Trust Series – Part I: What is a Trust?
You may have heard from time to time, that high-net worth individuals will use a Trust as part of their comprehensive tax planning. But what is a Trust? Does it make sense for you? What are the tax advantages? What are the drawbacks and potential tax traps? How does it work?
Our series of Trust articles will provide a high-level overview of some common considerations. You should work with your advisors directly to find the best solution for you.
What is a Trust?
A Trust describes a relationship where one party (the Settlor) contributes property for the benefit of one or more parties (the beneficiaries) and the legal title of the property is held and administered by a separate party (the Trustee) on behalf of the beneficiaries. Common examples of contributed property would be cash, investments, or a cottage.
Beneficiaries may be entitled to income (earned on the cash or investments), capital (the actual initial cash/investments or cottage) or both from the Trust depending on the terms of the Trust. Your overall goals should be discussed with your lawyer.
When is a Trust created?
Trusts may be created at the death of a taxpayer (Testamentary) or they may be created by a person during their lifetime (Inter Vivos).
The Testamentary Trust will receive property from the deceased taxpayer, paying tax on any income or capital gains earned on the property until such a time as the property is distributed to the beneficiaries of the Trust.
Inter Vivos Trusts are set up with specific tax planning goals in mind, such the split of income to lower rate taxpayers within the family (subject to the Tax on Split Income Rules), or to utilize the Lifetime Capital Gains Exemption on the sale of property for multiple beneficiaries of the Trust. Both items will be discussed in further detail in future articles in this series.
When are Trusts helpful?
Common reasons to set up a Trust are:
Tax savings and planning
Succession planning
Confidentiality and asset protection
How is the Trust taxed?
Unlike a corporation, a Trust is NOT a separate legal entity. But it is still required to file an annual tax return (known as a T3 return), due 90 days after the year end of the Trust. Trusts are effectively taxed as individuals but are subject to the highest personal rates. For this reason, most Trusts choose to allocate the income to one or more beneficiaries as they tend to be in lower tax brackets. When the income is allocated to the beneficiaries, it is taxed on the beneficiary return (and not the Trust return).
Stay tuned for our next article that will discuss some of the benefits or planning opportunities when using a Trust. Click here for Part II: Planning Opportunities with Trusts.