Getting Assets into and Funding your Family Trust - Part 4

Family Trusts should avoid earning active income as it could incur liability through any active income arrangements. If you want to earn income from a trust you should set up a different type of trust, such as a Limited Partnership Trust or Income Trust.

Some examples of passive income that the trust would receive are:

1. Dividends from Corporations owned by the Trust
2. Capital Gains from the sale of a Stock owned by the Trust
3. Interest from investments and promissory notes owned by the Trust
4. Rental Income from Real Estate owned by the Trust

There are many other ways to receive Passive income, however the main types of passive income you will see coming into your trust are dividends, interest, capital gains and rental income. Each form of passive income is taxed differently in the individuals’ hands, however in a trust this is not always the case. Dividends and interest income that are retained by the trust incur the highest marginal tax rate. (currently 39% in Alberta). For Capital Gains, 50% of the Gain that is retained by the Trust is taxed at the highest marginal tax rate. Rental income gets the rental expenses deducted from it, and any net income that is retained by the trust is taxed at the highest marginal tax rate.

So you must be wondering “Why I would retain income in the trust if I am going to pay the highest marginal tax rate?” Before answering this question you must have the knowledge of what marginal tax rate you are at personally. Obviously if you are already at the highest marginal tax rate personally then you may not want to take any further income from the trust. The next thing to look at is why you would need to retain income in the trust. You can simply flow through that income to the beneficiaries, which include yourself, your spouse if you are married, children if you have any, and so on. Trusts are great to flow through income, and most income that the trust receives can flow to the beneficiaries retaining the same characteristics from when it comes in to when it goes out. For example, if the trust is receiving dividends, it can typically pay dividends in the same amount to the beneficiaries. Dividends are taxed lower to individuals as we receive a dividend tax credit on these dividends and we also pay no CPP! Typically you can split the income between multiple beneficiaries which is key in tax planning!

There are many examples of how not to retain income in the trust. Another example would be to own real estate in a Corporation that is owned by the trust. This Corporation can deduct all the rental expenses and then can further pay more expenses, such as a management fee, to offset any profits. Trusts can do this as well, but there may be more benefits and options to do it in this way.

There are many more strategies that can be incurred using a trust, and there may be some specific instances where you would want to retain income in the trust, such as a Capital Gains sale where you can apply the Capital Gains Exemption. Trusts do require thought and planning and Kustom Design is here to help you plan and maximize the use of your structures, minimize your taxes, minimize your liability, create more cash flow and put your assets into the hands of the next generations without the Government taking half of them!

Getting Assets into and funding your Family Trust – Part 3

We have been discussing the 4 main ways that you can get assets or funds into a trust and each of them are dealt with differently for tax purposes:

1. Lend

2. Gift/Transfer

3. Sell/Acquire

4. Income from Business and/or investments

We’ve now gone deeper into #1 and #2, so let’s now discuss the other 2.

Similarly to gifting to a trust, when the trust is purchasing an asset in an arm’s length transaction it should purchase the asset at Fair Market Value. We’ve already discussed Fair Market Value in a prior blog, however “arm’s length” is another term we must become familiar with. Some examples of an arm’s length purchase by the trust would include purchasing assets from the Trustee, the beneficiaries, the settler or a corporation that the trust has ownership of. If the asset is purchased by the trust in a non arm’s length transaction then the Fair Market Value is not important and we can just deal with the asset at the actual purchase price.

When you are selling assets to a trust, similarly to other sales, cash is not the only form of payment that can be used. For example the trust could give a promissory note, another asset such as shares, or a combination of assets and promissory note. The same rules for the promissory note that we discussed in prior blogs would apply when it comes to interest and payments. As always with specific transactions of your trust it is best to seek Professional advice, Kustom Design is here to work with you for all your financial, accounting, tax and structuring needs.

The other main way to get assets into a trust is to simply receive income from business and/or investments. Typically the businesses and investments that the trust is receiving income from are owned by the trust. Trusts would typically receive non active income, such as dividends, interest or capital gains from these businesses and or investments.