Using trusts effectively (2)
Let’s examine two of the most common of these: living trusts and spousal trusts.
We’ll start with a “living trust”. At its simplest, this is a trust established by you during your lifetime. It is also called an inter vivos trust. It can be one of two types, revocable (which means they can be terminated by you) or irrevocable (which means you no longer have control over the assets).
Living trusts can serve a number of useful purposes. Among the most common are to:
1) preserve your property and assets
2) reduce probate fees
3) generate donations to charities or other worthwhile causes over longer time periods
4) generate long-term income for the support of minor children, dependents, etc.
5) potentially split income with family members who are in a lower tax bracket.
However, the tax aspects need to be carefully explored with a professional advisor. The Canadian Customs and Revenue Agency (CCRA) treats trusts as though they were “individuals” for tax purposes, but they are not entitled to any of the tax credits that an individual taxpayer woulenjoy. Living trusts are also taxed at the top marginal tax rate, a fact that may be their single greatest disadvantage. Transfers of property to trusts are subject to the attribution rules, so all capital gains and income will be taxed back to the settlor. An important exception to this can be found in spousal trusts.
Spousal trusts are created, as the name suggests, for your spouse. Such trusts must adhere to two key requirements:
1) All the income from the trust must be paid to the spouse during his/her lifetime.
2) There may be no distributions of trust assets to anyone other than the spouse during the spouse’s lifetime.
Such a trust may be established as either a living or testamentary trust. An important feature of the spousal trust is that the transfer of property takes place at the settlor’s cost (the settlor is the person creating the trust). There is no triggering of accrued capital gains up to the moment of the transfer. In fact, the property is only taxed when it is disposed of, or when the spouse dies.
This works because you are “deemed” by the CCRA to have disposed of your assets at a certain adjusted cost base when they were placed in the trust, and your spouse assumes that cost base. Therefore, no capital gain will be triggered. The tax is postponed until the earlier of actual disposition of the asset by your spouse, or the spouse’s death. Several criteria must be met for this to apply.
1) You must have been resident in Canada immediately prior to your death.
2) Your property must have been transferred on or after your death to one or the other (or both) of the following: your spouse (who was also resident in Canada immediately prior to your death) or a qualifying spousal trust, such as we have described. No other person may receive any of the income or capital from the trust and the trust must be resident in Canada immediately after the property is settled in the trust.