Canadian family trust

Canadian family trust

Introduction

A family trust, in this context, is an arrangement whereby an individual may allow family members to share in the growth and value of an incorporated active business without that individual losing control over the operations of the business. In the typical situation, an individual (the “trustee” of the family trust), will hold property (shares of the active corporation) “in trust” for the benefit of family members (the beneficiaries of the trust).

Although title to the property is in the trustee's name and the property (the active corporation's shares) are under the trustee's control, the income and capital growth attributable to the shares accrues to the beneficiaries.

To the extent that income earned by the trust is paid to its beneficiaries, the income is taxed in the beneficiaries' hands. Where these beneficiaries earn little of no other income and are not subject to the "Kiddie Tax", they may pay little or no income tax on those distributions.

Note, that a typical family trust agreement is drafted so that the trustee may pay that income out to, or for the benefit of, any or all beneficiaries at his discretion as he sees fit. In that way, future problems associated with issuing shares directly to children may be avoided. Legitimately used, family trusts were a good method of splitting income, because they allowed parents to allocate income to their children's needs and pay little or no tax. A family trust is established when a person referred to as the settlor (usually a relative) gives a gift to the trustee for the benefit of (usually) other family members. (Jake Wart 2007 Pp. 144)

At the same time, a written agreement is drafted which sets out the terms whereby the trustee will hold and manage the property on behalf of the beneficiaries. As it is this agreement which gives the trustee the power to distribute funds from the trust at his discretion, the trust agreement is a critical part of any family trust arrangement. Example of the Operation of A Family Trust

Scenario 1: Income Splitting

Mr. X establishes a trust for the benefit of himself, his spouse, Mrs. X, and their three children, A, B and C. A and B are over 17 years of age and attending university. C is a minor living at home. The participating shares of Opco, Mr. X's active business corporation, are owned 100% by the trust. After salaries are paid to Mr. X, Opco is earning $100,000 before tax and $82,000 after tax. Based on current tax rates, if Mr. X wishes to pay out the net after corporate tax income of $82,000 to himself to enable him to use it personally, he would pay additional taxes of over $26,000 if he were the sole shareholder of the company.

Using the family trust arrangement and paying the income earned by the trust equally to the adult beneficiaries (except Mr. X.), the trust's dividend could be split evenly between Mrs. X, A, and ...