In Part 1 of our series on Family Trusts, we covered topics on family trusts from a high-level - how they can protect your assets, minimize taxes, and give you more control over your business legacy.
In this post, let’s go deeper. Our goal is to focus on the why. Understanding these technical details matters to you as a business owner: how the right structure can unlock tax efficiencies, protect your family from future headaches, and give you more flexibility as your business (and family) evolves.
The Key Players & Why It Matters to You
When you set up a family trust, you're creating a structure that gives you control today and flexibility tomorrow. Here's how:
- Settlor: Kickstarts the trust by contributing a small amount (usually a $10 bill). This gets the structure going, but the real power sits with the trustee.
- Trustees: This is where you stay in the driver’s seat. As a trustee (whether solely or jointly with other persons of your choosing), you manage the trust, decide on distributions, and stay in control of the assets while protecting them from personal liabilities.
- Beneficiaries: Your family can benefit from the trust, but you decide when and how. This lets you support them strategically - think tax-smart distributions or milestone-triggered gifts.
- Protector (optional): An added safeguard, giving you a trusted person who can step in if needed.
Why does this matter? You keep control over your business and assets while future-proofing your plans. You decide who benefits, when, and how, without giving up ownership prematurely.
Key Tax Benefits of Family Trusts for Business Owners
- Maximizing Income Splitting: A family trust lets you allocate income to adult family members, potentially lowering your family’s overall tax bill. But beware of pitfalls, like the Tax On Split Income (or TOSI)!
Example: Allocating dividends to your spouse or adult children working in the business can reduce taxes and spread wealth strategically. - Preserving the Lifetime Capital Gains Exemption (LCGE): When your business shares are sold, a trust can allow multiple family members to each claim their LCGE - currently $1.25M per person. That's a huge tax-saving opportunity you might miss if you own shares personally. If you’re thinking of ever selling your business, you should definitely consider a Family Trust.
- Protecting Family Assets: By holding assets in a trust, you may shield them from future lawsuits, creditors, or marital breakdowns. This is about protecting not just your business, but the wealth you've built for your family.
- Capital Gains Flexibility: Trusts let you decide who claims capital gains and when - giving you control over when taxes are triggered and who bears them.
The Mechanics That Protect You and Your Family
- Distributions Must Be Documented and Payable by Year-End: To get the tax benefits, you can't just paper over income allocations. You need to document them properly and make them legally payable by December 31. Missing this step means losing the tax benefits (and inviting CRA attention).
Why it matters: Missing documentation deadlines can cost you thousands in avoidable taxes or penalties. - 21-Year Deemed Disposition Rule: Trusts don't last forever tax-wise. Every 21 years, a trust must pay tax on the unrealized gains of its assets unless they're transferred out beforehand. Planning for this is key to avoiding an unexpected tax bill down the road.
Why it matters: Failure to plan can mean an unwanted capital gains bill you never saw coming.
Inter Vivos vs. Testamentary Trusts: Which One Protects You Best?
For business owners, inter vivos trusts (also called “living trusts”) are typically the best choice. They give you flexibility, control, and tax advantages while you're alive.
Testamentary trusts, created through your will, are useful for estate planning but don't offer the same proactive control or tax advantages during your lifetime.
And since 2016, testamentary trusts no longer enjoy special lower tax rates (except for Graduated Rate Estates (GREs) during the first 36 months after death).
Why it matters: Using the wrong type of trust can mean missed planning opportunities and higher taxes.
The Trust Deed: The Rules That Shape Your Flexibility
Your trust deed is more than a legal formality - it's your playbook. Done right, it gives you:
- The power to decide exactly how (and when) family members access funds.
- The flexibility to name a broad class of beneficiaries (even those not yet born).
- The ability to add a protector to oversee the trustee's powers and add an extra layer of safety.
Why it matters: A cookie-cutter trust deed can limit your options. A carefully crafted one can protect your family for generations.
CRA Red Flags and Audit Triggers: What to Avoid
CRA keeps a close eye on family trusts. Here are common mistakes that can attract attention:
- Allocations to non-active family members without valid exemptions.
- Using minors to split income without respecting attribution rules.
- Trustees who aren't actively managing the trust.
- Overly aggressive attempts to avoid TOSI or split passive income.
These are signals to CRA that your trust may not be operating as it should.
Final Thoughts
A well-structured family trust gives you more than tax savings. It gives you control, protection, and peace of mind that your business legacy and family wealth are handled the way you want.
The details matter. Get the right setup, manage it properly, and you can unlock the full benefits for years to come.
If you want to see what this could look like for your business and family, our team at ConnectCPA is always here to walk you through it.
