Category: AvisoWealth

Disability needs planning using trusts

Aligning trust features with individual circumstances

Disability planning can be challenging to manage, even when focused on the health and medical issues alone. Extend that to navigating financial supports and tax benefits, and understandably it can feel overwhelming. Trusts1 can ease both the financial pressure and mental stress this can bring on, whether planning for oneself, a spouse2, a child, a sibling, or extended relations.

The table below highlights the type and features of trusts that can assist those with disabilities, with more detailed discussion in the following pages. In addition, for current tax and financial figures, please see the companion article Disability income support and tax benefits.3

 

 

1.    Personal trust principles

At its core, a trust separates legal ownership of property from beneficial ownership. The original property owner (the settlor) wishes to provide for someone (the beneficiary) who may be incapable of, or unsuitable to be managing property personally. By creating/settling the trust, the settlor chooses a person (the trustee) whom the settlor trusts in both the generic sense of confidence and in the formal position of having legal control.

For the disability trust types and features discussed below, the drafting must adhere to the appropriate regulation or administrative guidance. Even so, there can be trade-offs among these options, so legal advice is a must.

2.    Discretionary / ‘Henson’ trust

Provincial disability income support programs require that applicants provide initial and ongoing financial disclosure. The specifics vary by province, but generally these programs are intended as a safety net for vulnerable people who do not have, or have exhausted, personal resources in managing their lives. Thus, if an individual’s assets or annual income exceed prescribed figures, benefits may be reduced or eliminated altogether.

A discretionary trust can help shield against inclusion of some assets and income sources in this determination. This is sometimes called a ‘Henson’ trust, a reference to the 1980s Ontario case that ruled on the issue. Though technically only applicable to the Ontario program (now the Ontario Disability Support Plan, or ODSP), most provinces abide by similar principles, but with some variation so it is prudent to verify with provincial officials.

The defining (and really the only) feature is that the trustee has absolute discretion as to the amount and timing of trust distributions. As the beneficiary cannot compel payment, those assets will not be counted when determining eligibility or amount of support. Distributions to the beneficiary are subject to the program’s usual income rules.

Helpful as this can be, other factors aside from public support may influence when, how and even whether to use such a trust, depending on available assets and other income sources, and implications for access to tax benefits.

Ontario Inheritance trust

Up to $100,000 that is received as beneficiary of an estate or life insurance policy may be transferred into a non-discretionary trust. It is treated as income in the month received, but an exempt asset thereafter if transferred into trust within six months. Annual trust income does not affect ODSP if added to trust capital (up to the prescribed $100,000 level), but distributions to the beneficiary are subject to the program’s usual income rules.

Manitoba EIA trust

Manitoba has a “trust property exemption”, under its Employment and Income Assistance (EIA) Regulation. It allows up to $200,000 to be contributed to either/both an EIA trust and a registered disability savings plan (RDSP) without affecting support eligibility. Recent legislation passed in 2021 came in force in 2023, but the associated regulation did not come in force at the same time. Consult a Manitoba lawyer for current status.

RDSPs generally

A RDSP is not a personal trust, but as it was mentioned above in discussing Manitoba, it bears noting that all provinces exempt it as an asset. As well, distributions are treated as exempt income (partial in NB, PE and QC).

3.    Preferred beneficiary election (PBE)

The preferred beneficiary election (PBE) allows for tax on income earned in a trust (inter vivos or testamentary) to be allocated to certain beneficiaries, while the income itself remains in the trust. The trust must have one or more preferred beneficiaries, and may also have other non-preferred beneficiaries. A preferred beneficiary is a person:

    • Of any age who qualifies for the DTC, or
    • Who is 18 or older, and a dependant of another individual due to mental or physical impairment, and whose annual income (not including any allocation under the PBE) is no more than the maximum basic personal tax credit amount

In addition, the beneficiary must be one of the following:

    • Settlor of the trust
    • Spouse/CLP or former spouse/CLP, of the settlor
    • A child, grandchild, or great grandchild of the settlor, or
    • Spouse/CLP of a child, grandchild, or great grandchild of the settlor

The trust will pay no tax up to the basic personal exemption and can apply graduated bracket rates above that. Despite using the beneficiary’s credits and brackets, the election does not affect provincial disability income support.

Legal requirement for a joint election

To obtain this treatment, the preferred beneficiary and the trust must make an annual joint election that is filed with the trust’s T3 Tax Return. If the beneficiary is legally incapable of making the election, it may be made by the person’s attorney for property if one was appointed before the beneficiary was found to be incapable, failing which it will be necessary to commence a court application to appoint a guardian of property for the beneficiary.

4.    Qualified disability trust (QDT)

Since 2015, most testamentary trusts are taxed at the highest marginal tax rate in the province, as has long been the case for inter vivos trusts. However, if a testamentary trust has a ‘qualifying beneficiary’ (one who is eligible for the DTC), it may be able to use graduated tax brackets as a qualified disability trust (QDT).

Like the PBE, the trust and beneficiary must make an annual joint election, and if the beneficiary is incapable then an attorney or guardian for property may do so. Note that while a qualifying beneficiary can only make this election with one trust in a year, the trust may have other beneficiaries in addition to the qualifying beneficiary. Be aware that if a capital distribution is made to anyone other than the qualifying beneficiary, QDT status will be lost and the trust will be taxed at the highest bracket rate that year, with the added risk of reassessment of past years’ T3 returns.

There was initial concern when the QDT was introduced that use of the PBE may be limited thereafter, but either or both elections may be made in a year if the respective conditions of each provision are met.

5.    Lifetime benefit trust

A person’s assets are deemed disposed on death, including causing the value of registered retirement savings plans (RRSPs) and registered retirement income funds (RRIFs) to be taxed in the deceased’s final year. This inclusion can be deferred to a spouse/CLP or financially dependent child/grandchild who is a plan beneficiary. However, if that person has a disability, concerns may arise as to how the money might be managed after receipt.

With this in mind, the RRSP/RRIF holder could instead direct the proceeds to a lifetime benefit trust (LBT), of which the intended recipient is the lifetime beneficiary. Preferably this will be done using a Will, so the trustee can be given detailed instructions, as needed. Whether designated on a plan or by Will, this is only available for mental infirmity, not for strictly physical conditions. On the other hand, the condition need not be so severe that the person qualifies for the DTC, though if the DTC is being claimed then that can bolster the assertion of mental infirmity.

There is no tax when the LBT receives the RRSP/RRIF. The trustee must use those funds to acquire a qualifying trust annuity (QTA), which will make periodic payments to the LBT. By default, the trust is taxed at top bracket, but the annual annuity income may be attributed to the beneficiary, to make optimal use of tax credits and graduated brackets. The trust then pays the beneficiary’s tax, and the net income remains under the trustee’s control.

The trustee must use the trust money for the comfort, care and maintenance of the beneficiary, who has a lifetime interest. This is to distinguish from any contingent beneficiary/ies the RRSP/RRIF holder has designated to receive any undistributed balance in the LBT and any commuted value of the QTA upon death of the lifetime beneficiary. This provides comfort and certainty that the remainder cannot be redirected by the lifetime beneficiary’s Will (or by intestacy in the absence of a Will), and that it will also bypass any probate tax.

Despite attribution to the lifetime beneficiary, the annuity payments to the LBT will not be considered the beneficiary’s own income, and so will not affect provincial disability income support. However, distributions from the LBT to the beneficiary may affect the amount of those benefits, subject to the program’s usual income rules.

6.    Home ownership trust

Apart from assuring sufficient financial support for living needs, top priorities for the parent of a disabled child are a caring social network and a stable home environment. Indeed, the two go hand-in-hand, with the parent being the main provider. But as a parent ages, this becomes increasingly difficult to handle, and there can be even greater uncertainty after the parent’s death, even with diligent planning.

For the range of reasons already outlined, it may not be practical or desirable for a disabled person to directly own the home they live in. Consider further that a parent with other children will likely want to share his/her estate among them, even if a larger share may be earmarked for the child with a disability. This presents an especially large obstacle when the home (or the money needed for its purchase) constitutes the bulk of the expected estate.

So, whether it’s an only child or one of many, a trust may be a prudent alternative for home ownership. It could be an inter vivos trust created while the parent is alive and continuing after death (see Alter ego and joint spousal/CLP trust below), or a property owned by the parent at death could pass through the Will to a testamentary trust.

Principal residence exemption (PRE)

Without getting into all the criteria for the PRE, it generally protects against taxation of capital gains on disposition of a residence that a person owns and ordinarily inhabits. This can include a trust owning a residence inhabited by a beneficiary, though the availability of the PRE to trusts has been significantly circumscribed since 2016, now limited to the following trusts:

    • A qualifying spousal/CLP trust, alter ego trust or joint spousal/CLP trust
    • An ‘orphan trust’, being for a minor child of a deceased parent, or
    • A qualified disability trust (QDT), but only if the trust was settled by a parent or spouse

If there are multiple beneficiaries of a QDT, and the trust claims the PRE on behalf of the DTC-qualified beneficiary in a year, this can affect future PRE claims of other beneficiaries on properties owned during overlapping years.

7.    Insurance proceeds trust

For a parent preparing for what will happen after their own death, insurance and/or segregated funds may be intended as a principal source to provide for a child (minor or adult) with disability needs.

Generally, beneficiaries may be designated by an insurer’s forms, or by making a written declaration, including by Will. The declaration must comply with, and explicitly refer to, the relevant provincial Insurance Act provision to assure that the policy/plan proceeds do not form part of the estate for creditor or probate purposes. (This should be verified with a local lawyer, particularly in Saskatchewan where some courts have held otherwise on certain facts.)

If the beneficiary is a minor or is otherwise unable to give legal consent, the proceeds must be paid to a trustee for the beneficiary. As with a direct designation, a trust designation may be made by way of the insurer’s forms or by written declaration, again including a Will. Either way, it will be considered a testamentary trust for tax purposes.

Insurers will generally only allow brief terms for trust designations, whereas a Will may contain as much detail as desired. As will be evident from the foregoing discussion, a clear identification of powers and rights is critical to be able to make use of desired trust types and features. To achieve this, a properly drafted Will is recommended.

8.    Alter ego trust and joint spousal/CLP trust

A person who is at least 65 can settle an alter ego trust of which he/she is the beneficiary, or joint spousal/CLP trust where both spouse/CLPs are beneficiaries. In the latter case, one or both may be settlors. Property is transferred into the trust tax-deferred at adjusted cost base (ACB), and future trust income is attributed to the settlor. Only the settlor or spouse may receive the income or capital of the trust while they are living, and contingent beneficiaries may be named to receive the remainder on death for an alter ego trust, or on 2nd death for joint spousal/CLP trust.

The main purpose of such trusts is as a Will alternative, as the contingent beneficiary designation allows for the bypass of any probate tax, and streamlines distribution outside of the formal estate. They may also be used with knowledge or anticipation of the settlor or spouse/CLP’s future disability or incapacity.

For parents of a disabled child, the contingent beneficiary designation may be part of the plan to provide for that child after the 2ndparent’s death. In deciding whether, when and how much to settle into such a trust, parents should be cognizant that this an inter vivos trust, so will not meet the requirements of a QDT which is required to be testamentary, but may qualify for the PBE.

9.    Qualifying spousal/CLP trust (inter vivos or testamentary)

Like an alter ego trust or joint spousal/CLP trust, property can roll into a qualifying spousal/CLP trust at ACB, but in this case the spouse/CLP is the only beneficiary. Only that spouse/CLP may obtain the income (though taxation may be attributed to the settlor) or capital of the trust during his/her lifetime, and contingent beneficiaries may be named to receive the remainder at death.

Though this type of trust can be created inter vivos (at any age), it is more commonly established in a deceased’s Will to create a testamentary trust that provides for a surviving spouse/CLP. The ACB rollover in this case defers the tax that would otherwise apply due to the deemed disposition on death. There are a range of reasons for creating such a trust rather than making an outright transfer to the spouse as an estate beneficiary (which may also be by ACB rollover). For example, this may be useful in a second marriage situation, allowing continued use of assets by a surviving spouse/CLP, with ultimate distribution of capital going to children of a first marriage.

When testamentary, this trust may be an effective tool to care for a disabled surviving spouse/CLP, and after that person’s death to be part of the support for a disabled child. For either of those beneficiaries, it can qualify for the QDT and PBE, and may also be able to serve as a house ownership trust, including the ability to claim the PRE.

Alter ego and joint partner trusts

Privacy, probate minimization and more for those 65+

In estate planning, your Will is the central document for controlling what happens with your property at death. It could be argued though that having a Will alone could, in a sense, be too much management held in one place.

As odd as that may sound, a Will is a product – albeit a very important one – of you thinking through your own needs and those of the important people around you, and deciding how best to take care of them. That’s the estate planning process, and your Will’s role is to set out who is to receive the property you own when you die.

However, sometimes it may make sense to make changes so that select property does not flow through your Will, and therefore is not part of your formal estate. That is where alter ego and joint partner trusts can offer greater flexibility and control.

Mechanics of alter ego & joint partner trusts

Alter ego and joint partner trusts are inter vivos trusts, meaning they are set up while you are living.

You must be at least age 65 to set one up, with an alter ego trust for one person and a joint partner trust for a couple.

Commonly you will be both trustee and beneficiary, though you can also include one or more others as trustees with you. That will provide some flexibility should you become incapacitated while living, as discussed further on. Trustees have all the legal powers to buy, sell and manage the property that you have decided to transfer into the trust. As the beneficiary, during your life you are entitled (and actually required) to receive any income, and you have full use and enjoyment of the capital, just as you did before the trust was created.

You can name one or more residual beneficiaries. If it is an alter ego trust for yourself then those residual beneficiary rights will arise on your death. In the case of a joint partner trust, the survivor of the two of you will continue on as beneficiary on a first death, and then the entitlement of those residual beneficiaries will take effect on the survivor’s death. Commonly the residue would be paid out upon death of the primary beneficiary/ies, but it is also possible to draft it so that the trust will continue on for a period of time if you wish.

Income tax issues

These trusts may be used with any property you may own, but most often the focus is on real estate and non-registered investment accounts. With the exception of your principal residence, a property transfer usually triggers a taxation disposition.

Fortunately, you may roll capital property into these trusts at their cost base. Thereafter, income and capital gains realized in the trust are taxable to you (or both of you for a joint partner trust), in proportion to the assets you contributed.

At death, in the case of an alter ego trust (or at the second death with a joint partner trust), all remaining property is deemed to be disposed, with any resulting capital gain/loss is reported on the trust’s tax return. The trust’s capital gain/loss cannot be netted against capital gains/losses realized on your death by you personally. For this reason, you must carefully consider what initially goes into the trust and what you will continue to own personally, and carefully monitor all pending tax liabilities.

As an incapacity substitute, and for continuity of management

You should still have powers of attorney (POAs) for property and personal care drawn up in case you become incapable in future. Bear in mind though, that POAs can only deal with property that you own yourself, meaning that the named attorneys would not have legal power over the trust property.

With this in mind, whether it’s an alter ego or joint partner trust, you can name one or more co-trustees who can act with you now, act for your benefit later, and continue to act after your death as trustees for your residual beneficiaries. It is possible and common to name the same people as trustees and attorneys, or you may prefer to name different people as a way to spread out responsibility and oversight.

Estate liquidity, and time & cost savings of avoiding probate

On your death, the continuing trustees will have control of the trust assets without having to wait for a probate application. Not all provinces levy probate tax, and should not be a driving concern in your estate planning anyway. However, if the other features of these trusts serve your needs, then this cost saving is a bonus.

Privacy and insulation against estate litigation

Unlike a probated Will that can become part of a court file, trusts of this sort do not have to be made public. Apart from maintaining your privacy, this can be especially important if you or your beneficiaries are concerned about creditors. And even if those creditors pursue their claims, there are narrower means to attack a trust than may be available with a Will challenge.

AvisoWealth2404

Trust reporting rules for 2023 and beyond

More, more, more: Affected trusts, entity disclosure and information required

Trusts have been around for centuries, used for flexibility, control and protection in personal, business and estate planning. The defining feature of a trust is that title and control of property – being anything that can be owned – is legally held by a trustee, distinct from the trust beneficiaries who are entitled to the use, consumption and income of that property.

While historically trusts could be actively employed to reduce tax, primarily by using graduated tax brackets, this was curtailed in 2015. Since then, graduated bracket use has been limited to graduated rate estates (generally the first 36 months of an estate) and qualified disability trusts. All other trusts are taxed at top bracket.

Today, tax planning serves more of a supporting or complementary role to a trust’s core purpose, rather than being the focus of planning. In that respect, trusts are still effective as a shield against excess tax, often by strategically allocating income and associated tax liability to make optimal use of beneficiaries’ lower tax brackets.

But regardless of the extent to which tax is an intention or effect of the arrangement, trusts continue to be tax reporting entities. And as of 2023, reporting obligations have significantly expanded the scope of affected trusts, the parties required to be disclosed, and the amount of information about those parties.

Legislative history

Federal legislation requiring enhanced trust reporting was first tabled in 2018, with revisions passed into law in December 2022. The revised rules apply to trusts with taxation years that end after December 30, 2023. As all trusts affected by these rules must use a calendar year-end, the new rules apply for 2023 and all future tax years.

The filing deadline is 90 days after the trust’s year-end. For 2023 reporting, the filing deadline of March 30, 2024 falls on a Saturday, so it is extended to the next business day, Tuesday, April 2, 2024.

However, on Thursday, March 28, 2024 — the last business day before the deadline — the Canada Revenue Agency (CRA) announced that “in recognition that the new reporting requirements for bare trusts have had an unintended impact”, reporting for bare trusts would not be required for the 2023 tax year unless the CRA makes a direct request for the filings. The agency stated it would clarify its guidance in the following months.

Enhanced reporting

Under the old rules, a trust resident in Canada was generally not required to file a T3 Trust Income Tax and Information Return unless it had tax payable or it disposed of capital property. As well, CRA generally granted administrative relief from filing where the trust had only nominal income, whether retained by the trust or allocated to Canadian-resident beneficiaries.

Three main changes

Generally, the new rules require that:

    • All trusts (with limited exceptions) must now file an annual T3 Return
    • Other than certain “listed trusts”, a Schedule 15 Beneficial Ownership Information of a Trust must be included with the T3 filing
    • Bare trusts are subject to the new reporting rules, but are exempt from the filing requirements for the 2023 tax year, unless CRA makes a direct request to a taxpayer

Whose information must be reported?

Schedule 15 requires information to be reportable on all of the following parties, collectively referred to as “reportable entities”. A reportable entity may be a natural person, corporation, trust or other legal form.

    • Settlors
    • Each trustee
    • Each beneficiary
    • Each “controlling person”, being anyone who has the ability, by the terms of the trust or related agreement, to exert influence over trustee decisions regarding the appointment of income or capital of the trust

What information must be reported?

The following information must be provided for each reportable entity:

    • Name
    • Address
    • Date of birth (if applicable)
    • Country of residence, and
    • Tax Identification Number (i.e., Social Insurance Number, Business Number, Trust Number, or, in the case of a non-resident trust, the identification number assigned by a foreign jurisdiction)

Affected trusts

Other than “listed trusts” (see below), the new reporting rules apply to all express trusts, being those created with the express intent of the settlor. According to common law, a trust comes into being once three certainties are in place: that the settlor intended to create the trust, that the subject property is ascertained, and that the beneficiaries are identified. Most often this will be in writing, but the terms may be oral, or both oral and written.

Examples of familiar arrangements that were previously exempt from filing but will now be covered by the new rules (understanding that this is not a comprehensive list), include:

    • Business use trusts established to hold private corporation shares or other ownership interests
    • Personal/family trusts used for property ownership, for example a vacation property
    • Spousal trusts used to allow tax rollover between spouse/common law partners
    • Alter ego and joint partner trusts used for oneself or a couple as a Will alternative
    • Testamentary trusts (ie., created under a Will), except graduated rate estates and qualified disability trusts

Bare trusts

Bare trusts are subject to the new reporting rules. A bare trust is one where the trustee is merely acting as the agent of the beneficiary/ies. Though property title may be in the trustee’s name, the trustee has no significant powers and can only act by permission and/or instruction of the beneficiaries. Examples of bare trusts include:

    • For privacy, a property developer may have real estate held by a trustee, while retaining beneficial ownership
    • Protecting against title merger of real estate and/or land transfer tax exposure
    • Interim title ownership pending completion of activity of a joint venture or partnership
    • Gratuitous addition of a child as joint owner on a parent’s financial account or property (depends on facts)
    • Specific trust accounts held by a lawyer pending or following a transaction

‘In trust for’ accounts

Adults, usually parents or grandparents, may deposit money into a financial account and record the name as being ‘in trust for’ a minor age child/grandchild. Naming an account as such does not in itself suffice to create a trust, but a trust may indeed be proven, according to the facts of the situation. While the determination of this being a trust will open the arrangement to the new reporting requirements, where small dollar figures are involved, it may qualify for exemption as a “listed trust” as discussed further below.

Exemption for listed trusts

“Listed trusts” are exempt from Schedule 15 beneficial ownership filing.

Listed trusts of a personal nature

As a non-exhaustive list:

    • A trust that has been in existence for less than three months at the end of the year
    • A trust that holds assets with a total fair market value less than $50,000 throughout the year, if the only assets are a combination of money and common financial instruments like publicly-listed shares and bonds, mutual funds and segregated funds

Listed trusts of a professional, commercial or financial nature

As a non-exhaustive list:

    • A registered charity, or non-profit club, society or association
    • Financial/commercial arrangements such as mutual funds, segregated funds, or other trusts with all units listed on a designated stock exchange
    • Regulated trusts such as lawyers’ general trust accounts, but not separate trust accounts for specific client trusts
    • Registered plans, including a DPSP, PRPP, RDSP, RESP, RPP, RRIF, RRSP, TFSA, EPSP, RSUBP, or FHSA
    • Cemetery care trusts and eligible funeral arrangements

Penalties

If a T3 Return or Schedule 15 is not filed as required, a penalty may be imposed. The penalty will be the greater of $2,500 and 5% of the highest amount of the fair market value of all the property held by the trust at any time in the year.

To accommodate for this being a first filing requirement for most bare trusts, CRA initially communicated that late filing penalties would be waived for 2023 reporting filed after Tuesday, April 2, 2024. With its March 28, 2024 announcement that bare trusts would only have to file when directly requested by CRA, its earlier positioning became moot.