An important thing to consider in your wealth planning process is how the taxes work with family trusts. A family trust is viewed as a taxpayer for federal income tax purposes and pays the top marginal tax rates. As such, it will enable you to avoid tax so much as to reduce your tax liability. The trust’s tax liability and that of its beneficiaries can be reduced in several different ways.
Are family trusts taxable?
A trust is a taxable entity in Canada and is required to report its income and expenses on a Trust Income Tax and Information Return (T3 return). It has to pay tax at the highest personal marginal tax rate on all of its taxable income without the benefit of any personal tax credits. That being said, a trust can reduce its tax bill by distributing income to its beneficiaries. The beneficiaries will then have to report this income on their tax returns. By carefully planning the distribution of income between the trust itself and its beneficiaries, the overall tax liability of the trust and its beneficiaries can be reduced.
How to reduce your tax with a family trust
Tax reduction can be accomplished by using a variety of tactics, including income splitting, capital gains exemption and incorporating your trust in your estate planning.
- Income splitting: The trustees have the power to distribute the trust’s income to any of the beneficiaries, including those who might fall into a lower tax bracket. This reduces the trust’s tax bill and provides income for its beneficiaries – potentially with minimal tax implications. If a beneficiary has no other income, they can receive up to $35,000 in dividends annually without having to pay a significant amount of personal income tax.
- Capital gains exemption: Each beneficiary can utilize their Capital Gains Exemption on the sale of the corporation’s shares. The more beneficiaries the trust has, the more Capital Gains Exemptions are available to it, which can lead to significant savings.
- Estate planning: If you transfer your shares into a family trust, your beneficiaries will not inherit those shares directly; they will remain as the trust’s property. This means that the beneficiaries can avoid paying estate tax on the shares so long as they are held by the trust. Individual shareholders can thus cap the value of the shares that are subject to estate taxes, ensuring that the maximum possible amount of wealth can be passed on to the next generation.
Nour Private Wealth (NPW) is a Canadian company with a team of wealth advisors servicing clients across seven provinces. We are committed to helping high net-worth families and individuals manage their wealth, grow their assets and plan their estates for a tax-efficient transfer. Contact us today for more information on setting up a family trust and what is required to get the process underway.