The Canadian Money Roadmap
Understanding Trusts for Effective Financial and Estate Planning
Gain a clear understanding of trusts and how they can be leveraged for estate planning with tax expert Amanda Doucette, my insightful guest and fellow podcaster from The Tax Chick. We take the mystery out of trusts, explaining the three certainties - intention, subject matter, and beneficiaries - that are essential to their formation. Whether you're considering setting up a formal or informal trust, this episode illuminates the importance of precise documentation and the implications of each type.
The landscape of trust taxation is ever-evolving, and we're here to guide you through the complexities. We discuss the changes that have affected testamentary trusts taxation, including the shift to the highest marginal rates and the critical 21-year "birthday" that could trigger a significant tax event. As we explore the cultural perceptions surrounding "trust fund kids," we clarify the realities and debunk myths associated with trust beneficiaries. This episode offers a practical look into how trusts can provide for future generations while meeting your intended objectives.
Dive into the roles and responsibilities that trustees bear, as this episode highlights the fiduciary duties vital to the proper management of a trust. We address the intricacies of trust taxation and how integrating income from different sources can affect your estate planning. Whether you're faced with a beneficiary's milestone birthday or adapting to new tax regulations, this episode is packed with insights to ensure you're well-informed and prepared to engage with your advisors effectively. Join Amanda and me as we equip you with the knowledge to handle your trust-related financial planning with confidence.
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Become more confident with your money - Financial Foundations Course
Gain a clear understanding of trusts and how they can be leveraged for estate planning with tax expert Amanda Doucette, my insightful guest and fellow podcaster from The Tax Chick. We take the mystery out of trusts, explaining the three certainties - intention, subject matter, and beneficiaries - that are essential to their formation. Whether you're considering setting up a formal or informal trust, this episode illuminates the importance of precise documentation and the implications of each type.
The landscape of trust taxation is ever-evolving, and we're here to guide you through the complexities. We discuss the changes that have affected testamentary trusts taxation, including the shift to the highest marginal rates and the critical 21-year "birthday" that could trigger a significant tax event. As we explore the cultural perceptions surrounding "trust fund kids," we clarify the realities and debunk myths associated with trust beneficiaries. This episode offers a practical look into how trusts can provide for future generations while meeting your intended objectives.
Dive into the roles and responsibilities that trustees bear, as this episode highlights the fiduciary duties vital to the proper management of a trust. We address the intricacies of trust taxation and how integrating income from different sources can affect your estate planning. Whether you're faced with a beneficiary's milestone birthday or adapting to new tax regulations, this episode is packed with insights to ensure you're well-informed and prepared to engage with your advisors effectively. Join Amanda and me as we equip you with the knowledge to handle your trust-related financial planning with confidence.
Invest With Evan
Become more confident with your money - Financial Foundations Course
Hello and welcome back to the Canadian Money Roadmap podcast. I'm your host, evan Newfeld. On today's podcast, I am joined by Amanda Doucette. She is a tax partner at Stevenson Hood here in Saskatoon and the host of the Tax Chick podcast. If you listened to last week's episode, you would have heard me on her podcast. I was very excited to have her share her expertise on the area of trusts today here on the Canadian Money Roadmap. So, without further ado, please enjoy this episode with Amanda Doucette. Enjoy this episode with Amanda Doucette. Amanda, thank you so much for joining me today here in the office here in Saskatoon. Locally, we don't get to do in-person recordings too often, so this is fun.
Speaker 2:I know we're meeting in the wild.
Speaker 1:I'm so excited In the flesh. This is great, but today we are going to be talking about a topic that I haven't mentioned on the podcast before, and it's something that is in the Certified Financial Planner curriculum, but I always struggled with it because I feel like this is an area that requires expertise, and you have that expertise. We're talking about trusts today. I've had a few emails recently from listeners and from clients of mine asking questions about trusts. It's been in the news a bit recently with things related to tax and so, being a tax lawyer yourself, I think no one else top of mind anyways would be better to speak to the topic of trust today, so I'm excited to get into this.
Speaker 2:Yeah, me too. I think that personally, up until the last year or so, I didn't really have any clients wanting to talk about trust. We would put them in place, but they never wanted to talk about them. And now it's this big topic of conversation almost every time that I'm meeting with someone, so I love to spread the news and spread the word about what it is.
Speaker 1:Awesome, let's just get started at a high level. Then what is a trust?
Speaker 2:So there's no good definition of trust in the Income Tax Act or in any other piece of legislation. But if we take a step back, a trust is really just a legal arrangement. So it's kind of like a contract. It's a formalized relationship between people and you essentially have a party another party known as a trustee to hold for the benefit of third parties being beneficiaries, and they do this and there has to be a number of things present. Just like if you have a contract, there needs to be certain things for it to be a true contract.
Speaker 2:In trust they call it the three certainties. So you need to have a certainty of intention. So the person that gives that stuff initially to the trustee they need to intend to give it. It needs to actually come from them. It's usually a $20 bill or two $10 bills, and so I have conversations with clients to say, make sure you don't turn around and go buy that person a Starbucks as they leave the office to compensate them for the fact they just gave you that money. It's very important that this be a selfless gift, a selfless gift of cash at the front end, and there also needs to be a certainty of subject. So you must be able to clearly identify what's going into this trust. And then, third, there has to be something called a certainty of object, which is maybe a weird way to describe beneficiaries, but you have to know who's going to benefit from this. And so if we can identify those three things and we have something going into it, we have a trust.
Speaker 1:Okay. So it sounds like the main defining features of a trust revolve around certainty of all the different pieces. What happens when there's like uncertainty, I guess is the word when, when things aren't clear, then is it? It's an informal trust. I've heard that language before. Maybe this is too far down the rabbit hole, necessarily, but it's. It's just unenforceable then perhaps.
Speaker 2:It might be, and I guess you have to ask the question of well, who's going to question whether this is a formal trust or not? So, for example, will Canada Revenue Agency question it? Is a third party going to question it because this alleged trust is going to purchase something and the third party says, hey, I don't think this is a trust. I mean, I think the trusts that are on the cusp of maybe not being trusts is this concept of bear trusts which is its own rabbit hole. But we've seen a lot of people that you know add someone on as a joint holder of a bank account or add someone as a joint owner on a piece of property. That is technically a form of trust, although not the same really detailed formalized trust. You might think it looks more like an agency relationship. Cra might not agree with you. They would say that that looks a heck of a lot more like a bear trust. So those are kind of those more maybe informal trusts that you're talking about.
Speaker 1:Gotcha Okay. So today maybe we can just stay with the formal trust and some of the details around those. So within that structure, what different types of trusts would exist out there in the world?
Speaker 2:So there's many different ways to categorize trust, but I think the easiest way is you split it down the middle and you say that there's inter-vibos trusts, which are trusts in lifetime, and then there are testamentary trusts, which are trusts created on death, and I think for me personally, that's the easiest way to split the pie so you can do a trust at either point in time.
Speaker 2:Some people have both that they have created, and the terms of whatever trust that you've created are usually set out in writing. I say usually because it's not technically required, but it's hard to know what the terms are if there's not something on a piece of paper. So usually there's a trust agreement or there's a trust deed or a trust indenture are the usual words that we hear, and if it's a testamentary trust, that's happening once you've passed the stuff. The terms of the trust are in your will. So if you look at your will, you'll see these provisions that talk about creating a trust and say who's going to run it and talk about who the beneficiaries are going to be, and that's where you look to for those provisions.
Speaker 1:Gotcha. So the, the trust while you're alive, the inter vivos.
Speaker 2:Yes, inter vivos, or some people say inter vivos.
Speaker 1:I don't know what the Latin term is there.
Speaker 2:I might be saying it wrong.
Speaker 1:I think it's just like viva la vida, yeah, yeah, so anyway. So those ones, why would somebody use a trust while they're alive? What kind of benefits would come along with that?
Speaker 2:So the benefits of having a trust in lifetime have changed a little bit over the last, you know, 10 years. There's been fairly significant tax changes and so, although there are still a lot of non-tax reasons to have a trust in lifetime, the number of tax reasons to have a trust has definitely decreased. But the creation of a trust no different than forming a company, creating a partnership, creating a joint venture there's always going to be tax and non-tax reasons for doing something, and so when you're making that decision, you need to sit down and lay out your reasons and what you're trying to accomplish and then figure out whether a trust fits. Trusts are cool for a number of reasons. They're really neat because if you have something called a discretionary trust, a fully discretionary trust, it means the person running the trust, the trustee, has full control. Absolute discretion I mean within limits, to choose to benefit one or more beneficiaries of a trust at any given time, and we see this used often for family-owned businesses. If we have, for example, parents who are not ready to give up control and they have kids who are adults, who are maybe actively involved in the business or they want to start funneling some money to their children, to one or more of their children, but they're not ready to give them shares yet. A trust is often a way that we utilize, because you can pay money into the trust from the company and then the trust can take that money and it can allocate it out as it chooses to any one or more of the beneficiaries, regardless of sort of them proving their activity in the business. There are some limitations on that now and some different tax rules that apply, but that's one reason it's used.
Speaker 2:The main reason, though, that I think is still valid, and one of the main reasons why people use trusts, is that when you die, immediately before you die, you are deemed to sell everything you own and I talk about this all the time. I call it the biggest yard sale of your life. You're deemed to sell everything, you reacquire it at fair market value, and the whole purpose of that is that you know we often don't have to pay tax on our stuff until we sell it, but there are many things that we may choose to never sell, and the government doesn't like that because they want to get paid on a sale. So they say we're going to pretend that you sold it immediately before you die, so we get our pound of flesh. One of those things is shares in a company. So if you own an operating company and you have shares in that company, you probably put $100 in when you first incorporate it and, let's hope, that company is super successful and now it's worth $100,000.
Speaker 2:Well, if you were to die, you're going to be taxed on the gain, the change, the difference between the $100 you put in and the $100,000 that that company is now worth. And you got to find the money somewhere. And, yes, there are exceptions to that, but let's say, none of those exceptions apply. Well, where's the money coming from? You're going to have to liquidate some assets, maybe, and there's going to be less to give your beneficiaries. You're going to have to liquidate some assets, maybe, and there's going to be less to give your beneficiaries.
Speaker 2:Well, if, instead, the growth in the company, those common shares that go up and down with the value of the company, if they're owned by a trust, one of those intravivos trusts a trust doesn't die when you die, so that's really cool. The trust doesn't have this big yard sale. You've actually deferred or you've pushed the tax problem down the road and likely the shares that are owned by the person that passed away are probably like a basic voting share, that is, a preferred share with a fixed value that probably isn't that much. So we don't have a huge tax problem on debt and that's one of the main reasons why people use trusts right now.
Speaker 1:Is that the concept of an estate freeze or partially that concept? It is.
Speaker 2:It's an estate freeze. So if someone's listening to this and you've had an advisor suggest, oh, you should do an estate freeze, that's kind of what I'm getting at here is that if we had, you know, mom and dad own shares in a company, those shares grew in value. We take those shares and we put them in the hypothetical tax freezer. I always like people to visualize putting water into an ice cube tray. You throw it into the freezer, you pull it back out. It's the same thing. It's just now in a different form. So if they had shares that were worth $10,000 and they put them in the freezer and they pulled them back out, well, they're going to pull them out and now they're an ice cube. So if before they were a class A share, maybe now they're a class D share or they're something different and they have a fixed value of $10,000.
Speaker 2:And then what we want to do is we want to melt those shares away over time and we sometimes call this a melting freeze or a wasting freeze, where we slowly redeem those shares out over time. So you're left with almost nothing again limiting your tax bill. But we have to give the growth somewhere on an estate freeze. So where is the new growth going. A lot of times it goes to a family trust. Other times it can go to new family members, it can go to new business owners, but this is a key place where a family trust is used.
Speaker 1:Okay. So if you are in a situation like that where you own a business that has meaningfully appreciated and value, you don't necessarily need any more of the growth for yourself in one. Maybe you don't have any kids, maybe you don't have any family members. Is the estate freeze trust situation valuable at all, or is this largely for the purpose of just passing something on to the next generation while deferring taxes?
Speaker 2:Largely, that is what it's used for, because you have to figure out, if you don't have anybody that you want to give it to, who's the beneficiaries of your trust going to be? So that's when you'd be looking at. Well, can you mirror this with charitable donations? Is there something like that that you can do? Can you create a foundation? We hear lots, hear lots of talk about. You know donor advised funds and the creation of personal foundations. Maybe that's what you do instead, but typically, if we're talking about what 90% of the people I see use them for, I have a lot of clients that have owner managed business farming families. They're using it to get funds to the next generation. That's what they're using it for.
Speaker 1:Gotcha, so maybe let's talk about the testamentary trust then as well, so ones that are established through the will upon death. How are they different and what are the benefits of those types of trusts?
Speaker 2:Well, I wonder if and not to run your podcast because I feel like I'm I'm trying to take the driver's seat but I think we need to explain what the taxation is of inter vivos trust first, and then I can juxtapose it with testamentary trust. Thank you for indulging me. So for inter vivos trust a trust in lifetime it's taxed as a person, right. So a trust is a legal person for tax purposes and it has the same set of rates an individual has, although if funds are staying in the trust and being taxed in the trust, they're taxed at the highest marginal tax rate. For interviewers trust.
Speaker 1:Federal and provincial.
Speaker 2:Correct. So from a tax savings perspective, it doesn't make a lot of sense to take money out of your company on a regular basis, throw a dividend into a trust and let it just sit there because it's going to be taxed at a very, very high rate. That's not what we really use these trusts for. A testamentary trust, so a trust created in a will used to be really a favorable little tax vehicle, and if you look back at wills that were done like when I first started practicing 15, 16 years ago, we had multiple testamentary trusts. I mean, that's what tax lawyers were doing, and it's because each trust had its own set of graduated tax rates and there was no maximum you could have 10 trusts on your wills. So it was letting you separate out to all these different income pools so that, as investments were growing after you passed away, your beneficiaries weren't having to bear all of that personally. They could sort of hide it in these separate tax returns of these different trusts. However, there were major changes that came in in the 2016 tax year, and so now testamentary trusts only have favorable tax rates for the first three years, and there's a limit of one of those trusts getting good tax rates.
Speaker 2:It's typically the estate itself when you pass away, as long as it meets certain criteria to be called a graduated rate estate and that's outside the scope of today's podcast. But if it meets that criteria it gets the good rates for the first three years and then it's taxed at the highest marginal rate going forward. The only exceptions is if we can get something called a qualified disability trust. So the government is still recognizing the importance of providing for dependents people who have dependency into adulthood. If somebody qualifies for the disability tax credit and you've put something into a trust for them in your will, arguably it will likely be one of these qualified disability trusts that qualify for great tax rates going forward. It is an annual determination and if you fall off of that determination there are penalties because you got the benefit when you shouldn't have. So it's a bit dicey, but the taxation is not as great as it used to be.
Speaker 2:The other thing to keep in mind in terms of big picture taxation of these trusts is if you think about trusts you create in lifetime and we think about this concept of the deemed disposition on death and this yard sale that I talked about, a trust is another example of something that it could just keep going and going and going right, and I indicated earlier that a trust does not fall into the yard sale because you don't own the trust. You might be the trustee and control it, but you don't own it. So once again the government went wait a minute, we're never going to get our pound of flesh out of this trust. What if this trust owns capital property? What if it owns shares in a company, a cabin investments? How are we ever going to get paid off of this? Because if we don't have income accruing in here, there's nothing to be and the trust never dies.
Speaker 2:And the trust never dies. What are we going to do? And so they created this concept that every 21 years, a trust has a birthday. I like to call it a birthday. It makes it seem happier. So a trust has a birthday every 21 years and it has its own yard sale and, depending on what it owns, there may be a tax to pay. Or, if you plan in advance, there are ways to further defer that birthday, but it requires planning in advance.
Speaker 1:How did the 21 years thing come around? Why not 20? Why not 10? I don't know.
Speaker 2:I think it's just an income tax rule and I think it might be tied back to some of the concepts in provincial law, so trust law, if we sort of think of where it sits in the legal world. Trusts are provincial. They are provincial creatures. So each province has its own piece of legislation, often called a trustee act or something like that, that governs how trusts are created, what they look like, what they can do, and then, layered on top of this provincial set of rules is the tax rules. Tax rules provincially, but also the Federal Income Tax Act, and there's often inconsistencies.
Speaker 2:I know shocking between federally and provincially and how trusts are treated. And so even you know when I said at the beginning there's no clear definition of a trust. Well, it's because, you know, the Income Tax Act says something very different than some of the federal or provincial pieces of legislation. So there is this inconsistency Now in the provinces. You may have heard, or have heard about this, that there used to be these rules against perpetuities or rules against accumulations, and these are old sort of kicking around rules that essentially prohibited a trust from being around forever and ever. It was trying to stop that trust from being around. Most provinces have abolished that rule, but for some provinces there was a 21-year idea, and I don't know if that's maybe where the history came in the act. Interesting, it was around before I started practicing, so I do not know the history of that one.
Speaker 1:That was not a skill testing question. It was just a why that number?
Speaker 2:You hoped I'd have some fun tax trivia for you.
Speaker 1:Well, you do. That was great, that was perfect answer. Okay, so you know, for the average person who may or may not be as familiar with tax I suspect you don't have this in your notes here but like the, the cultural concept of a trust fund baby or whatever, a trust fund kid, what does that mean? So, like they, is that person, um, the beneficiary of a trust and, in theory, is, uh, receiving money every year or whatever? My high level understanding might be that one of these trusts exists and there are living beneficiaries, but there are rules set up in the trust that can spit money out at a maximum or minimum interval or something like that. Could you explain, kind of how that concept works?
Speaker 2:Absolutely so. I mean, if we're thinking about this from the concept of like gossip girl or like US TV shows where you've got these trust fund kids.
Speaker 2:I really wish I was a trust fund kid. I am not, but I think that is a separate piece from. You know, you can be a kid and have a trust, and it doesn't mean you're a trust fund baby. So I think it's important to talk about those two different things. So many of our clients will will create either inter vivos trust in lifetime, where one of their kids is a beneficiary but the parent controls the trust and decides if they ever want to distribute any money out or any capital out. There's also, you know, kids who receive inheritances. Right, that is not necessarily that they're receiving, you know, $10 million, but maybe they're receiving $400,000. And technically, before you're 18, you know either the public guardian and trustee needs to keep an eye on your money or it needs to go into a trust for you and someone will be running that trust. Many of our clients, though, say say just because someone hits the magic number of 18 doesn't mean that I want to hand them $400,000.
Speaker 1:So maybe what I, or more like you, were talking about life insurance proceeds or something like that.
Speaker 2:Absolutely it could be it could be millions, right Um, or maybe it's shares in private companies, or it's farmland, or there's all these different things.
Speaker 1:So you have to decide yes exactly.
Speaker 2:And so so often what they'll do is they'll say I want to create a trust to age 30 or age 35. And what I want to do is I want to say, at age 20, at age 21, at age 24, they're going to get a lump sum and they can blow it on a motorcycle or go to Paris or whatever they want to do, but that's all they get. And in the meantime, the trustee that's running the trust can use the money to pay for their university tuition, if they need to go to the Mayo Clinic for healthcare reasons, if they need to pay for hockey camp. All those things can be paid for, but it doesn't go to the kid directly. And then eventually we make the kid a co-trustee. So they have to learn to work with the financial advisors and learn how to use the money, because the ultimate goal is, by the time they hit whatever magic age we've chosen, that they have some knowledge right, that they're better apprised to deal with their money. That's the ultimate goal.
Speaker 2:And in order to do that, there are things we have to keep in mind.
Speaker 2:So there's an old case called Saunders and Voitier and it's a Canadian case, and we had a beneficiary who wanted to try to get his inheritance early, and that created a series of rules so that if you're over the age of 18 and you go to court and say I want to collapse my trust, they'll look first to see what the trust is and how these terms that I talked about earlier and, for example, if that child is not also the trustee and if there are other beneficiaries, such as the future children of this individual, even if these kids don't exist right now.
Speaker 2:Those are really important factors that can prevent them from collapsing the trust early. So things to keep in mind. Also, you have to remember that if you're dealing with farm stuff and I'm just going to call it farm stuff, because we know there are specific rules around what's farmland and what's farm property you have to be careful because if stuff goes into a trust, you can lose the ability to get some of the other tax benefits involved on death and in lifetime when transferring farmland and shares of a family farm property. So just to keep that in mind, trusts and farm stuff do not always mix very well and so you want to be careful.
Speaker 1:We're landlocked here in Saskatoon. I assume that's fishing property. It is fishing property too.
Speaker 2:Yeah, I can't say that I've had to deal with that very often, but, yes, it also includes the fishermen. So just those are things to keep in mind, but those are the typical trusts we're seeing. Now, if you want to talk about the really exciting trusts, what they're what I call legacy trusts and I have done a couple of these in my career they're very exciting because there's lots of money going into them, so there's lots of opportunities, and this is where you have, you know, five, six, 7 million, and the intention is that you want this trust to continue for generations. You want to benefit your children, their children, their children's children and you want to create a legacy to leave behind. And these are the, the trust fund babies that we often hear about. This is like the Rockefeller family idea Correct.
Speaker 2:Yeah, on a much larger scale. Right and so with those types of trusts, what you're typically seeing is the person running the trust is usually not a person. Usually it's a trust company because you think about it, this thing's going to run for the next 150 years, people are going to die. So usually you want this independent arm and these trusts. I've seen them done a number of different ways. I've seen them done as incentive trusts where it'll say, if my child earns X amount doing a certain type of job, or either in salary or dividends or whatever, we'll match it. I've seen, if my child volunteers a certain number of hours, if my child donates a certain amount to a registered charity, that there's a matching. I've seen other things where it talks about well, if the child receives these funds, it's taxable to the child. So they're getting a gross amount, but they have to still report it and they're going to get taxed on it.
Speaker 2:There's many different things that you can do in order to incentivize or decentivize certain behavior within the group, coming down below right, because you're dead at this point.
Speaker 2:So how much do you want to control from the great? And I often find that people wish to incentivize versus decentivize, and there's always this big concern of creating a trust fund baby. I mean, I've had clients come in and say this to me I don't want to create a trust fund baby, and I said, well, then we got to. We have to put in some sort of incentivization then to encourage philanthropic behavior, to encourage activity. If you don't just want someone sitting back in a loft apartment somewhere collecting their trust money, you want them to do something. And I've had clients who are in the artistic space, who they write or they draw. So they're very careful about the wording because oftentimes if their child chooses an artistic pursuit, it's harder to get to the place where you're making significant funds. So we're very careful how we word things so that we can still incentivize that good behavior. But that's this concept of a legacy trust.
Speaker 1:Okay, so you mentioned five, six, seven million. There, legacy trusts sound expensive and if you're trying to pass money off to future generations that don't yet exist, you don't know how many people are going to be involved here. So what kind of dollar figures? Like you mentioned those figures, I know that's just off the top of your head. But just out of curiosity, when does something like this come into play?
Speaker 2:Well, I mean, I think I mentioned those figures because I see those as being the very bare minimum.
Speaker 2:If you don't have numbers kind of like that, you're probably not trying to create this legacy trust environment. More realistically, we're seeing, you know, 20, 30, 40 million, like those kinds of numbers. In terms of the cost to put it in place, it's. It's really not that bad, because you're building it into your, your will itself, and then, once it's there, the terms are there, and then you're going to pay if you hire a corporate trustee, because they're going to take a piece off of whatever assets are under management within the trust, and so you'd have to factor in those costs as part of it. And so that's why, to me, if you're not at least looking at a five, six, seven, $8 million amount, the costs start to kind of outweigh. In addition, now that there's all these new filing requirements for trusts from a tax perspective, you're also paying somebody every year to file taxes for this trust and there's a cost associated with that. And if it's going to be happening for the next hundred years, you got to factor that in too.
Speaker 1:And, in theory, like it could actually be getting bigger, not smaller.
Speaker 2:Well, one would hope, right. One would hope, if you have the correct advisor on the file, that the funds would just keep growing and that, if nothing else, that you'd probably be living more off of the income, even though you'd have a right to kind of encroach or grab some of that capital if you wanted to. The goal is to kind of keep growing that and to keep investing it.
Speaker 1:Right, okay, so the idea of tax integration is kind of popping into my head here a little bit. So how does the income that comes out of a trust get taxed in the hands of the beneficiary at the end of the day?
Speaker 2:So it depends if it's an inter vivos trust or if it's a testamentary trust, and it also depends on whether certain elections are filed. So it depends on whether something is chosen to be taxed in the trust or taxed outside of the trust. Those are two different things. But if we do a flow through and you say, hey, I'm paying this money out of the trust, it's going to the individual, well then it just goes on your tax return. You receive a slip saying just like you would if you got a dividend from a company, saying I received something from a trust. It goes on your tax return. It's taxed at your marginal tax rate.
Speaker 1:As regular income. Correct, Perfect. So it's not like dividends that come out of a corporation that have different, like a gross up in a credit system. This is this is kind of like RSP withdrawals or employment income. It's included.
Speaker 2:Well, it depends what type of income that you're getting. Okay, so I feel like I'm giving a very lawyerly answer right now, because it depends.
Speaker 1:This is good. This is why we have a lawyer on the podcast. This is wonderful.
Speaker 2:So if your trust owns shares in your family company and your family company has declared a dividend payable to the trust, the trust can take that dividend and it can allocate it out to one or more of the beneficiaries. What's cool about trust taxation is that things maintain their form while they're passing through the trust.
Speaker 1:Okay.
Speaker 2:So if a capital dividend is declared, a capital dividend being a great kind of dividend because it's zero tax to the recipient, if a capital dividend is declared from a company to a trust and then allocated out, well, it maintains that status as a capital dividend. So the individual is just seen to have received a capital dividend. Similarly, if a dividend, an eligible dividend, is declared from a corporation to a trust, that still maintains its character, If there's an allocation of capital, then the capital treatment of whatever is received by that trust maintains its way out. The other end to the individual. Now, saying that you and I were talking before we started recording, about the budget, the federal budget in Canada and these new proposed changes to the capital gains inclusion rate. What we don't know right now, and what is not clear because there's no draft legislation, is do we have integration anymore when we have a trust? And I'm sure you've talked lots about integration on this podcast.
Speaker 1:Indirectly. I don't know if the language of it comes up as often.
Speaker 2:Should we do a quick little primer on the concept of integration? It's always kind of fun.
Speaker 1:We can go back and listen to my episode of Mark McGrath about corporations, but this would be oh, there you go Do that too, do that too.
Speaker 2:So integration is just this concept that if you earn a dollar personally, you should pay the same amount of tax on that dollar as if you earned it in a corporation or in a trust and paid it out to yourself. I think that old saying was what a buck is a buck is a buck, isn't that something?
Speaker 2:from like 1975, the Carter Commission or something, and so that's the idea behind integration, and our Canadian income tax system is based on that. And what's important to know is that not every tax system around the world is based on the same concept. So you know, when tax changes happen, we as tax advisors are always thinking what's the impact on integration? Because if integration is off, then it encourages you to choose one option over another. When integration is almost identical, it doesn't encourage you, and so we often talk about. You know why do you incorporate? I know you've talked about this a lot in your podcast. Well, you only incorporate and you only get the benefits of incorporation if you plan to stockpile stuff in your corporation. If you're just going to take the money, put it in your company and blow it out, you're going to end up almost the same place that you were if you just earned it personally. But now you're going to have an extra tax return instead of financial statements and a bunch of other stuff that you have to deal with.
Speaker 1:And refuse to do so.
Speaker 2:Correct. You have to bookkeep. It's just a lot. So what the problem is with these new capital gains inclusion rate terms that have come in play because of the new federal budget which, to summarize for people, apparently are going to take place sometime after, you know, on or after June 25 of 2024.
Speaker 2:And as of that period of time, if you're an individual, you can choose to include 50% of the gain on the first $250,000.
Speaker 2:And over that amount you have to include two thirds of the gain in your income. If you're a trust, you have to include two thirds from the beginning and previously everyone just included half. So our starting point as it is right now if you have a capital gain so if you bought something for $100, now it's worth 200 and you sell it, that gain of $100, you had to include 50 bucks in your income and it was taxed at your rate and everybody was subject to that. Now we have this differential We've got a 50% over here and we've got a two thirds over here. So nobody really knows what impact this is going to have on trust, because I don't know what the inclusion rate is when a trust is allocating a capital gain out to an individual. I don't know if we get that 250,000 threshold and so it's going to have to be a bit more complicated of a calculation and maybe, you know, we'll get draft legislation that would help.
Speaker 1:Yeah, so we're recording this on April 26th, so if you're listening to this afterwards, these rules might have already been abolished or clarified or simplified or something. But anyways, this is what we know today.
Speaker 2:That's right. Fingers and toes are crossed. That we get some clarification.
Speaker 1:Yeah, that's right. Any idea about whether the higher inclusion rate is applicable to disability trusts as well?
Speaker 2:As far as I understand it is, we have not seen any carve-outs for any specific other types of trusts, which is concerning, Because again, it seems to fly in the face of other public policy that they've done in the past. There's hope there. There's actually some hope that it won't apply to deemed dispositions either, like on death when you leave the country. There's some people who are hopeful about that. I, I, am less hopeful. I, I mean, that would be great. I don't think it's going to happen, but right now we actually don't know what it's going to apply to. There's not enough information out there.
Speaker 1:Interesting. Okay, um, I'm going to get you off topic here a little bit again, um, or off that topic, I guess, specifically. But can we clarify the actors in a trust for me, again a little bit more?
Speaker 2:Absolutely Um. So I like to call them actors, cause I think that's how people can think about them. Who are the different roles and what do they play? So the first role is something called a settlor, um S E T T L? O? R, if you're listening to this, not like settlers of Catan or you know whatever that game is. Um, a settlor is the person who kind of gets things started. They're the ones who provide the initial sum to start this trust. They fund it. They're like the first investor Think of it that way and usually in the lifetime context, in the intravivos context, it's a family friend, maybe it's a sibling of mom and dad's, like one of the aunts and uncles, a godparent, somebody like that that they will fund the trust using some cash and they get things started and it's very important from a tax perspective that that is the end of the role for that person.
Speaker 2:Very bad things happen from a tax perspective if there's ever an opportunity for that person to have control over the trust, to receive something from the trust. We don't want that. And so once they've given the money and signed the trust deed, there's actually stuff that's usually in the trust deed that says, okay, you now wash your hands of this trust as a whole and you have no longer any responsibility. Okay, there's a slight exception to that, which I'll talk about once I finish the actors. The second actor or role is the trustee, and this is the person who's running the show. They don't own the stuff. They have power over the stuff, and this is so important because I think a lot of my clients who created trust they still think of themselves as owning the stuff that's in the trust. But you don't. You just have power over it and you're subject to the terms of the trustee, which tells you how to exercise your power.
Speaker 2:Then we have beneficiaries. These are the people that get the good stuff. They get to benefit from the stuff in the trust and if you have a trustee at home and you're looking at it, you might see a reference to an income beneficiary or a capital beneficiary and think, huh, I wonder what those are. You're probably both, but capital is the ability to actually take like the stuff itself. So if you have, like an investment in a trust, you could actually give part of the investment to a beneficiary. The income is the income on that investment that can be distributed and there's different tax rules for those, which is why we have that separation in the document.
Speaker 2:You may also see the role of protector, and we see this, I would say, more often in trusts that are created in wills because people know they're dead and they won't be there to keep an eye on what's going on. And a protector is exactly what it sounds like it's someone that's there to protect the beneficiaries and they're kind of like the angel over the trustee's shoulder and they watch what the trustee is doing and they get to weigh in on things and they have certain requirements or roles they're supposed to play. So that's an additional role that you have to play in a trust.
Speaker 1:What's the incentive for that person to actually do the job?
Speaker 2:I guess, care and concern for the beneficiary. Any of these roles like, for example, you can be named as a trustee and go I don't want to be a trustee. Or you can be named as a protector and say I don't want to be a protector, no different than you can be named as an executor and say I want to be a beneficiary.
Speaker 2:That sounds like way more fun.
Speaker 2:So I mean, other than that settler, that initial person that kind of has to sign on and if they're going to be taking on that role, when you have things like a testamentary trust, well, the settlor is the dead person, right, and they've named someone to be a trustee.
Speaker 2:But if that person says I don't want to be a trustee, well now we have a trust without a trustee and we have to go find one and, depending on what the terms say in the will or what the terms say in our legislation, to go find somebody. But it can be a bit sticky because these are not fun rules and there's an assumption, I think, that people think that if they name somebody, that person is obligated to act. But they are not, and so, especially when you're thinking of choosing executors or powers of attorney or any of these special roles, you want to have a conversation with that person, because it's not like you can just force them into a corner and make them act. They can say I'm out, and so it's better off to have someone who's at least prepared to play ball than to name a bunch of people that are all just going to walk away anyway. Very interesting.
Speaker 1:Okay, that was a random offshoot there, so okay, so the the situation um, I I've I've had the question come up more often than I would have thought, but say someone, um, I'm not asking for legal advice here, I'm just like where is this going?
Speaker 1:Hypothetically and this is not me hypothetically Um, someone is wanting to use this testamentary trust and their children again. You've probably seen this more than I have, then, but it's like I want the money to eventually end up with my daughter, but I don't like the guy she's with. Is this a case for a trust?
Speaker 2:Yes, so that's one of the other benefits of a trust and I mean I guess we're offshooting into family law now, which my proviso is I am not a family law lawyer, but I do know the intersection between family law and tax law. So I can talk about that, and I can talk about it in the context of Saskatchewan law, Because family law much like trust law is also provincial, so we're recording this in Saskatoon. I do not practice in other provinces, that's my proviso.
Speaker 1:I've had a few other lawyers on the podcast that they did the exact same thing. This is perfect. Everybody's following the letter of the law Awesome.
Speaker 2:I feel like the law society is just watching us. So the starting point in Saskatchewan is that inheritances are what we call family property, and family property is anything that is divisible 50-50 when you separate and that's different in Alberta. So that's why it's important to know what the law is in your jurisdiction. So, yeah, every client that comes in says to me well, amanda, either I don't like my child's current spouse or this is a fictional person, but I know that I'm not going to like them and I don't want them getting a piece of the pie. So the only way in Saskatchewan to fully protect is to have an interspousal agreement a prenup, whatever we want to call it cohabitation agreement that says you know, we are two spouses, we're both getting independent legal advice. You can do it if you're common law or if you're a legally married spouse and we're choosing not to have inheritances or gifts in lifetime, which could be gifts from a trust in lifetime form part of family property division. That is your gold seal of approval. If you don't have that, then there are certain things that you can do to make it more difficult, but they are not guarantees. One of them is a trust, because if it's a fully discretionary trust and your child is one beneficiary of a bunch of others. Now you get into a discussion of how is that child's interest in the trust actually valued? And there is a ton of case law across the country on this.
Speaker 2:In Saskatchewan there was a very famous case five or six years ago now called the Gross Decision G-R-O-S-S-E. Five or six years ago now called the gross decision G-R-O-S-S-E. It's been reviewed since that time, but it was discussing what the value of someone's interest was in a family trust for the purposes of family property division. In that particular case the facts weren't great because the person was also a trustee and they had control over their own distributions. And the court said listen, you could give yourself anything you want. You've chosen not to because you know that we have this fight happening. So if you ever pay yourself anything in the future, we're taking half of it and giving it to your departing spouse. So not great facts. But arguably, if someone's not a trustee and they've never received a distribution in the past, well what is their value, right? So it creates a boundary, it creates a barrier, it creates a problem that you have to kind of overcome, which is helpful. I mean, that's better than having no boundary, but it's not a guarantee, because the court can still say your interest is worth X amount and they can still allocate some of that.
Speaker 2:The court has very broad, broad powers in terms of family law division to do whatever they want. They can give shares of private companies, they can force you to assign life insurance, they can force you to change beneficiaries on your RRSPs. They have very, very broad powers. And you also have to keep in mind that when you die, if you die with a spouse, whether that spouse is a common law spouse or a legally married spouse, and whether or not you liked them or were in the process of separating prior to your death, you have a legal obligation to provide for them.
Speaker 2:There is a piece of legislation in our province and there is one across every province in Canada that says if you have a spouse, you're required to provide for them reasonable maintenance in the will, and if you don't, they have a right of action. So if you come in and see me and say I want to disinherit my spouse, I'm going to have a conversation with you about these legal obligations and if you say I don't care, let them have a court fight, fine, but you just need to realize what you're walking into by doing that.
Speaker 1:Messy, messy stuff.
Speaker 2:It is messy.
Speaker 1:And so I think the other podcasts I've done with lawyers talking about wills and all that kind of stuff. If you have an intention with what you want to do with your money, just get legal advice for your situation, as opposed to trying to pull out little tidbits from from podcasts all over the place. And actually act on what you think is law. Talk to a lawyer in your province.
Speaker 2:Absolutely, I agree.
Speaker 1:Awesome. What do we have left on our to-do list here? I feel like we've covered a lot of ground and I got you really off pace of everything that you wanted to talk about. So what's left that I haven't asked that you'd like to discuss about trust?
Speaker 2:Well, there's maybe two things, and we can be fairly quick about them because I recognize that there is a time to be considered here. So one of the things I want to talk about is if you are a trustee of a trust. So if you're listening to this and you are a trustee of a trust, I think it's important to know what that rule means and some of the practical requirements. And then the other thing I wouldn't mind very quickly touching on is the tax filing requirement for trusts.
Speaker 1:Sure.
Speaker 2:Because I know a lot of people are being asked to provide information right now and wondering why? So I think if we could address those two, perfect.
Speaker 1:Probably good Sounds great.
Speaker 2:So if you are a trustee of a trust, I think a lot of my clients or a lot of other clients will sign on to this because they're implementing an estate phrase. They understand the concept behind the estate phrase. They're like we're good to go, this is what we're doing. That's great. But I think it's important for you to understand what it means to be a trustee, and a trustee is a special role at law, called a fiduciary.
Speaker 2:Fiduciaries are held to a higher standard of requirement. It's a very important, very serious role, and if you breach your fiduciary duty, you know bad things can happen to you, both at regular law and tax law, and so it is important to remember that you know you're responsible for the stuff that's in the trust. You're responsible for following the rules of the trust, and if a beneficiary doesn't like what you're doing and if it's found that you're not following the rules of the trust, the beneficiary can sue you, and so we have seen this go south sometimes when we have adult beneficiaries and one of them goes rogue and is not happy with mom and dad. If mom and dad have not been following the terms of the trust, mom and dad can be hauled into court and can be removed as a trustee and can have damages paid against them. So you want to be keeping track of what you're doing.
Speaker 2:You want to be asking for legal advice or whatever. So you want to be keeping track of what you're doing. You want to be asking for legal advice or whatever advice you need to, to make sure you understand the terms of the trust. It's really your requirement to make sure that if there's a tax filing due, that you've done it. You can't just wait for an advisor to tell you. All of these things are sort of your responsibility as a trustee all of these things are sort of your responsibility as a trustee.
Speaker 1:Can you transfer, say you are a trustee, can that then be transferred to someone else? Or is you being named as the trustee, kind of largely set in stone?
Speaker 2:So, if you accept the role of appointment as trustee, you can, at some point in time, choose to resign or to remove yourself from that position, and there are typically rules within the trustee that say how a new person is appointed or, for example, if you die right or you lose capacity, usually, the trustee says whoever your power of attorney is or whoever your executor is steps in in the interim. Sometimes it doesn't, but that's usually what it says. If, instead, though, it's one of those things where it's not that you want to give up the role of trustee, but you don't want to be the one filing the tax returns and dealing with things, you can delegate your authority, but you're still responsible for making sure it gets done. So that's kind of the two different pieces.
Speaker 1:Gotcha Okay, there's always moving pieces.
Speaker 2:There's always moving pieces, but I think just the takeaway is, if you're a trustee, it is an important role, just like being a director in a company, and you do have responsibilities. So making sure you understand what those responsibilities are and that you're properly documenting things and following the rules, that's so critical, so very, very important. So then the other piece is the tax filings, and I just want to very briefly touch on this, because a lot of you may have been getting phone calls or emails over the last couple of months from your friendly neighborhood accountant saying, hey, can you provide me all this information about your trust? And you're probably sitting there going why am I doing this? I've never had to do this. We've had this trust for 10 years. No one's asked me this. Well, it's because the rules have changed. So asked me this? Well, it's because the rules have changed.
Speaker 2:So, as a starting point, prior to the change in the rules which took place as of the end of last calendar year, many trusts never had to file a tax return. If a trust did not have ongoing income that was being taxed in the trust, it typically didn't have to file a return. So you may have had a trust that was created 10 years ago. You've never you have no trust number with CRA. You've never filed a tax return. So you may have had a trust that was created 10 years ago. You've never. You have no trust number with CRA. You've never filed a tax return.
Speaker 2:That has now changed, and so new rules came into place that now say, at minimum information needs to be filed with the government. So even if there's still no income being taxed within the trust, you still have to file a schedule that sets out the actors in the trust. So we talked about the settlor within the trust. You still have to file a schedule that sets out the actors in the trust. So we talked about the settlor, the trustees, the beneficiaries, the protector, and remember I said that typically the settlor gives the money and that's it.
Speaker 2:Well, now, the exception to that is that now you have to say who the settlor is, you have to give the settlor social insurance number and you need to give all their address information. So now CRA can link the individual stuff to the trust. Part of what we believe that the government is doing by asking for this extra information is they are trying to gather data on when settlers do receive things they're not supposed to from the trust. This is a way of them connecting and seeing. But now you have to get that consent to get some fairly important information from a settler and you're going to have to gather that for all your beneficiaries, for your trustees, and have that reported to Canada Revenue Agency, even if you don't have income in the trust.
Speaker 1:Can I ask your opinion?
Speaker 2:Sure opinion.
Speaker 1:Sure, is this solving a problem that existed, or is this creating work that has some sort of window dressing, of transparency and bringing back bad actors into the light of day, kind of thing?
Speaker 2:I think that the changes to tax filings for trusts are part of what we have seen as a series of changes around the government requiring information to be provided even in circumstances where there is no income. We've seen that with the underused housing tax filings. We've seen that with the trust filings principal residence sale filings they're not making any money off that. There's this whole history now of these new filings that have been created the foreign currency filings. So if you have over $100,000 in foreign property, even if there's no tax to pay on that stuff, you still have to file a form and give it to CRA. This is part of a series of information gathering and what we know is that CRA has changed their or overhauled their computer system over the last number of years and there's now a lot of AI that's being used as part of this. And this is all part of a new way for them to figure out how to audit, because before they had to actually put people in a room and have them actually go and check different boxes and figure out who we're going to audit and figure out who we're going to audit. This is a way for them to see trends see trends within provinces, trends across the country trends within Western Canada versus Eastern Canada and start identifying audit risks.
Speaker 2:That's what I think is going on and I don't think there's anything nefarious about this. I mean, a lot of these rules came in because they were trying to track foreign ownership and foreign investment. The problem is is that they used a hammer to put a nail hole and, as a result, now we're hitting the general population and all this information is being provided. So your question, you know, is it a lot of work? It almost feels like a make work project because we're having to explain to clients why we're gathering all this stuff and charging them for it when we never had to before. But I don't think the government's doing it just to give a make work project. There is a bigger picture plan of how to utilize the information.
Speaker 1:Interesting. Okay, I've got some questions for you off the mic.
Speaker 2:It's not a very conspiracy theorist.
Speaker 1:No, okay, awesome. Well, this was awesome. We covered a lot of ground on trusts here today, so if someone had um, you know, other questions about trusts, you've covered this extensively on your podcast. Can you give a little pitch for your own podcast?
Speaker 2:Oh, that's so kind of you. Um. So yes, I do have my own podcast, the tax chick podcast, and because I was getting so many questions about trust and I was saying the same thing over and over again, I recorded a series of three short episodes on this topic. For the beginning of season five, I did a trust 101 and then I did an advanced trust section. So if you're curious about things like alter ego trust if your advisor mentioned that, or if you can add a beneficiary, remove a beneficiary, or what to do on the 21st birthday, I talk about that. And then I did a session on the new trust tax filing requirements. So if you're curious to get a little more in detail, those episodes are available.
Speaker 1:Awesome. Amanda, thanks so much for joining me. This has been fun.
Speaker 2:Thank you for having me.
Speaker 1:Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a certified financial planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.