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What is an Alter Ego Trust?

When it comes time for estate planning, the common estate planning tools that people turn to are Wills and Power of Attorneys. Although Wills are a common and useful estate planning tool, there are some other methods of estate planning which can be used in addition to, or even as a substitute to, a Will.  This article will provide some information regarding Inter Vivos Trusts, in particular Alter Ego Trusts.

WHAT ARE INTER VIVOS TRUSTS?

An Inter vivos trust is defined as “a trust other than a testamentary trust” in the Income Tax Act (“ITA”)[1]. Testamentary trusts are trusts that are created following the death of the testator.[2] Testamentary trusts are usually specified in the testator’s will and the estate trustee will create the trust in accordance with the testator’s instructions for the benefit of the named beneficiary. Inter vivos trust, however, are legal documents created while the individual is still alive. The assets listed in an inter vivos trust are used for the benefit of the Settlor, being the individual creating the trust, and once the Settlor passes away, then the assets are distributed to the designated beneficiaries in accordance with the trust. An Alter Ego Trust, is a special type of inter vivos trust.

WHAT IS AN ALTER EGO TRUST?

The requirements for an An Alter Ego Trust are outlined in subsection 248(1) of the ITA by reference to paragraph 104(4)(a) of the Act. An Alter Ego Trust is:

  • an inter vivos trust created after 1999;[3]
  • by an individual who had attained 65 years of age at the time the trust was created; [4]
  • only the individual was entitled to receive all the income of the trust before the individual’s death and no other person could, before the individual’s death, receive or otherwise use any of the income or capital in the trust;[5]
  • is a trust that has not elected out of the provisions to be an Alter Ego Trust;[6] and
  • the individual and the trustee (the individual that holds the property) must be resident in Canada.[7]

An Alter Ego Trust may be created if the above requirements have been met. An Alter Ego Trust creates a legal relationship between the Settlor (the individual setting up the trust), the trustee (the individual that holds the property), and the beneficiaries (the individual(s) whom the trust property is intended to benefit).  Property owned by the Settlor that is transferred to an Alter Ego Trust is no longer held by the Settlor personally but held and managed by the Settlor in their capacity as trustee. It is the Trust that holds the property. As per the relevant section in the ITA, only the Settlor is entitled to receive all the income from the trust before the Settlor’s death, however, you also name beneficiaries that you would like to leave those assets to when you pass away.

TAX TREATMENT OF ALTER EGO TRUSTS

Generally, a transfer of a property into a trust is considered to be a disposition and, as such, will trigger tax on any accrued gains.[8] However, one of the benefits of transferring property to an Alter Ego Trust is that the transfer will not attack tax on accrued gains as it will be deemed for tax purposes to have occurred on a tax-deferred rollover basis. The tax deferral is available only if the requirements of an Alter Ego Trust are met and the individual does not make an election in the first taxation year of the transfer for the rollover to not apply. [9]

Further, with trusts there is a 21-year deemed disposition rule which applies.[10] This rule provides that, following the 21st year the trust was created, the assets are deemed to be disposed, thus, taxes paid accordingly on the accrued gains. The purpose of this rule is to prevent a trust from holding property and deferring taxes on capital gains for an indefinite period.  It is important to note that the 21-year deemed disposition rule does not apply to Alter Ego Trusts. With an Alter Ego Trust, the trust is deemed to have disposed only on the death of the Settlor.[11] Therefore, there are no capital gains taxes payable until the death of the Settlor.

It is important to note that annual taxes must be filed for trusts. Any income that is retained in the trust and not paid to the Settlor will be taxed at the highest marginal rate. [12]

ESTATE PLANNING BENEFITS OF ALTER EGO TRUSTS

Alter Ego Trust as an alternative to a Will

Similar to a Will, a Settlor has the power to determine the beneficiaries in an Alter Ego Trust after his or her death. The assets which have been transferred to an Alter Ego Trust will be distributed in accordance with the Settlor’s instructions in the trust deed. The assets are distributed by a replacement trustee, named in the trust deed, upon the Settlor’s passing. The replacement trustee in an Alter Ego Trust has the same rights and obligations with respect to the assets of the Settlor as in a Will.

Avoid Probate Process

Probate is the Court procedure for the formal approval of a Will by the Court as a Valid Will of the deceased and the appointment of the person who will act as the executor of the estate. Probate gives the executor the authority to act on behalf of the deceased. This process is now referred to as a “certificate of appointment of estate trustee with a will”. When you apply for an estate certificate, you need to pay Estate Administration Tax (“EAT”). The EAT does not apply if the value of the estate is $50,000.00 or less. However, the EAT will be calculated as $15.00 for every $1,000 of the value of the estate.[13] This process is not only costly, but also time consuming expected to take approximately one (1) year. The process is even further lengthened where an individual owns property in several jurisdictions because multiple probate applications may need to be filed. It is important to note that the probate process does not apply to Alter Ego Trusts as the assets transferred to a trust do not form part of the Settlor’s estate. The Alter Ego trusts results in a reduction in the value of the Settlor’s estate by placing the assets in the trust that would otherwise form part of the estate. Because the probate process does not apply, the replacement trustee in named in the trust deed would be able to distribute to assets without delay and difficulty.

Alternative to a Power of Attorney (“POA”)

A POA for Property is a legal document which gives an individual the authority to act on the grantor’s behalf in the event of the grantor’s incapacity. The POA expresses the intention that the authority given may be exercised during the grantor’s incapacity to manage property.[14] The continuing POA allows the person named as attorney to do on the grantor’s behalf anything in respect of property that the grantor could do if capable, except make a will.[15] A person must have capacity to sign a continuing POA.[16] Additionally, POAs are provincially regulated which means that a POA would be required in each jurisdiction that assets are located. An Alter Ego Trust provides a convenient structure for a continuing POA for property to deal with the administration of property in the event of the Settlor’s incapacity. The replacement trustee named in the trust will manage the trust property in the event of incapacity. Because trusts are effective in all provinces, the jurisdictional limitations prevalent with the conventional POA do not apply to trusts. Therefore, the trust deed can be effectively used instead of a POA. (NOTE: you may still need POA for property that are not transferred to the trust.)

CONCLUSION

This article provided some of the benefits of an Alter Ego Trust which is an important estate planning tool which can be utilized in addition to, or as an alternative for, Wills and POAs. Canadians who are 65 years or older may want to consider establishing Alter Ego Trusts for some or all of their estate planning needs.

If you are interested in or require further information regarding Alter Ego Trusts, please feel free to contact us.

Also, look out for our article regarding some of the disadvantages of an Alter Ego Trust.

 

[1] Income Tax Act, R.S.C. 1985, c. 1, ss. 108 (1)

[2] Ibid.

[3] Ibid., para. 104 (4)(a)(ii.1)

[4]Ibid., para. 104(4)(a)(iv)

[5] Ibid., para. 104(4)(a)(iv)(A)

[6] Ibid., para. 104(4)(a)(ii.1)

[7] Ibid., ss. 73(1)

[8] Ibid., ss. 248(1)

[9] Ibid., ss. 104(4)(a)(ii.1)

[10] Ibid., ss. 104(4)(c)

[11] Ibid., ss. 104(4)(iv)

[12] Ibid., ss. 122(1)

[13] Estate Administration Tax Act, 1998, S.O. 1998, c.34, Sched.), ss. 2(6.1)

[14]  Succession Decisions Act, 1992, S.O. 1992, c. 30 (“SDA”), ss. 7(1)

[15] Ibid., ss. 7(2)

[16] Ibid., ss. 8(1)

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