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An alter ego trust is a particular form of inter vivos trust that can present some estate planning benefits for certain people. The alter ego trust is a creature of statute; it was created by amendments to the Income Tax Act in 2001.

Although alter ego trusts have been around for a number of years, they have become a more prominent estate planning tool due to the changes in 2014 to the tax treatment of testamentary trusts.

Prior to 2014, testamentary trusts were attractive because income in the trust was taxed at low marginal rates. The 2014 budget introduced changes so that beginning in 2016, testamentary trusts will be taxed at the top marginal rate. This means that going forward, alter ego trusts may be more attractive than before.

Criteria

A valid alter ego trust must meet the following criteria:

(i) The trust must have been created after 1999;

(ii) The settlor must be 65 years of age or older at the time the trust is created;

(iii) The settlor must be a resident of Canada

(iv) The settlor must be the sole income beneficiary of the trust; and,

(v) The settlor must be the sole person with a right to the trust’s capital during the settlor’s lifetime.

Tax consequences

There are a number of tax implications associated with executing an alter ego trust that should be evaluated before entering into one.

Firstly, property can be transferred to an alter ego trust on a tax free basis. This means that there will be no taxable disposition at the time of the transfer and any capital gains or losses will be taken into account at the time of the settlor’s death

Secondly, non-depreciable capital property transferred to an alter ego trust will be recorded at its adjusted cost base, while depreciable property is transferred into the trust at its undepreciated capital cost.

Additionally, trust income distributed to the settlor during the settlor’s lifetime is taxed at the settlor’s marginal tax rate. Accordingly, alter ego trusts are generally tax neutral while the settlor is alive. Income earned by an alter ego trust, however, will be subject to the top marginal tax rate.

Once property is transferred to an alter ego trust, there is no deemed disposition 21 years after the date the trust is created. Accordingly, an alter ego trust is an exception to section 104(4) of the Income Tax Act. An alter ego trust can elect, however, to have the 21 year rule apply. The deemed disposition will instead occur on the date the settlor passes away. All of the trust income and capital gains realized on the deemed disposition of the assets are taxed at the top marginal rates. This may result in higher tax than if the settlor of the alter ego trust had not transferred them to the trust but rather had held them personally.

Finally, since there is a deemed disposition at the date of death, a spousal rollover is not possible

Benefits

Avoid Probate

The main benefit of an alter ego trust is its use as a vehicle to avoid probate. Property transferred to an alter ego trust belongs to the trust, not the estate. Accordingly, assets held in an alter ego trust are not subject to estate administration tax.

Another benefit to avoiding probate is that it removes the necessity of filing a probate application, which can cause a significant delay in some cases. Instead, the trustee can deal with the property immediately at the time of the settlor’s death

Administration and Organization of Assets

The risk of lost assets is minimized with an alter ego trust, since assets of an alter ego trust must be dealt with at the time the trust is settled. Accordingly the estate is effectively “pre-administered”, allowing for expeditious distribution of assets.

Assets in Multiple Jurisdiction

Alter ego trusts centralize property – ownership is centralized to one jurisdiction under the control of the trustees whose authority to deal with the assets will not need to be subsequently ratified by a court of any jurisdiction. Moreover, the trust allows for general recognition by third parties of a trustee’s authority to deal with trust assets across different jurisdictions, which eliminates the need to have a separate power of attorney for each jurisdiction.

Privacy

This benefit relates to the alter ego trust’s role as a will substitute. When wills are probated, they become public record and their contents are openly viewable. However, there are no disclosure or reporting requirements for trust documents.

Alternative to Power of Attorney

An alter ego trust can act as an attractive alternative to a continuing power of attorney. The settlor can appoint substitute trustees to manage the trust property if settlor becomes incapable. The alter ego trust also sets out powers and duties of trustee, which can be tailored to specific needs of client.

A benefit of using an alter ego trust as an alternative to a power of attorney is that the settlor can set precise standard of incapacity and the standard of care that the trustees must exercise.

Disadvantages

Disadvantages of alter ego trusts include:

  • Significant up-front set-up costs to ensure that trust is properly drafted
  • On going costs for accounting, filing, and trustee fees
  • Increased complexity that may not be appropriate if client is advanced in age
  • Some tax consequences (eg. loss of spousal rollover);
  • Limited creditor protection.

Please contact a member of Mills & Mills’ estates team for more information on alter ego trusts.

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