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.