Alter ego and joint partner trusts

The Income Tax Act of Canada (the “Tax Act”) includes specific estate planning opportunities for people who are 65 or older: alter ego and joint partner trusts. Since those trusts were introduced in 2001, they have become a central component of many estate plans.

What is a trust?

A “trust” is not a legal entity, although it is treated as such for Canadian tax purposes. It is the word used to describe the relationships created when property is transferred by one person (the “settlor”) to another (the “trustee”) to hold for the benefit of individuals or organizations such as charities (the “beneficiaries”).

Alter ego trusts

An alter ego trust can only be created by an individual who is 65 years of age or older. The terms of the trust must provide that the settlor is entitled to all of the income that arises from the trust property before his or her death, and only the settlor may receive or obtain the use of the income or capital of the trust while the settlor is alive. On the death of the settlor, the remaining trust property will be distributed to, or continue to be held for, family members, friends or organizations such as charities as specified in the document creating the trust.

Joint partner trusts

A joint partner trust is similar to an alter ego trust, except that the settlor and his or her spouse, together, must be entitled to receive all of the income of the trust that arises before the death of the survivor of them. In addition, no person other than the settlor and the settlor’s spouse may be entitled to receive or have the use of the capital of the trust until the settlor and his or her spouse have both died. The definition of spouse, for the purposes of a joint partner trust, includes married, common law and same sex spouses.

What makes these trusts special?

Many estate planning objectives can be achieved through the use of a trust established during one’s lifetime (an “inter vivos trust”), as opposed to one created by a Will. However, a potential downside associated with the use of inter vivos trusts exists as a result of Canadian tax rules which generally provide that an asset transferred to a trust will be considered to have been disposed of in the year in which the transfer occurs for proceeds equal to the fair market value of that asset at the time of the transfer. This means that, if the asset increased in value while it was owned by the settlor, the transfer of it to the trust could trigger an unwanted tax liability.

If a settlor who is resident in Canada transfers a capital asset to an alter ego trust or a joint partner trust, the transfer of that asset will be deemed for tax purposes to have occurred on a tax-deferred rollover basis. Accordingly, one of the main obstacles to the use of such a trust as part of an estate plan no longer exists where the person is 65 or older.

Estate planning goals that can be achieved through the use of alter ego and joint partner trusts

1. Elimination of probate fees

In Ontario, probate fees (also referred to as estate administration taxes) are charged at a rate of approximately 1.5% of the value of the deceased’s estate. This means that for every $1,000,000 in assets passing pursuant to a Will that is probated, approximately $15,000 in probate fees will be payable.

In British Columbia, probate fees are calculated at approximately 1.4% of the value of all real and tangible personal property owned by the deceased in the province and, if the deceased was ordinarily resident in British Columbia immediately before death, 1.4% of the value of intangible personal property (such as bank account balances, stocks and other securities) wherever located.

Assets transferred by an individual to an alter ego or joint partner trust will not form part of the individual’s estate on his or her death. Accordingly, probate fees will not be payable in respect of the value of those assets.

2. Incapacity planning

A trust can be used as an alternative to an enduring Power of Attorney for property to help ensure that an individual’s financial affairs will be properly managed should he or she become mentally incapable. When compared to the use of a Power of Attorney in this context, a trust can provide for a more certain and efficient administration of one’s assets and financial affairs both during one’s life and after death.

3. Will variation concerns

The Wills, Estates and Succession Act of British Columbia (“WESA”) provides that if an individual dies leaving a Will that does not make “adequate provision” for his or her spouse and children, including adult children, the Court can vary the Will as it considers appropriate in order to do so. A great deal of litigation is commenced every year based upon this legislation, often resulting in significant legal costs borne by the estate. Will variation litigation is especially common in situations involving competing interests created by second marriages and blended families, as well as situations where a parent (sometimes for good reason) decides to treat his or her children differently. The decisions of the Courts in these cases are often highly fact driven. As a result, it can be difficult to predict whether a particular Will would be upheld if attacked. Under current law, alter ego and joint partner trusts can be used to eliminate the possibility of a Will variation claim under WESA by an adult child.

4. Confidentiality

When an individual dies and an application is made to the Court to probate his or her Will, the original Will and details of the individual’s assets must be filed with the Court. In many jurisdictions, that information and copies of related documents are available to members of the general public upon request. This is a concern for many people for reasons of privacy and family security. In contrast, an alter ego or joint partner trust document and details of the property held pursuant to its terms, can generally be kept confidential to the general public both before and after the settlor’s death.

5. Estate administration simplified

The use of a trust can also facilitate the administration of assets after death by eliminating the need for a grant of probate in order to deal with the assets of the trust, thereby permitting the administration and distribution of those assets more quickly after the settlor’s death for the benefit of family members and other intended beneficiaries.

6. Reduction in tax on capital gains

Under the Tax Act, on the day that the settlor dies (in the case of an alter ego trust), or on the death of the last to die of the settlor and his or her spouse (in the case of a joint partner trust), the trust will be deemed for tax purposes to have disposed of all of its capital property at fair market value. Any gains in the value of that property will be taxable at that time in the trust at the highest individual marginal income tax rates applicable in the province where the trust is resident for tax purposes. However, if by December 31 of the year of death, the trust is resident in a lower taxing province, the income tax rates of that jurisdiction could apply. To achieve this possible benefit, the trust might be established in a lower taxing province from the start, or the trust document can be drafted so as to permit the trust to change its residence for tax purposes in the future.

Conclusion

If you or your spouse is 65 years of age or older and would like to consider the possibility of an alter ego or joint partner trust, the lawyers in our private wealth, trusts and estates group would be pleased to talk to you in greater detail about the estate planning opportunities that these structures can offer.