In the 2014 Federal Budget, the Federal Government proposed changes to the taxation of testamentary trusts that will significantly reduce the potential benefits of testamentary trust planning – and will likely make establishing an alter ego or a joint partner trust a better option for more taxpayers:

  • Taxation Changes. The proposal to apply flat top-rate taxation to certain testamentary trusts beginning with the 2016 taxation year may make alter ego and joint partner trusts more attractive – and more common – estate planning vehicles for some.
  • Alter Ego and Joint Partner Trusts. These trusts can only be established under certain conditions.
  • Benefits of Alter Ego and Joint Partner Trusts. Benefits include minimizing probate costs and delays, increased privacy of the terms and the assets held, while still achieving some of the other benefits of testamentary trusts, like some forms of income splitting.  
  • Planning Issues Around Alter Ego and Joint Partner Trusts. Some common planning issues that arise with alter ego and joint partner trusts include contribution of private company shares, charitable giving and post-mortem planning. 

TAXATION CHANGES

Testamentary trusts have made more sense than alter ego and joint partner trusts for many people for some time, but that may change:

Budget 2014 Taxation Changes. In Budget 2014, the Federal Government proposed applying flat top-rate taxation to grandfathered inter vivos trusts and trusts created by will and certain estates beginning with the 2016 taxation year.  The proposal includes exceptions for the first 36 months of an estate and for trusts for people eligible for the federal disability tax credit. Click here to read more about Budget 2014 in McInnes Cooper’s February 11, 2014 Legal Alert: Economic Action Plan 2014 – The Road To Balance: Creating Jobs And Opportunities.

Alter Ego and Joint Partner Trusts. An alter ego or joint partner trust is an inter vivos trust to which a taxpayer can transfer capital property on a tax-deferred basis. They can be very effective when a client’s objectives include privacy and probate tax minimization.  However, a disadvantage is that the assets that an individual contributes to these trusts won’t form part of her estate on her death – so testamentary trust planning can’t occur with them.

Impact of Taxation Changes. Testamentary trusts make sense for many people because the anticipated annual savings using them often exceeds the one-time probate tax savings arising from use of an alter ego or joint partner trust. However, the changes to the taxation of testamentary trusts will likely make alter ego and joint partner trusts a more attractive estate planning vehicle for some. 

ALTER EGO AND JOINT PARTNER TRUSTS

These trusts became available in 2000 and have become important estate planning vehicles:

Conditions. An alter ego or joint partner trust can only be established if certain conditions are met, including:

  • the settlor must be at least 65 years of age
  • only capital property can be transferred to the trust
  • the settlor and the majority of trustees must be Canadian residents
  • the settlor (and the settlor’s spouse, if it’s a joint partner trust) must be entitled to receive all the income arising during the settlor’s lifetime (and the lifetime of the settlor’s spouse, if it’s a joint partner trust)
  • until the settlor’s death (and the settlor’s spouse, if it’s a joint partner trust), only the settlor (and the settlor’s spouse, if it’s a joint partner trust) can receive or otherwise obtain the use of any of the trust’s income or capital 

Deemed Disposition. An alter ego trust will have a deemed disposition of its property on the death of the individual who created it. If it’s a joint partner trust, the disposition is deferred until the death of the survivor of the settlor and the settlor’s spouse.

ALTER EGO AND JOINT PARTNER TRUST BENEFITS

Alter ego and joint partner trusts have several benefits:

  • Avoid Probate. A primary benefit is that they minimize the costs and delays associated with the probate process. Upon the settlor’s death, in the case of an alter ego trust, or the death of the survivor of the settlor and the settlor’s spouse, in the case of a joint partner trust, the assets in the trust will be distributed according to the terms of the trust agreement rather than according to the settlor’s will. A grant of probate isn’t required to administer the assets and probate tax isn’t payable in connection with them.
  • Privacy. A will becomes a public document once it is submitted to probate, and the probate process may also involve disclosure of the nature and extent of the estate assets.  But a trust document is a private document – and the terms of an alter ego or joint partner trust, and the nature and extent of the assets it holds, won’t be publicly available.
  • Some Testamentary Trust Benefits. The remaining benefits of testamentary trusts can generally be achieved using an alter ego or joint partner trust.  For example, asset protection and planning for blended families can be accomplished using these trusts.  Upon the death of the settlor (and the settlor’s spouse, if applicable), assets can continue to be held in trust, allowing for the settlor’s children to income split with their families in much the same way as a family trust. 

COMMON PLANNING ISSUES

Some of the common planning issues that come up with alter ego and joint partner trusts include:

  • Private Company Shares. Any gain arising on the deemed disposition on the settlor’s (or the settlor’s spouse’s) death isn’t eligible for the capital gains deduction for qualified small business corporation shares – so it’s important for parties to give this careful consideration before contributing shares of a private company carrying on an active business to an alter ego or joint partner trust. 
  • Charitable Giving. It’s also important to carefully structure charitable gifts to avoid the Canada Revenue Agency taking the position that an amount to be paid by an alter ego or joint partner trust to a charity is a payment in satisfaction of the charity’s interest as a beneficiary of the trust rather than a gift. 
  • Post-Mortem Planning. Unique considerations arise in post-mortem planning when an alter ego or joint partner trust is involved, making it important to carefully address post-mortem planning to minimize double taxation.