Canadian Tax Lawyer Explains the Basics of Alter Ego Trusts

What is an alter ego trust

An alter ego trust is an inter-vivos trust, which means it’s created during your lifetime, established after 1999. To qualify as an inter-vivos trust, you (the settlor) must be a Canadian resident aged 65 or older and the sole beneficiary of all income from the trust during your lifetime—no one else can receive or benefit from the income or capital of the trust while you’re alive.

While you can appoint a third party as trustee or co-trustee, you can also appoint yourself. If you choose to be the trustee, it’s advisable to name an alternate trustee who can take over and manage the trust after your passing (similar to an executor). Both the trustee (or majority of trustees if there are several) and the alter ego trust itself must be resident in Canada.

Alter ego trusts are established under the Income Tax Act and are often seen as a substitute for a will. The trust document dictates how trust assets are distributed upon your death. This allows you, as the settlor, to name beneficiaries who will benefit from the trust after your passing. This is similar to naming beneficiaries in the residual provisions of your will. Upon your death, the distribution of trust assets typically bypasses probate and its associated legal fees. While probate is a public process, the distribution of trust assets is usually private. These types of trusts are often used for probate planning, to mitigate inter-provincial asset issues, and for incapacity planning.

What kind of assets can you transfer into an alter ego trust?

You can typically transfer any type of “capital property” to an alter ego trust without immediate tax consequences. Capital property includes “depreciable property” and any property that, when disposed of, could result in a capital gain or loss. For instance, a building from which you earn rental income is considered depreciable property.

Other examples of capital property are stocks, bonds, mutual funds, personal-use assets like your primary residence, and shares in private companies, and some crypto assets or NFTs or capital properties under your TFSA. However, you cannot transfer non-capital property, such as inventory, to these trusts on a tax-deferred basis. Additionally, you cannot directly transfer assets from your RRSP or RRIF to these trusts without first withdrawing the assets. This is generally not recommended because any amount withdrawn from your RRSP or RRIF is taxable in the year of withdrawal.

What is the difference between joint partner trust and alter ego trust?

A joint partner trust resembles an alter ego trust in that both are inter vivos trusts allowed by the Income Tax Act. However, the key difference lies in their structure: an alter ego trust permits only the settlor to receive trust income and capital during their lifetime, whereas a joint partner trust allows both the settlor and the settlor’s spouse or common-law partner to benefit from the trust’s income and capital during their respective lifetimes.

In a joint partner trust, you can designate your spouse as the successor trustee to manage the trust after your death, or you can choose another replacement trustee. This trust continues after the first spouse’s death, with the surviving spouse or partner receiving the trust’s income and capital while alive. Upon the surviving spouse’s death, the trust assets pass to the named beneficiary or beneficiaries according to your instructions in the trust deed. It’s worth noting that while you must be a Canadian resident aged 65 or older to establish a joint spousal trust, your spouse does not need to meet the age requirement.

Pro tax tips – benefits and disadvantages of an alter ego trust

Alter ego trusts offer several benefits, including the potential to avoid probate and associated legal fees upon death, asset protection, and the ability to transfer assets to the trust at their cost basis, thus avoiding the realization and taxation of capital gains. However, there are certain limitations and considerations in tax and estate planning once assets are transferred to an alter ego trust. During your lifetime, the trustee can only distribute income or capital to you as the settlor, or to your spouse in the case of a joint partner trust. This restriction limits charitable gifting options. Additionally, if the alter ego trust holds private company shares, has non-resident beneficiaries, includes U.S. persons as the settlor or grantor, or holds U.S. situs assets, these factors can lead to additional tax complexities, tax mismatches, and the potential for double taxation. An experienced Canadian tax lawyer can assist you in determining whether an alter ego trust or a joint partner trust should form a part of your estate planning strategy.

FAQ:

What is an alter ego trust?

Alter Ego Trust is a special type of trust permitted under the Income Tax Act (Canada) (the “Act”), under which you are the Settlor, Trustee and Beneficiary for as long as you are living. The main criteria to be able to set up an Alter Ego Trust is that you must be 65 years of age or older.

What type of property can you transfer to an alter ego trust?

In most cases, capital property can be transferred to an alter ego trust without immediate tax implications. This includes assets such as portfolio investments (e.g., mutual funds, segregated funds, individual stocks), rental properties, your primary residence, and other similar assets. However, certain assets, like undeveloped land, or certain crypto assets, might be classified as inventory, making them ineligible for transfer to the trust without triggering taxes. It’s important to note that transferring an RRSP or RRIF to an alter ego trust results in the deregistration of those registered accounts, making the full value taxable at that time. Conversely, an alter ego trust can be designated as the beneficiary of registered accounts without immediate tax consequences.

Disclaimer: This article just provides broad information. It is only up to date as of the posting date. It has not been updated and may be out of date. It does not give legal advice and should not be relied on. Every tax scenario is unique to its circumstances and will differ from the instances described in the article. If you have specific legal questions, you should seek the advice of a Canadian tax lawyer.