Intervivos
For income tax purposes, the intervivos trust is deemed to be an individual.
- Therefore, the trust will calculate income, file a tax return and pay taxes in much the same way as you do.
There are some key differences from how individuals are taxed:
- A trust is not allowed to claim personal tax credits.
- An inter-vivos trust generally pays tax on all income at the top federal and provincial tax rate for individuals.
- therefore, there's often little advantage in having an inter-vivos trust pay tax on income. The trust's income should be taxed in the hands on low-income family members (known as income allocation).
- If certain conditions are met, trust income can be allocated to the beneficiaries and taxed in their hands rather than the trust. Most of the tax benefits associated with an inter-vivos trust are achieved in this manner.
Purpose
The transfer of assets to beneficiaries is better from a tax point of view if the recipient pays less tax than you would on any income earned on the asset.
This is what the trust does for us. The settlor transfers ownership of their assets to the trust, while retaining control of them.
Income or capital gains-splitting
Income splitting occurs when trust income is taxed in the hands of the beneficiaries of the trust.
- This income doesn't have to be given directly to the beneficiary. For instance, an "in trust" account can be set up for a minor. The money entering the account is then taxed in the hands of the child (Remember however that the money does belong to the child and will have to be turned over once the child reaches the age of majority).
- There are certain payments that can be made for the benefit of the beneficiary that are treated as income to the beneficiary.
- The trust may pay for a beneficiaries tuition fees and medical expenses, and the payment amount will be taxed in the hands of the minor.
This may come in handy in a situation where the settlor may have a large amount of income while other family members are not fully utilizing personal tax credits and low marginal tax rates.
- Tax savings could arise if you could transfer beneficial ownership of your income producing assets to a trust. If the income in the tax is taxed under the tax bracket of the individual family members, they'll pay less tax.
The potential benefits from income splitting were reduced for some after 1999 with the introduction of the kiddie tax.
- Under these rules, the child will pay tax on the split income at top rates and the child can't claim personal credits to reduce the tax.
- Despite the kiddie tax rules, you can still split interest income received from arm's length parties and certain other forms of income with a minor. In addition, the kiddie tax does not apply to spouses/common-law partners and adult children
For capital gains, the benefits are similar, except that if the property sold is qualified farm or fishing property or shares of a qualified small business corporation, the use of a trust may allow better access to the capital gains exemption of each family member that is a beneficiary of the trust
Estate freeze
Imagine you own shares in a company that is carrying on business. You expect the value of the corporation to increase rapidly in the future. As the value of the shares increase, the amount of tax payable upon your death increases too, due to fair market value of capital gains.
Under an estate freeze, you exchange beneficial ownership of your common shares for preferred shares with a fixed value.
- New common shares will be issued and held by a trust for your children. Future gains will accrue to them through the trust.
- This plan effectively freezes the capital gain that will arise on your death based on today's value while allowing you or your trustees to retain control over the common shares.
- It can also enhance the ability of a family to access the capital gains exemption.
Income Attribution Rules
The income paid or payable to the beneficiaries must not be subject to the income attribution rules. Whether or not these rules apply depends on how the trust was set up.
- The attribution rules can potentially apply whenever you gift property or make a loan at little or no interest to a family member, including loans and gifts made through the use of a trust.
Most important rules are:
- If you make a loan at an interest rate lower than prescribed by the government OR gift property to a trust for the benefit of your spouse, any income or capital gains from the transferred property allocated to the spouse will be taxed in your hands.
- If you make a loan or gift property to a minor child or a trust for a minor child, income from the funds allocated to the child will be taxed in your hands. In this case, a minor child includes a son, daughter, niece or nephew under 18 or some other minor with whom you do not deal at arms length. Note, however that capital gains arising from the property will be taxed in the hands of the child.
- If you gift property to a trust and you are a trust beneficiary, all income and capital gains of the trust (as well as income losses and capital losses) will be taxed in your hands. This rule will also apply if you gift property to a trust and you can later control who will receive trust property or you can control when the property is disposed of. Consequently, you should never transfer income-producing property to a trust and be a controlling trustee or beneficiary, if income splitting is desired. Trusts subject to these rules are often called reversionary trusts
- If you make a loan to a trust benefiting an adult child or other adult relative, income from the funds may be attributed to you, if the purpose of the loan was to reduce taxes. Capital gains, however, will not be attributed to you.
- If you make a low interest (or interest-free) loan or transfer property to a corporation, and a trust for other family members is a shareholder, then you could be deemed to earn interest on the loan or transfer
- this rule doesn't apply if your corporation is a Small Business Corporation.
The attribution rules should not be a concern if the rules of thumb are followed:
- Select your settlor and settlement property carefully
- A gift must be made by a settlor to create a trust. The gift should be easily segregated and should not produce income, such as a gold coin. The concern is that attribution can arise if the gift becomes intermingled with the income-producing property
- Borrow funds from a third party to purchase income-producing property.
- If the trust borrows money from a third party to purchase income-producing assets such as shares of your small business corporation, attribution can be avoided. In this case, you didn't make a loan to the trust.
- Make sure the income producing property isn't from you
- Even if a loan is obtained from a third party, attribution can still apply if the asset is purchased from you.
- In the case of a family-owned corporation, this is easily accomplished by having the trust purchase new shares directly from the corporation, rather than purchasing existing shares from you. The shares must be acquired at fair market value.
- Hold growth assets in a trust for minors
- If the trust invests in assets which will produce capital gains, such as Canadian equity mutual funds, there will be no income to attribute.
Intervivos includes many subcategories, such as:
- employee benefit plan
- personal trust
- mutual funds
- NPO
- RESP
- RRSP
- TFSA
Children
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