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Family Trusts for Business Owners , Are They For You?

Introduction and Overview

The goal of this newsletter is not to define a “Trust”; please contact us if you want this concept explained to you. However, we will give you a brief overview.

A Trust exists where a person places property with someone else (a Trustee) to hold for the benefit of another person or persons (the Beneficiaries). A Trust can have some very important uses, both before and after death. The tax consequences vary depending on whether the Trust is created during life or upon death. Common uses include setting money aside for family members who cannot handle money responsibly, or to ensure certain assets go to your children if your spouse remarries. Another use is to protect assets from creditors in case the beneficiary falls into financial hardship.

Uses of Trusts for Business Owners

So where is a Family Trust applicable to you as a business owner? Estate planning is an important reason, combined with the following other common uses:

  1. Business succession
  2. Confidentiality
  3. Creditor proofing
  4. Income tax savings

Business Succession

Do you believe your children will be interested in continuing your business? Do you know which of your children will be interested? Do you know how you wish to divide up ownership of the business?

Once you are ready to deal with the issue of passing on your business for retirement and estate purposes, rather than making a final decision, you can transfer your ownership to a Trust. You, your spouse, and all of your children can be beneficiaries of this Trust. Not knowing what will happen in the future, you can make the Trust “discretionary”, allowing the Trustee to have control over how the income and shares of the company will be divided. You can appoint yourself as Trustee (and possibly some other people jointly, for reasons not discussed in this article). What does this do? As some future time, when you are ready to relinquish control and know how you wish to divide your ownership, you can transfer the shares of your corporation from the Trust to the beneficiaries. On the other hand, since you are also a beneficiary of the Trust, you can allocate the shares to yourself if you so wish. Therefore, tax issues should be considered carefully, especially if you plan to be a beneficiary or Trustee.

What if you sell your business to outside parties? The company can be sold with the proceeds of the shares received by the Trust. The Trustee can then allocate the cash and related capital gains to the beneficiaries as desired, and possibly multiply the use of the lifetime capital gains exemption, significantly reducing income taxes.

Estate planning goals and tax reduction are not always achievable in the same way.

Confidentiality

Your Last Will and Testament does not govern assets held in a Trust. As a result, the Trust assets are not subject to probate, not only avoiding probate fees but also not becoming public record. Business owners and wealthier individuals often prefer to keep their estate value private, and use of a Trust is a way of doing this. In addition to regular Trusts, the government allows the use of two special Trusts, called Alter Ego Trusts and Joint Partner Trusts, to accomplish this objective for individuals who are age 65 or over.

Creditor Proofing

Assets held in a discretionary Trust for more than one beneficiary may be secure from creditors in the event of financial problems. Since the Trustee has the power to allocate the income and property to any of the beneficiaries, lawyers have successfully argued that a creditor is unable to sieze any of the Trust assets. Any one particular beneficiary has no right to the property until it is allocated by the Trustee. A Trust can be used to protect your assets or those of your family, and can do so before or after your death.

Income Tax Savings

If you establish a Family Trust, it will become an owner of your business. If you are the primary shareholder of the business, and you establish a Family Trust with a number of beneficiaries, the income distributed from the corporation can be allocated over a greater number of people. Assume you are the sole owner of your business at the present time. All of your income is taxable to you as self-employment income if you are not incorporated, or taxable to you as wages or dividends when eventually removed from an incorporated business. Now, assume you set up a Family Trust where you have your spouse and children as beneficiaries (which will require you to incorporate, if you are not already). As long as the beneficiaries are 18 years of age or older, the corporation can distribute dividends to the Family Trust, and the Family Trust can allocate those dividends to the beneficiaries. As long as the tax bracket of any beneficiaries receiving dividends is lower than your bracket, less taxes would be payable. Of course, the beneficiary is receiving this money, and it is no longer available for your own personal use. For this reason, Family Trusts are often considered for higher income families, and particularly where parents are planning to help out their children with education costs and other needs as young adults.

As noted above under our business succession discussion, taxes can also be saved by multiplying the use of the lifetime capital gains exemption if the corporation is sold.

Risks, Costs & Other Concerns

You should understand a Trust before you create one. Once established, it can be a challenge to modify or undo at a later date if you change your mind or unexpected circumstances arise.

You need proper documentation to create a Trust. For example, a Trustee has a legal duty to be “evenhanded” among beneficiaries and is legally liable to carry out his or her duties responsibly and with proper diligence. In a discretionary Trust, the documentation upon creation of the Trust should indicate the extent to which the Trustee may exercise discretion. A good Trust lawyer is also required to ensure a legal Trust is established and enforceable. Ongoing documentation includes maintaining minutes for meetings of the Trustees, a bank account, bookkeeping and annual filing of tax reporting forms.

Costs will vary depending on which professionals are used and what type of Trust you are setting up. On average, we see fees from $2,000 to $5,000 expended to set up a Trust, and $1,000 to $2,000 per year for bank account fees, tax planning and filing of tax reports. Trusts are very technical arrangements. For tax reasons, the Family Trust is usually established by the
contribution of a gold coin or a dollar bill, often given by a grandparent. Trusts have been found to be void by CRA because the Trustees could not find the original property, or because the grandparent didn’t know about the Trust. Work with reliable advisors and ensure proper trust records are kept, including minutes of Trustee meetings. The banking transactions must flow from the company to the trust, and then to the beneficiaries. Your bookkeeping and documentation is important, and there are no shortcuts.

Discretionary family trusts create unique challenges in a family breakup situation. Questions arise when a husband and wife (or life partners) go their separate ways and need to divide their assets and determine their incomes for support purposes. The discretionary nature of the trust prevents clear answers to these questions, and can result in substantial legal costs for separation and divorce.

Conclusion

In conclusion, a Trust can have many benefits, but before setting one up, consider the following issues by talking with a qualified professional lawyer and accountant:

  • the financial benefits to be obtained;
  • the set-up and ongoing costs to be paid;
  • long-term social effects on the family – will it affect family relationships?;
  • annual bookkeeping and reporting requirements;
  • the likelihood of unfavourable attacks by the government;
  • your ability to understand the whole deal without constantly relying on other people;
  • if circumstances change, how can the Trust be changed or wound up?

These are issues not to be taken lightly. Our firm believes tax savings are important, but the use of a Trust should be considered in light of both personal and financial circumstances. When procedures are carried out solely for tax reasons, the benefits may be short-term and costly in the long run. As a result, we only recommend Trusts to our clients when we feel the situation is appropriate. However, we prepare information such as this article so you can contact us if the topic interests you and you would like to explore the matter further.

Blair Corkum, CPA, CA, R.F.P., CFP, CFDS, CLU, CHS holds his Chartered Professional Accountant, Chartered Accountant, Registered Financial Planner, Chartered Financial Divorce Specialist as well as several other financial planning related designations. Blair offers hourly based fee-only personal financial planning, holds no investment or insurance licenses, and receives no commissions or referral fees. This publication should not be construed as legal or investment advice. It is neither a definitive analysis of the law nor a substitute for professional advice which you should obtain before acting on information in this article. Information may change as a result of legislation or regulations issued after this article was written.©Blair Corkum