Family trusts offer business owners plenty of benefits, but they’re not without their fair share of upkeep. Whether you’ve chosen a family trust to enhance business succession and estate planning, facilitate asset protection or multiply access to the lifetime capital gains exemption, your decision to create a family trust is just the first of many steps.
To get the most out of your trust—and make sure it complies with Canada Revenue Agency rules—it’s important to manage it effectively. Specifically, you’d be well-served to pay attention to three areas—the beneficiaries’ personal and financial situations, Tax on Split Income (TOSI) rules and dividend allocations—to avoid common missteps.
1. Stay attuned to family life events
If you hope to get the most out of a family trust, you can’t simply lock it in a drawer and forget about it. Rather, it’s critical to treat it like a living document and revisit it regularly.
As you do, one thing to keep an eye on is your beneficiaries’ financial situations and inevitable life changes. For the trust to continue supporting your financial needs and goals, you must also stay on top of major life events, such as a dependant turning 18. In this case, the trust’s beneficiary may have access to low tax brackets and be eligible for tax credits you can leverage to generate tax savings. On the other hand, you may lose access to low tax brackets and tax credits if this dependent enters the workforce.
Beyond finances, natural changes in life circumstances can also affect your trust. Moving (particularly to another province or country) or getting married, for example, are common events that can alter a beneficiary’s tax credits, tax rates and tax obligations—and have a big impact on your family’s overall tax situation if left unaddressed.
2. Get clear on split income
Under the new Tax on Split Income (TOSI) rules, which came into effect in 2018, it’s harder to split income. Dividends allocated to family members through a family trust may be taxed at the highest marginal rate for the individual who receives the dividend, regardless of their income level. There is a long, complex and very specific list of exceptions, however, and if you meet one of them, income splitting is possible. The most common exceptions that apply when allocating from a family trust include:
The Excluded Business exception, which applies when the individual receiving the dividend is actively engaged in the business on a regular, continuous and substantial basis in either the taxation year or any five preceding taxation years. This active engagement can be achieved by working in the business for at least an average of 20 hours per week while the business is operating, or for businesses that require work of less than 20 hours per week, by performing duties crucial to the business’s ongoing success.
Allocation of capital gains to beneficiaries, which is allowed if the capital gain relates to shares of a corporation that, at the time of the disposal, would be considered “qualified farm or fishing property”, or “qualified small business corporation shares”. This exception continues to make family trusts a very important tool when considering multiplication of the lifetime capital gains exemption.
Beneficiaries 65 years or older can income split with a spouse. TOSI will not apply on dividends allocated to a beneficiary of a family trust if the beneficiary’s spouse has attained the age of 65 during the year and the amount itself would have been excluded from TOSI had it been received by the spouse directly.
3. Time dividend allocation wisely
If it’s appropriate to allocate dividends out of a family trust, two steps must be taken before the end of the trust’s taxation year:
- The trustees must decide how income/capital will be allocated to beneficiaries and document the decision in a Trustee Resolution; and
- The decided-upon income must be paid or payable to the beneficiaries (either by cheque or through issuance of a promissory note).
It’s important to take the right steps at the right time to avoid trust income being taxed at the highest marginal rate, resulting in a significant loss of potential savings.
Be sure to stay ahead
Proper management of a family trust is not particularly difficult—it simply requires a high attention to detail, clarity around your own goals and ongoing knowledge of your family’s changing circumstances. And if you make the effort to look after it, your family trust can provide a number of tax and non-tax benefits for years to come.
If you’ve been thinking about creating a family trust—or if you’d like to get more out of the one you already have—contact us.