The Basics of Trusts
We have all heard about the wealthy kids who live off their trust funds. But what exactly is a trust? In this article we will give you an overview of what a trust is and how it works as well as the reasons why you might want to consider creating one.
What is a trust?
A trust is the legal name that describes the division of ownership of property between the legal owner of the property, the trustee, and the beneficial owner of the property, the beneficiary. In other words, the trustee holds legal title to the property for the benefit of another.
Although a formal trust document is not generally required to create a trust, having something in writing is a good idea. In order to create a trust, there are three specific requirements.
1. There must be a clear intention by the maker, referred to as the settlor, to create the trust.
2. There must be no doubt as to the property of the trust. It must be clearly identified.
3. The beneficiaries of the trust must be specified or be ascertainable.
There are two broad categories of trusts – testamentary and inter vivos. The former is created in a will and comes into operation only after the settlor has died. The latter is any trust that is not a testamentary trust.
Why a trust?
The trust that you are probably most familiar with and most likely to set up is a trust in your will for your minor children. Minor children are not entitled to own property and therefore property is placed in a trust for their benefit. As the creator of the trust, you can choose the trustee and you can stipulate how the property is to be used.
In addition to the above, there are a number of other reasons for setting up a trust, including:
– income splitting,
– avoidance of probate taxes,
– tax deferral,
– as a vehicle to hold property for the benefit of an individual, who by reason of age, mental incapacity or lack of business experience, is unable to deal with the property personally,
– as a way of transferring property to beneficiaries while at the same time retaining a certain control over the property and
– as a way of providing a stream of income for a spouse or for children.
Trusts and taxes
The creation of a trust engenders a number of tax issues. Therefore, while a trust can be an effective tax planning tool, if it is not set up properly there can be some nasty tax consequences. The following are some facts you should know about trusts and taxes.
– A trust is treated as an individual and therefore an income tax return must be filed on its behalf.
– A testamentary trust is subject to the regular graduated tax rates, however, an inter vivos trust will normally be taxed at the highest marginal tax rate.
– When property is transferred to a trust this will generally result in a disposition and the settlor will be taxed accordingly.
– Where the beneficiary of a trust is a minor child, capital gains will be taxed in the hands of the child, even if the gain was not paid out. However, this rule will not apply if the trust is a discretionary one or is revocable.
– In an effort to close what it saw as a loophole, the Canada Customs Revenue Agency now taxes dividends from a private corporation, held in a trust, at the highest marginal rate, even where the beneficiary is a minor. This change primarily impacts family owned businesses and professional firms.
Is a trust for you?
Everyone’s situation is different and it is difficult to generalize. If you think that you might be a candidate for a trust, contact Howard Steinberg or Stanley Landau.