Are alter-ego trusts for you?

Various types of trusts can be used in estate planning by Canadians. Among the most common are: an estate trust that holds the assets of the deceased before they are distributed according to the instructions of the will; a testamentary trust that is set up according to instructions in the will, where the assets are transferred from the estate trust to the testamentary trust on behalf of a beneficiary; and an inter vivos, or living trust, to which an individual may transfer assets while alive.

A more recent development is the alter ego trust. Despite its name, an alter ego trust isn’t a strange Jekyll-and-Hyde estate-planning strategy. Rather, it is a type of trust that’s been around since 1999 and offers unique planning opportunities for some people.

Also known as a joint spousal or joint partner trust when it’s used by a married couple or by partners of the same or opposite sex, an alter ego trust is an inter vivos trust in that it is set up while you are alive. However, its tax treatment is quite different from other types of inter vivos trusts.

Usually, when assets are transferred from your name into an inter vivos trust, those assets are deemed have been disposed, and any capital gains become taxable in the year in which the assets are transferred. With an alter ego trust, the assets may be moved into the trust on a tax-free rollover basis – and the unrealized taxes on the capital gains deferred until death or, in the case of a joint spousal/partner trust, until the death of the surviving spouse. In this way, the trust income earned would be taxed at the individual’s tax rate rather than being subject to the top marginal tax rate.

Advantageous, but not for everyone
Barry Corbin, a Toronto-based lawyer with Fraser Milner Casgrain LLP, says that alter ego trusts “are not for everyone, but they can offer a number of tax and non-tax benefits.” Among the benefits offered by these types of living trusts are a level of privacy that is not possible with a will and the potential for creditor protection, says Corbin. According to Arthur Fish, a lawyer with Borden Ladner Gervais LLP, also based in Toronto, whether an alter ego trust is suitable for you depends on your personal circumstances. You may want to consider an alter ego trust if you:

  • have enough wealth to justify the cost of setting up and administering the trust. 
  • would prefer the “certainty and rigour of trust law” over the relatively informality of the powers of attorney for managing property.
  • wish to minimize the cost of probate.

Once the trust is set up, the trust assets will be distributed according to the instructions in the trust document so probate and estate administration taxes are avoided. By contrast, with a testamentary trust, assets are distributed according to instructions in the will.

On the other hand, remember that a living trust generally cannot become a testamentary trust and, by choosing an alter ego trust, you forgo the tax advantages to your beneficiaries that may be achieved with a testamentary trust. You’ll have to measure the potential savings from minimizing probate costs against any tax savings a testamentary trust set up in your will could offer your beneficiaries.

Currently, the cost of setting up an alter ego trust starts around $2,000 and, depending on the complexity required in the trust document, could be significantly more. As well, there is a cost to prepare the annual tax return for the trust. As with any estate-planning tool, the alter ego trust can be useful, but whether it is appropriate for you ultimately depends on your individual situation and objectives.

Conditions for alter ego or joint spousal trust

  • Trust established after 1999.
  • Transferor age 65 or older.
  • Terms of trust include:
    (a) All income must be paid out during lifetime.
    (b) No other person(s) may receive  income or capital from trust.
  • Income is attributed to transferor during his or her lifetime.
  • Trust assets are disposed of at fair market value on death of transferor in the case of an alter ego trust and on the death of the last-to-die in the case of a joint spousal trust.