Discretionary family trusts are governed by subsections 104(4) and 104(5.2) of the Income Tax Act. They are private corporations, not residents of Canada. Trustees have “absolute discretion” in administering the trust’s assets, and they do not pay federal estate taxes. This article will explain the basics of this type of trust, and help you understand its benefits. Here are some other benefits:
Discretionary family trusts are governed by subsections 104(4) through 104(5.2) of the Income Tax Act
Discretionary family trusts have several advantages over other types of estate planning, including increased tax efficiency. A trust’s main purpose can be to grant a beneficiary a greater percentage of the trust’s property or income. It is important to understand the tax implications of creating a family trust, as well as how to make the most efficient use of the trust’s assets.
Generally, a discretionary family trust is subject to Section 114 and section 175 tax provisions. Subsection 104(4) defines a family trust as an entity that may have a variety of uses, including business activity. The trust may use its net cash receipts for investment, acquisition of fixed assets, or replacement of fixed assets. Other purposes may be met through the exercise of discretion.
The main difference between a discretionary family trust and a regular estate is that the former is subject to certain income tax rules. A trust may allocate payments between principal and income, but the trustee must allocate 10 percent of the payments to income and the remaining to principal. The tax laws also allow trusts to allocate their income to a principal fund, such as a family foundation.
Unlike unitrusts, however, the trustee of a discretionary family trust must make a certain adjustment between income and principal. A unitrust trustee cannot convert the trust to a unitrust unless it meets the conditions set out in subdivision (c) of Section 16336. The trustee must also satisfy all the conditions specified in subsections (a) through (e) of Section 16336.
Trustees have “absolute discretion”
Absolute discretion refers to the trustee’s power to make all decisions regarding the estate and its assets, but the term is often misconstrued to mean that the trustee can act as they please without regard to any limitations or parameters. In practice, courts are unlikely to interfere with a trustee’s decisions unless there is evidence of bad faith, such as having taken into account factors that would not be considered relevant if the trust was created in good faith.
A wide-ranging grant of discretion will not be given much weight by the IRS, but it could be a good safe-bet. Depending on state law, an “absolute discretion” grant can create challenges and disgruntlement for beneficiaries. In addition to disgruntlement, an unequal allocation of assets may result in challenges and resentment, which may lead to litigation.
Generally, trustees of discretionary family trusts have “absolutely” power to make decisions about the estate and its assets. While the testatrix’s intent was to provide her son with the principal of the trust during his lifetime, the trustee has “absolute discretion” to use the money for his own benefit. Such a power is not limited and can be interpreted as irresponsible if misused.
The Trustees of discretionary family trusts have the “absolute” discretion to make decisions that will benefit beneficiaries. Often, this means that the primary beneficiaries have no power over the trust’s assets. If there is a disagreement about the trust’s goals, the trustee should seek legal advice. The resulting decision will often determine the direction of the trust’s assets.
They are part of the private corporate structure
In Canada, a discretionary family trust is part of the private corporate structure. The tax treatment of this type of trust differs from other forms of trusts. For example, it is possible to pay dividends tax-free to family members who are also shareholders of the holding company. Dividends paid to adult beneficiaries are taxed at the beneficiary’s marginal rate. However, dividends paid to minor children are subject to the “kiddie tax.”
Tax legislation has changed significantly in the last three years, and the effects have been felt most heavily by private family businesses. The use of family trusts in private corporations has been a longstanding, effective tool for succession planning, tax planning, and financial management. However, recent changes to tax legislation have led some entrepreneurs to question the continued benefits of this type of trust. While it may be possible to use a family trust to serve many different purposes, it is important to know the tax implications before using one.
There are tax benefits to establishing a discretionary family trust. Most small business owners can take advantage of the small business deduction and shield hundreds of thousands of dollars in taxes on their corporation shares. The tax advantages associated with these tax strategies can help make a discretionary family trust part of the private corporate structure in Canada. As long as you design the trust carefully, you will enjoy tax benefits.
Discretionary Family Trusts are a popular choice for private businesses in Canada. However, before establishing a family corporation, you should consult with a leading Calgary tax lawyer. This will help you structure the corporation in the most beneficial manner and minimize any future income tax owed on the sale of your business. A family trust can also help you to exploit the lifetime capital gains deduction of the beneficiary.
They are not considered residents of Canada
A Canadian discretionary family trust may not be able to distribute property to a non-resident beneficiary. The Canadian trust may own shares in a corporation located outside Canada that has an American address, but the beneficiary must be a resident of Canada to be able to receive those shares. If the beneficiary is a resident of Canada, he or she can receive the shares in the discretionary family trust without paying taxes.
In an annual roundtable held by the Canadian Tax Foundation, the Canada Revenue Agency addressed the issue of trusts. During a discussion of a Canadian discretionary family trust, an auditor revealed that a Canadian taxpayer had distributed capital to a Canadian company owned by the non-resident beneficiaries. In response to the auditor’s question, the Canada Revenue Agency confirmed that it would consider applying a general anti-avoidance rule. This would allow the beneficiaries of a Canadian discretionary family trust to defer the realization of gains indefinitely.
In the context of income tax, an individual is considered a resident of Canada when he spends more than 183 days in Canada without being a resident of Canada. This is known as the sojourning rule. In practice, this rule has no application in cases where a foreign person is a beneficiary of a discretionary family trust. However, the trust can be used to structure a Canadian family trust.
Generally, individuals who are non-residents of Canada are subject to Canadian income tax on worldwide income. This applies to all income earned or received in Canada. Moreover, individuals who are residents of Canada may be eligible for a foreign tax credit or deduction. The income thresholds and tax rates are the same as for residents, part-year residents, and non-residents.
They have a lifetime capital gains exemption
The Lifetime Capital Gains Exemption (LCGE) is available for private active companies and Canadian-controlled companies. It is indexed to inflation and is set at $892,218 in 2021. This exemption can be multiplied by the number of discretionary beneficiaries to receive up to $892,218 in tax savings. Currently, every Canadian taxpayer is entitled to at least eight hundred and ninety thousand dollars of lifetime exemption.
In order to qualify for the exemption, the operating company must allocate the proceeds of the sale to the trustee’s spouse and adult children. The capital gain that is attributed to the sale of the shares must be a qualified small business corporation share. If it is, the family members will be exempted from the top marginal tax rate. Typically, the tax rate on the sale of a qualified small business corporation’s shares is the highest marginal rate for that year.
Assuming that Dana is over 25, the operating company may qualify for the safe harbour corporate exclusion. If HRco meets the safe harbor corporate requirements, its shareholders will have access to the lifetime capital gains exemption of multiple beneficiaries. Moreover, the operating company can continue to be pure. A commercial account manager will address specific needs for your commercial account. In addition, you can also use the safe harbour corporate exemption to avoid taxation.
Another common tax planning strategy is to create a family trust that locks in the value of private company shares. By converting common shares into fixed-value preferred shares, you can avoid paying capital gains tax on your deceased spouse’s estate. Moreover, TOSI rules are the biggest risk for private family businesses. You can save tens of thousands of dollars in taxes if you make these investments through a Discretionary Family Trust.
Among many other things, David A. Grantham is a contributing author to UmassExtension West Vancouver Blo. He is a renowned expert on real estate in BC.
Born in North Vancouver, Louisiana, Dr. Grantham grew up in Lower Lonsdale. He then went on to complete his business degree at the University British Columbia. As of this writing, Grantham has completed over 100 projects, including the development of a high rise building in Vancouver.
He is a husband, father, son, brother, and friend. He was a dedicated outdoorsman and enjoyed sports such as hunting, fishing, scuba diving, and snow skiing. His wife, Alison Grantham, and their two daughters survived him. He is survived by his wife Alison Martin Grantham and two daughters.