What are the important tax benefits of a family trust?

Family trusts are both powerful and poorly understood structures that can provide significant tax benefits for high-income Canadians. Family trusts are a complex subject and should be reviewed in-depth with your accountant and your lawyer to determine if they are a good fit for you. Today I’m going to discuss two of the most important tax strategies that can be used through a family trust.

First, the multiplication of the lifetime capital gains exemption.

1. If your family trust is structured to own shares of your privately held corporation, you can multiply the lifetime capital gains exemption on the sale of those shares by making use of the exemption for each of your beneficiaries. A family trust with four beneficiaries, such as yourself, your spouse and two children, could potentially use the LTCGE four times, permitting you to enjoy an exemption of $3.5m on the sale of your company shares at 2020 rates.

   1. Note that the shares of your company would need to be considered qualified small business shares. In order for the shares to be considered qualified small business shares they must have been held for at least two years and 90% of the assets inside of the business must be actively used inside of the business - both considerations that you should raise with your accountant.

   2. The process of taking assets out of your operating company that aren’t not actively used in the business (i.e. a stockpile of cash or other passive assets) is called purification, and a family trust structure with a holding company can be effectively used to accomplish that process - again something to talk in greater detail with your accountant.

   3. In terms of Canadian tax planning, the lifetime capital gains exemption is one of the most significant benefits that entrepreneurs can take advantage of in your lifetime, so it makes sense to plan accordingly.

Second, the prescribed rate loan strategy.

1. In 2018 the tax on split income or TOSI rules came into effect which eliminated most income splitting tax planning through the use of family trusts. However, a variation on this type of planning is still available through a prescribed rate loan strategy.

   1. How it works is that income can be split with family members who are inactive in the business, including minor children, by having the high-income member of the family loan the family trust funds at an interest rate equal to the prescribed rate under the Income Tax Act. The monies that are loaned into the family trust can then be used by the trust to fund publicly traded investments that yield dividends and capital gains for zero-income / low-income beneficiaries of the trust. Since the beneficiaries don’t need to be paid out immediately each year, those investment earnings can be reinvested. Over time, this type of planning can result in a significant tax savings.

   2. As of publication of this video, the prescribed interest rate is at a historic low - 1% - which means that this strategy can be highly beneficial assuming a rate of return of 5-6% on investments held by the trust. Additionally, the prescribed interest rate is locked in once the loan is made, irrespective of whether the prescribed rate is raised at a future point in time. In other words, now is a good time to take advantage of this strategy. The prescribed rate is set every quarter by the CRA.

   3. There are some important caveats for this strategy that you should discuss with your advisors. The interest on the loan must be repaid on January 30 of each year; failure to do so will immediately eliminate any tax planning benefit from the loan.