The value of trusts in modern tax and estate planning

Expanded AMT rules

The expanded alternative minimum tax (AMT) rules, enacted in 2024, have made trusts significantly more likely to be subject to AMT, since trusts aren’t generally entitled to a basic exemption when calculating AMT like individuals. When planning, you should carefully consider a trust’s potential AMT liability, and where it applies, how to maximize recovery of AMT paid.  

The AMT rules require certain individuals and trusts to calculate their “minimum amount” of tax using an alternative method, under which certain deductions and tax advantages are reduced or eliminated. If this minimum amount exceeds the income tax otherwise payable under the regular income tax rules, the excess is payable as AMT. However, AMT paid can be carried forward for up to seven years and applied against income tax otherwise payable under the regular tax system to the extent regular tax exceeds the minimum amount in a subsequent year.  

Under the expanded rules, AMT frequently arises where a trust holds an investment portfolio and derives a significant portion of its income from capital gains, or claims deductions such as investment counsel fees or interest expenses. This can occur even where the trust distributes all its taxable income to its beneficiaries and that income is taxed in their hands.  

The TOSI rules

When reviewing your existing corporate structure, the tax on split income (TOSI) rules are an important consideration. These rules can apply the highest marginal tax rate to certain types of income—such as dividends from private corporations—when certain conditions or exclusions aren’t met.  

Whether shares are held directly, through a holding company, or through a trust can affect whether income is subject to the rules.

For example, TOSI would apply where a family trust holds shares of a private corporation carrying on a related business, and dividends are allocated to an inactive spouse or child because the shares wouldn’t be considered “excluded shares”. While this exemption is generally available to individuals 24 or older that own shares representing at least 10% of the votes and value of a corporation, it requires direct ownership of the shares by the individual. Other requirements must also be met, including that less than 90% of the corporation’s business income be derived from providing services.

As a result, taxpayers who hold private corporation shares indirectly through a family trust must consider whether another TOSI exclusion is available.

For some, this is less ideal because other exclusions generally require some involvement in the business through labour or capital contributions. The excluded shares exemption, however, permits income to be received based solely on direct share ownership and the nature of the corporation’s business activities.  

Expanded trust reporting requirements

Most trusts are required to file a T3 return annually for 2023 and later tax years under the expanded trust reporting requirements, even when they have no income to report. As part of these rules, trusts must disclose detailed personal information of beneficiaries, trustees, settlors, and protectors. Trustees and their advisors should ensure this information is collected when the trust is established and kept up to date on an annual basis. Failure to provide the CRA with complete and accurate information could result in significant penalties.  

In addition, carefully consider who will be beneficiaries of the trust, as collecting and updating this information for a broadly defined beneficiary class can create administrative challenges. As beneficiaries will need to disclose their social insurance number and annually confirm their address and tax residency, specifically naming beneficiaries may help reduce the ongoing compliance burden. This should be balanced against the flexibility that a broader beneficiary class can provide in addressing future family, tax, and succession planning needs.

That being said, don’t let reporting obligations deter you from leveraging the use of a trust. Even before these rules were implemented, it was common to file annual T3 returns voluntarily to obtain a notice of assessment or a notification that no tax is payable.  

The advantages of trusts still exist

Despite these changes over the years, trusts continue to offer significant tax and non-tax advantages for business owners and families whose circumstances align with the benefits that trusts can provide.

Tax advantages

Multiply the lifetime capital gains exemption (LCGE)

A principal tax advantage that a trust can offer is that it effectively allows you to multiply access to the LCGE on the disposition of qualified small business corporation (QSBC) shares or shares of a qualified farm or fishing property. Specifically, where a trust realizes a gain on the disposition of qualified shares and properly distributes the gain to individual beneficiaries, each eligible beneficiary may be able to claim their own LCGE in respect of the amount allocated to them. For example, with an individual LCGE limit of $1.275 million in 2026, a family with four beneficiaries could collectively shelter up to $5.1 million of capital gains on a qualifying sale. This could potentially result in tax savings exceeding $1.2 million.

Note that the availability of the exemption depends on the trust’s terms, the beneficiaries’ attributes and exemption limits, and the proper implementation of the trust allocation and designation rules, including the requirement that the trust distributions be paid or enforceably payable.

Maintain QSBC status of shares

A trust can help maintain the QSBC status of shares while allowing business owners to defer personal income tax. Where an operating company accumulates excess cash or passive assets, those assets can jeopardize QSBC status because the corporation must use a sufficient portion of the corporation’s assets principally in an active business carried on in Canada, among other requirements.  

In some cases, an operating company can introduce a trust as part of a reorganization so that dividends can be paid to the trust and allocated to a corporate beneficiary. This structure can facilitate ongoing purification of the operating company while preserving flexibility in the broader corporate structure, given that intercorporate dividends can generally move earnings out of the operating company without triggering tax. 

Maintaining QSBC status is particularly valuable if a sale opportunity arises on short notice, as it may permit access to the LCGE. In addition, capital gains realized on the sale of QSBC shares that exceeds the available LCGE are generally exempt from the TOSI rules.

Estate planning

For many business owners and high-net-worth individuals, an estate freeze remains a valuable planning tool for transferring future growth to the next generation. If you expect the value of your company or investments to continue growing, an estate freeze can cap the value of your interests at that time while allowing future growth to accrue to family members, often through a trust. An estate freeze generally involves exchanging shares for new fixed-value preferred shares. This is beneficial because when you eventually pass away and the estate taxes associated with your shares are triggered, it’s calculated based on the frozen value.  

It can also provide greater certainty in long term planning. By fixing the value at a specific time, the tax liability in the future becomes more predictable, allowing you and your family to plan in advance for the taxes that will ultimately arise.  

Using a trust as part of an estate freeze provides significant flexibility in allocating future growth among family members. Trustees may be given full discretion to allocate income and capital among beneficiaries based on their individual circumstances and needs. This flexibility is particularly valuable where future family, financial, and succession objectives are uncertain.  

That flexibility does, however, come with an important timing constraint. A trust is generally deemed to dispose of its property every 21 years at fair market value. As a result, trustees will often need to consider, before the 21-year anniversary date, whether trust assets should be distributed to beneficiaries or whether other planning steps should be taken to manage the deemed disposition event. Recently, changes to the anti-avoidance rule and mandatory disclosure requirements have also limited certain planning opportunities also connected with the 21-year deemed disposition rule.  

Takeaway

Many of the most compelling reasons for establishing a trust are non-tax related. Trusts can provide flexibility and control. It allows trustees to allocate income and capital among beneficiaries based on family circumstances and financial need, while also accommodating future beneficiaries. They can also allow family members to benefit from wealth without controlling the underlying assets, helping business owners and parents preserve oversight of family assets and succession plans. In addition, they could provide a measure of protection against future creditor issues and family law disputes by separating beneficial interests from direct ownership of assets. Because trust property generally passes outside of an estate, trusts could reduce probate fees, enhance privacy, and assist in managing estate administration and potential estate disputes, in certain cases. The availability and effectiveness of these benefits depend on the local law and the particular circumstances of each family.

Our priority is to help you reach your long-term financial goals, at every step of the corporate journey. When done in advance, tax planning can both support and guide your decisions in a way that will maximize returns and help you avoid unexpected pitfalls. For more information, contact us.

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Disclaimer

The information contained herein is general in nature and is based on proposals that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or an opinion provided by Doane Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs and may require consideration of other factors not described herein.