are at personally. Obviously if you are already at the highest marginal tax rate personally then you may not want to take any further income from the trust. The next thing to look at is why you would need to retain income in the trust. You can simply flow through that income to the beneficiaries, which include yourself, your spouse if you are married, children if you have any, and so on. Trusts are great to flow through income, and most income that the trust receives can flow to the beneficiaries retaining the same characteristics from when it comes in to when it goes out. For example, if the trust is receiving dividends, it can typically pay dividends in the same amount to the beneficiaries. Dividends are taxed lower to individuals as we receive a dividend tax credit on these dividends and we also pay no CPP! Typically you can split the income between multiple beneficiaries which is key in tax planning!

There are many examples of how not to retain income in the trust. Another example would be to own real estate in a Corporation that is owned by the trust. This Corporation can deduct all the rental expenses and then can further pay more expenses, such as a management fee, to offset any profits. Trusts can do this as well, but there may be more benefits and options to do it in this way.

There are many more strategies that can be incurred using a trust, and there may be some specific instances where you would want to retain income in the trust, such as a Capital Gains sale where you can apply the Capital Gains Exemption. Trusts do require thought and planning and Kustom Design is here to help you plan and maximize the use of your structures, minimize your taxes, minimize your liability, create more cash flow and put your assets into the hands of the next generations without the Government taking half of them!

Getting Assets into and funding your Family Trust – Part 3

We have been discussing the 4 main ways that you can get assets or funds into a trust and each of them are dealt with differently for tax purposes:

1. Lend

2. Gift/Transfer

3. Sell/Acquire

4. Income from Business and/or investments

We’ve now gone deeper into #1 and #2, so let’s now discuss the other 2.

Similarly to gifting to a trust, when the trust is purchasing an asset in an arm’s length transaction it should purchase the asset at Fair Market Value. We’ve already discussed Fair Market Value in a prior blog, however “arm’s length” is another term we must become familiar with. Some examples of an arm’s length purchase by the trust would include purchasing assets from the Trustee, the beneficiaries, the settler or a corporation that the trust has ownership of. If the asset is purchased by the trust in a non arm’s length transaction then the Fair Market Value is not important and we can just deal with the asset at the actual purchase price.

When you are selling assets to a trust, similarly to other sales, cash is not the only form of payment that can be used. For example the trust could give a promissory note, another asset such as shares, or a combination of assets and promissory note. The same rules for the promissory note that we discussed in prior blogs would apply when it comes to interest and payments. As always with specific transactions of your trust it is best to seek Professional advice, Kustom Design is here to work with you for all your financial, accounting, tax and structuring needs.

The other main way to get assets into a trust is to simply receive income from business and/or investments. Typically the businesses and investments that the trust is receiving income from are owned by the trust. Trusts would typically receive non active income, such as dividends, interest or capital gains from these businesses and or investments.

Getting Assets into and Funding your Family Trust – Part 2

As mentioned at the end of my last blog, there are 4 main ways that you can get assets or funds into a trust and each of them are dealt with differently for tax purposes:

1. Lend

2. Gift/Transfer

3. Sell/Acquire

4. Income from Business and/or investments

Let’s start with lending to a trust. You can lend money or assets to a trust, by simply taking back a Promissory Note. This means that the Trust is taking a loan from you and is going to pay interest no less than once a year and intents to one day pay back the principal. When lending to a trust the current prescribed interest rate must be used as the minimum interest rate for the loan. You can go higher if there is a purpose for doing so. Currently the prescribed interest rate is quite low at 1% (as of the date of this blog) and has been that low for over a year now. This is extremely beneficial for loaning to a trust or Corporation as well as for spousal loans. If you have any such loans that are still at a higher interest rate, now would be the time to reissue the loan at the lower interest rate. Interest on loans must be paid within 30 days after the trust’s year end. A Family Trust has a year end date of December 31^st, so the interest must be paid by January 31^st of the following year.

Let’s now talk about gifting to a trust. Gifting to a trust is not used in many circumstances as there are many issues around gifting to a trust. As discussed in the last blog, when assets are put into a trust they must be put in at Fair Market Value. This is of course true if a gift is coming to the trust, meaning that the person gifting the assets may have a capital gain on the “deemed disposition” of the asset. If there is no gain on the asset then this would be irrelevant, however it is something that must be considered before the gifting happens. We also must look at attribution when an asset is being gifted to a trust. For example if someone gifted the trust some stocks, then the income from the stocks may be attributable back to the person who gifted the stocks. There are many considerations when looking at gifting to a trust, and in fact it may not be the best option to get assets into a trust. Typically the settlor and trustees would not want to make gifts after the set up of the trust.

Again, it is best to consult with a professional before making any movement of assets and/or funds into and out of a trust. Kustom Design is here to help you. In my next blog we will discuss the other 2 ways to get assets and funds into a trust.

Getting Assets into and Funding your Family Trust – Part 1

If you’ve been reading the series of blogs on Family Trusts, you should now have a good understanding of the how to set up a trust, the basics of using it, and the benefits and drawbacks associated with having the trust. We will now begin to discuss some of the different ways to get assets into your trust, as well as how to get funds into your trust.

As already discussed, when you are setting up a Family Trust it is best to have someone else settle the trust with a small asset, such as a silver ingot. This is the initial property of the trust and should be the only asset given to the trust without consideration. Typically when assets or funds are put into a trust there should be consideration for the asset or funds. For example if we’re going to put real estate into the trust, there must be consideration to acquire the real estate, such as currency or another form of asset in consideration for the real estate. This is a general rule although there are some small exceptions which are very specific and will not be covered in this blog series.

When putting assets into the trust we must consider the tax consequences. First of all we must understand that all assets going into a trust should be at Fair market Value. Fair Market Value is the current price that the asset would sell for on the open market. For example if it is real estate, you can look at a Market Assessment by a licensed realtor, an appraisal from a licensed appraiser, or sometimes the value on the Property Tax Assessment of the property. This means that if you own the asset that is going to be put into the trust, you will most likely have a disposition that could result in a Capital Gain. Before transactions are made that add property into a trust or take property out of a trust, you must plan for the potential tax consequence. Kustom Design can help you with the planning, but it is up to you to ensure you take the time and book the consultation.

There are 4 main ways that you can get assets or funds into a trust:

1. Lend

2. Gift/Transfer

3. Sell/Acquire

4. Income from Business and/or investments

Each of these methods are dealt with differently for tax purposes. In the next blogs we will begin to look at each of these ways to get assets and funds into a trust.

Drawbacks of a Family Trust part 2

Another issue to look at with Family Trusts is the potential attribution that could happen. The trust must use its own funds to acquire property. That is, the trustee and any other beneficiary of the trust must not ever give property to the trust. If such a person does give property to the trust, then all future growth of the trust’s property could be attributable to that person for income tax purposes. It is important that all professional fees incurred on the creation of the trust be borne by the trust itself. Fees paid by persons other than the trust could cause unintended attribution. There are ways to loan funds to the trust which we will talk about in later blogs.

This issue can also be big if you are trying to get real estate into the trust that has a lot of equity. The trust must have the capital to acquire the property. If you are the trustee, you may be able to co sign a mortgage for a trust, however you have to be careful in how you construct this transaction. What you may want to do instead, is have someone else acquire the real estate, and then have the trust acquire it from that person/entity.

One other drawback that I want to mention is in regards to non-resident beneficiaries. If you do have beneficiaries of your trust that are non-resident to Canada, you may have to take withholding tax on any distributions to these beneficiaries.

As you can now clearly from the last series of blogs, the benefits of a family trust far outweigh the drawbacks. Over the next blogs we will get into how to get assets into a trust, and then we will discuss how to get income and assets out of a trust. If you have any further questions in regards to trusts do not hesitate to contact us!

Drawbacks of a Family Trust part 1

Over the last number of blogs we’ve covered many of the benefits of the Family Trust. As you will see after we cover some of the main drawbacks of a trust is that the benefits of a family trust far outweighs the drawbacks!

One of the main drawbacks of a family trust is the cost associated with setting up the family trust. Setting up a family trust requires legal documentation being drafted, thus the majority of the cost is the legal fees to set up the trust. Fees to set up the Family Trust can range anywhere from $2,500 to $8,000, with the average cost being around $5,000 for set up. The fees vary depending on your situation. For example do you need to set up a corporation, set up a holding company, or do you have existing corporations that you want to have the trust own. Although this is costly, keep in mind it is a one time fee. Once it is set up it is quite simple to maintain annually with the major annual cost being the T3 Return filing, which Kustom Design’s T3 prices start at $350 per year. In comparison to the value you get for you and the next generations the price is minimal.

Another drawback of the Family Trust is that CRA has a 21 Year Deemed Disposition Rule. This rule states that a Trust has a Deemed Disposition on assets 21 years after they are acquired, and every 21 years thereafter. The 21 Year Deemed Disposition Rule can be avoided by distributing property to the Beneficiaries before the 21st year or by providing in the Trust that the property will indefeasibly vest in the beneficiaries prior to the deemed disposition.

Another potential issue with Family Trusts is If income is left inside a Trust, the highest marginal tax rate is paid. (Unless it is a Testamentary Trust) Also, in most cases Losses cannot be flowed through like income and gains, however losses can be claimed against Trust Income. Trusts take tax planning to maximize, when used properly they are extremely beneficial and will save you a lot of tax, however if you do not plan properly you may pay more tax.

Benefits of a Family Trust – Part 4

As we are learning there are many benefits to setting up a Family Trust. Today we will wrap up the benefits of a family trust, however we will continue this blog series on the Family Trust, including areas such as drawbacks of a family trust, how to get funds and/or assets into a trust and how to get funds/assets out of a trust. As we wrap up this section on the benefits of a Family Trust, please keep in mind that there are even more benefits than what we’ve discussed here and you should consult with us further in regards to your needs.

Another benefit of using a Family Trust is that you can multiply the Capital Gains Exemption. Currently in Canada we all have a Lifetime Capital Gains Exemption of $750,000. This lifetime Capital Gains Exemption does not have to be used at once, but is cumulative throughout your lifetime. Although we discuss this in another blog, the Capital Gains Exemption means you are exempt on the sale of qualified small business shares, qualified farm property and qualified fishing property. Each beneficiary of the trust has a Lifetime Capital Gains Exemption of $750,000. The Family Trust also has its own $750,000 Capital Gains Exemption. So if you were to sell the shares of a corporation that is owned by the Family Trust, it may be possible to make millions of dollars in gains and pay little to no tax by splitting the Capital Gain amongst the beneficiaries and leaving some in the trust. Many people build a company and sell it, the Family Trust is very beneficial in the tax planning for the building and selling your Corporation.

Yet another benefit of having a Family Trust is that you can own shares of multiple Corporations, and if structured properly you may be able to make it so your Corporations are structured in a way that they are not associated corporations. Corporations can make up to $500,000 in net income before paying very much tax (currently 14% total in Alberta), this is due to the small business deduction. When you own multiple Corporations with the same ownership you may only be able to make up to $500,000 in net income amongst all the Corporations before paying a higher tax rate as they can be deemed “Associated Corporations” However, with proper structuring it may be possible for each of the corporations to not be associated, thus allowing each of them to make up to $500,000 net paying low tax.

One more benefit I’ll share with you is that a Family Trust is a great way to pass on the use of assets to the next generation tax free. Because a Family Trust stays “Living” there is no deemed disposition upon death of the settler, trustee or beneficiaries. The reason why people are taxed so high when they pass away is due to deemed disposition. This means that all gains and income on your assets is all taxed together the day you pass away. Because a Trust stays “Living” the assets remain in the trust. To allow the next generation to have access to and use the assets in the trust you can simply make them the next trustee of the trust. You may also set up specific clauses in the trust agreement (deed or amendments) that make up rules for the next generation.

If you want to know more about how a family trust can help you, please contact us!

Benefits of a Family Trust – Part 3

As you are starting to realize from this blog series on Family Trusts, there are some great benefits to setting up a Family Trust! We will continue to discuss more benefits of a family trust, however these benefits can be tailored to meet your needs so do come and consult with us for further clarification on family trusts.

Another Benefit of having a family trust is the privacy factor. The assets of a trust are typically described as being owned by the trust. For example, the records of a Corporation will state that its shares are owned by a trust, as opposed to being owned/held by an individual. Further, the trustee of a trust can be a numbered corporation. Also, the trust can have any name such as “The Rock” instead of “X Family Trust”

You can also use a Family Trust as an alternative to a will. A will should still be done, however none of the assets owned by the trust will have to be included in the will, thus avoiding probate! The more assets you can get into the trust, the less that will have to be dealt with through the will and probate when you pass away. By using a trust, there is a reduced risk of legal challenges that are often faced by wills. Some examples include undue influence, lack of capacity and “greedy relatives”. Because the assets of the trust would not be subject to the will of anyone, those assets will not be listed or described in any court document. A will, to some extent, becomes a public document when it becomes a court document during and after the proceedings for probating a will.

A Family Trust may also be used as an alternative to Power of Attorney. In the unforeseen event that the trustee becomes incapable of dealing with the trust property, a replacement trustee could take over the role of trustee. This alternative provides more administrative ease and dignity to the trustee in the event of incapacity than would someone else obtaining a power of attorney that would be needed to deal with the property of the trustee during his lifetime (absent a trust). A Family Trust makes asset transition much more private and tax advantageous. A Family Trust allows us to plan as a family and plan generationally!

Benefits of a Family Trust – Part 2

Income splitting is another major benefit of having a family trust. When tax planning you want to have the lowest household income, and income splitting is a very important tool to minimize your taxes. Income splitting allows lower income earners to receive additional income at a lower marginal tax rate. In a trust, dividend income can be split between beneficiaries. So if dividends come into the trust, they can be distributed between all beneficiaries. However, with respect to dividends from corporations that are not listed on a prescribed stock exchange, they must be allocated to beneficiaries who have reached the age of majority, which is 18 in Alberta. Interest income that comes into the trust may also be split amongst beneficiaries as well.

The other type of passive income that a trust may receive is Capital Gains, and typically they cannot split between spouses and family members after the fact. To split Capital Gains without a trust the individuals that want to split the gain in the end have to jointly purchase the asset. This can be an issue in tax planning as you don’t always know what income brackets the joint individuals will be in when they sell the asset, or one of the individuals may not have the funds to acquire the asset. However, with a trust you can split the Capital Gain amongst the beneficiaries after the sale of an asset. This is key in tax planning as Capital Gains can be large and are typically claimed by individuals who are in higher income brackets as they originally purchased the asset.

Not only can you split the Capital Gain among the beneficiaries of a trust, but if the Capital Gain is eligible for the Capital Gains Exemption (currently $750,000 lifetime exemption) you may also utilize any or all of the trusts’ beneficiaries Capital Gains Exemption. On top of this, the trust also has its own Capital Gains Exemption of $750,000. So if you had sold the qualifying shares of your Corporation, qualifying farming property, or qualifying fishing property then you could receive Millions of dollars in tax free Capital Gains!

So as you can see tax planning with a family trust gives you a major advantage in income splitting. Remember that tax planning should be done throughout the year so please do come in to plan with us at Kustom Design. Our goal is to save you more than you pay us in accounting and/or tax preparation fees, and we typically save you a lot more! Watch for my next blogs as we continue to discuss the benefits of a family trust.

Benefits of a Family Trust – Part 1

Over the next series of blogs we will begin to talk about some of the benefits of a family trust. Everyone’s family situation is different and although we will talk about the majority of the benefits of a family trust, there are specific benefits that are only used in specific situations. For example we will not be discussing the fact that a trust, when set up properly, can shelter assets for marital purposes in the case that one spouse does not want to bring specific assets into a marriage relationship. This can be done in place of a prenuptial agreement. There are many uses and benefits of a family trust and it is always best to consult with us for your needs.

One of the biggest benefits of a family trust is Asset Protection. By growing assets in a trust, those assets can be protected from claims against the trustees and beneficiaries who will not be considered to be the owners of property in the trust, because the trust will be discretionary such that creditors of the trustees and beneficiaries possibly may not be able to seize, garnishee or otherwise attack such property.

This protection is from future creditors and claims, not pre-existing ones. For example, the transferring of assets into a discretionary trust prior to insolvency or bankruptcy will likely be subject to attack, depending upon the timing of the transfer.

When a trust is holding the assets, they are usually safe if the trustee or beneficiaries are sued for any reason. What you are doing by putting your assets into the trust and becoming the trustee is to “Control the assets without owning them” Typically the only way that someone can put a claim against the trust is if the trust has broken contract or caused damage to someone (an individual or a company). If you don’t use the trust for business purposes or contracts then this should eliminate the possibility of the trust being attacked successfully.

The Trust will hold assets such as:

• Shares of private corporations (ones that you run, or just own shares in)
• Shares of public companies (stocks)
• Real Estate
• Precious Metals (Bullion, etc)
• Investments
• Other valuable assets, or assets that you want to protect

The real key is to set up a trust and get the assets into the trust before a liability arises. It’s like when you buy fire insurance, you need to buy it before the fire…not after! Asset Protection is a major benefit of a family trust, however there are many more benefits that we will discuss in my next blogs!

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