Every estate planning has three requirements: protect assets from significant taxes, fees, creditors, and litigations; manage wealth while you are alive; and ensure seamless transfer of wealth after death. Wills and family trusts are most common, but Joint Partner Trusts and Alter Ego Trusts are poorly understood or discussed. However, they can be an even more powerful tool than a will in estate planning.
The Working of a Trust in Estate Planning
A Settlor sets up the trust, transfers his/her property to the trust, and writes the Trust Deed detailing who will hold the property, how it will be managed and distributed after his/her death, and who will be the beneficiaries. The Settlor then appoints a Trustee to hold and manage the trust property as per the instructions in the Trust Deed. The base workings of all trusts are the same. The changes come in the details.
What Is Alter Ego Trust?
Only Canadian residents aged 65 or older can create an Alter Ego Trust. They will be the settlor and the sole beneficiary of the income and capital gain from the assets the trust holds. You cannot even add a charitable organization as the beneficiary. If you want to add your spouse as a beneficiary, consider Joint Partner Trust. It is similar to the Alter Ego Trust with only one difference – you and your spouse will be the only beneficiaries for your lifetime. Any one of the spouses has to be above 65 years of age, and the spouse below 65 cannot contribute assets to the trust.
Trustee: In both trusts, you can appoint yourself as the trustee. However, you are advised to appoint an alternate trustee who can take over the responsibilities in the event of your demise or incapacity.
If you don’t have any heirs and want to use your wealth for yourself, you could consider holding your property in Alter Ego Trust.
Tax-Deferred Transfer of Assets into The Alter Ego Trust
When you transfer assets into a trust, it is deemed that you sold assets to the trust at the fair market value and could face a capital gain tax. However, the transfer of assets into an Alter Ego Trust receives a rollover treatment in which the tax consequences from the deemed disposition are deferred at the time of your death. Moreover, alter ego trust is accessible from the 21-year deemed disposition rule. Other trusts have to pay tax every 21 years on the deemed disposition of the asset.
If you have a substantial estate, an alter ego trust can help you save on capital gains tax.
Alter Ego Trusts Are Not Subject to Probate
A Will is subject to probate. After your incapacity or death, the executor of the Will goes to the court and submits the probate application, which needs legal expertise and time. The executor has to pay the probate fees from the estate assets. This fee could be as high as 1.4% of the estate’s gross value.
Once submitted, the probate registry could take several months to approve the application and issue a grant. On receipt of the grant, the executor cannot distribute the assets within the next 210 days unless he receives the consent of all beneficiaries. The probate application is a public document anyone can view by visiting the Courthouse. Your Will and the list of assets are exposed to the public. During these 210 days, your spouses and children can contest the Will and demand variation.
The Alter Ego Trust is not subject to probate, relieving your estate from the high probate fees and ensuring seamless transfer of assets to the beneficiaries after your demise without delays and worries of Will variation. Since no probate application is involved, the information about your assets, beneficiaries and other terms remains private.
If your estate could be contested in court by any family members, an alter ego trust could protect your estate.
How Income Tax Works for Alter Ego Trusts?
While alter ego trust can defer capital gains tax till you are alive, the accrued capital gain will be subject to deemed disposition on your death and face the highest marginal tax rate. The trust can claim the donation tax credit if the assets are being transferred to a charitable organization.
Like all trusts, alter ego trusts must file annual tax returns. If the trust retains any income generated by the trust assets inside the trust and does not distribute it to the beneficiary, it will pay the highest marginal tax rate.
For instance, your assets include stocks that generated a dividend of $10,000. If you retain this income in the trust, the trust will have to pay the highest marginal tax rate on the dividend. However, if you collect the income, you will pay progressive tax. (15% federal tax on the first $55,867 taxable income in 2024). These tax slabs grow annually to index for inflation.
If the alter ego trust holds private company shares or U.S. situs assets, US tax laws will also apply, which could cause tax complications.
Should You Consider Alter Ego Trust in Your Estate Planning?
The Alter Ego Trust has tax benefits only during the beneficiary’s lifetime. After your death, the capital gain tax could significantly reduce the estate value.
Contact Glenn Graydon Wright LLP in Oakville for Expert Estate Planning Advice
A professional tax consultant can look at your estate and financial goals and help you determine if an alter ego trust is a good fit from the tax perspective. At Glenn Graydon Wright LLP, our tax experts can provide you with recommendations on storing wealth in structures best suited for your business. To learn more about how Glenn Graydon Wright LLP can provide you with estate planning expertise, call today at 905-845-6633 or connect with us online to schedule an initial consultation.