Although the 1999 Federal Budget has attacked certain income-splitting arrangements with family trusts, a family trust can still play an important role in your tax and estate planning, especially if you are a business owner.
What Is A Trust?
A trust is an arrangement under which a person (the “settlor”) transfers property to a “trustee” for the benefit of other persons (“beneficiaries”). The trustee has control over the property and administers the trust, while the benefits of ownership accrue to the beneficiaries.
In the past, family trusts have been used to provide a tax-effective way of splitting income with children and other family members. If properly structured, they offer the following benefits:
- flexibility in the payment of dividends to different family members
- multiple access to the qualified $500,000 small business capital gains deduction
- creditor-proofing for cash that has accumulated in an operating company
- minimization of income taxes paid by the family unit
Proposals announced in the 1999 Federal Budget could eliminate many of the income-splitting benefits of family trusts and shareholdings by minors – however, all is not lost. Many of the above benefits may still be available, but possibly not to the same extent as in the past.
In general, the proposed changes impose a new “kiddie tax” on any children under 18 years of age who receive taxable dividends from a private corporation, either directly or through a trust or other structure. This tax will effectively assess the top marginal rate of tax on this type of income, thereby eliminating any tax savings by income splitting with minor children. It is proposed that these new rules will apply to dividends paid in 2000 and subsequent years.
Where a trust has already been set up with minor children as beneficiaries and the trust holds shares in a private corporation, the structure can still be altered to retain some of its benefits.
For example, where a trust currently holds shares directly in a private operating company, a holding company can be set up between the operating company and the trust. The dividends from the operating company can generally be paid to the holding company on a tax-free basis and retained in the holding company until the beneficiaries of the trust are no longer minors. Once the children turn 18 – at which time dividends can begin to be paid out to them without imposition of the “kiddie tax” – they can receive approximately $24,000 per year in dividends without generating any tax liability (assuming they have no other income).
In addition, family trusts continue to be a useful way of providing multiple access to the $500,000 capital gains deduction. Capital gains have not been attacked by these proposed rules.
Based on your particular situation, other planning strategies may also be available. The new proposals do not trigger the demise of the family trust – they simply require that existing and future planning strategies be modified to realign with the benefits still available.
Trusts are also a valuable tool for transferring family wealth in an orderly and tax-effective manner. Through a trust, you may retain control over the assets and their income-earning potential during your lifetime.
Take the example of a widow who owns a family home and a substantial investment portfolio. She transfers the assets to a family trust of which she is the trustee and life tenant. During her lifetime, she retains control over the investments and receives the income from the trust which is taxable in her hands. Her children, as capital beneficiaries of the trust, will receive the assets on her death. Although the transfer of the assets to the trust may attract some tax, on her death, taxes and probate fees are minimized because she does not own the assets.
Professional Help Essential
Trusts can be sued for many other purposes – to fund education expenses for children, support disabled family members, and even in some cases, to protect assets from creditors. However, the rules for setting up and administering a trust can be complicated and the tax consequences can be far-reaching, so professional financial and legal advice is a must. Your adviser would be pleased to discuss the benefits that a trust may provide.
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