ALTER EGO TRUSTS can save you thousands in probate fees

Written by NIKA LAW LLP Partner, Nithila Murugadas, L.L.B

WHAT’S THE MAGIC?

In 2001, Alter Ego Trusts were permitted under the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), as amended, as an estate planning tool. This special type of trust is one that is settled during one’s life (inter vivos) as opposed to a testamentary trust which is settled on death.

Given that trust assets are held in your capacity as a “trustee” and not personally, they do not form part of your estate, thereby avoiding the Estate Administration Tax (commonly known as “Probate”) on those assets.  At present, in Ontario, Probate is approximately 1.5% of the value of your Estate over $50,000, so the savings can be significant for high net worth individuals.

BUT FIRST – A PRIMER ON TRUST TERMINOLOGY

• “Settlor” –the person who ‘settles’ or creates the trust
• “Trustee” – the person or persons who receive the transfer of property who then holds such property in ‘trust’ for the benefit of the beneficiaries of the trust
• “Beneficiary”– the person, group of people, or organization for whom the trust property is held

WHO’S IN CONTROL?

In an Alter Ego Trust, the Settlor is you.   The Beneficiary is also you and can only be you, during your lifetime.  In effect, your beneficial interest in the trust assets has not in any way been altered by creating the trust.   The controlling mind of trust rests with the Trustee or Trustees.   Because of this, in most cases, the Settlor will be the Trustee of an Alter-Ego Trust, until his or her voluntary resignation, or incapacity.  This may seem contrary to trust rules generally because of the fear of landing within section 72 of the Income Tax Act where trust income would attribute back to the settlor where he or she is also the sole trustee – but with an Alter Ego Trust, we are not concerned with attribution.  These are your assets and your income – so whether you hold the assets in the trust or not, you are paying tax on them during your life.   Some Alter Ego Trust settlors choose to be one of the multiple Trustees during their lifetime – which eases the transition to successor trustees on the incapacity of the settlor trustee.  The fear of ‘not having control over the assets during life’ can be mitigated by adding veto powers of the settlor trustee while in office, or by a majority rules clause that stipulates that the settlor trustee must be in the majority.   The point is, you can maintain control over your assets of the Alter Ego Trust, provided you are alive, and capable of making decisions regarding property.

Is that it?  Not quite.   An Alter Ego Trust must meet the following requirements:

• The settlor must be over 65 years old;
• Only the settlor is entitled to receive all the income of the Trust that arises before his/her death;
• No other person except the settlor may receive or obtain use of, or benefit from, any income or capital of the trust during the lifetime of the settlor;
• No special tax election can be made by the trust, which results in it ceasing to be an Alter Ego trust[1]

If you meet the above criteria, in addition to avoidance of Probate, an Alter Ego Trust can also offer the following other benefits:

Simplified Estate Administration

Beneficiaries often wait more than a year to receive their inheritance from an estate due to the lengthy court process of probating the Will.  Like a Will, the Alter Ego Trust agreement would outline the intended distribution of assets after the death of the settlor, but without the need for probate. This ensures that assets end up in the hands of the beneficiaries in a much more immediate fashion faster than had those assets formed part of your Estate governed by your Will.

Confidentiality

A Will that is submitted through the probate process is a matter of public record. Information on a probate application of your Will includes the value of your estate, your estate beneficiaries’ names and the desired distribution scheme. Conversely, trust documents are private in nature and do not require probate; therefore, the terms of the trust remain confidential. This may be especially attractive to high net worth individuals, people in the public eye, and those who anticipate estate litigation in the future.

Incapacity Planning

As mentioned above, appointing multiple trustees from the settlement date of the Alter Ego Trust is beneficial because of the ease of succession upon settlor incapacity. Generally, upon incapacity, your substitute-decision maker for your assets/property is appointed by a Power of Attorney document which must be vetted by third parties.  Where assets are part of the Alter Ego Trust, the power of attorney document is unnecessary – like the power to manage the trust assets is already vested in the replacement trustee (or trustees).  Furthermore, where the replacement trustees have been involved in the management of the trust prior to incapacity, the transition is seamless.

ARE THESE TRUSTS ALL RAINBOWS AND SUNSHINE?

If only…. like all things in life – there are some serious practical considerations and associated costs that must be contemplated before deciding if this strategy is right for you.

1. Cost

If the purpose of settling the Alter Ego Trust is to save the Probate fees – it is important to calculate the would-be Probate implication if the trust was not implemented, and to compare those anticipated savings with the cost of establishing the trust.  What are those costs?  First – legal fees and second – tax filing fees.

It is recommended that an Alter Ego Trust agreement be drafted by qualified estates and trusts lawyer, outlining the terms of the trust, setting out the initial trust property, and the distribution scheme of the trust property upon the death of the settlor.    Further, any trust is a taxable person.  As such, every year, a tax return must be filed with the Canada Revenue Agency for the Alter Ego Trust.  A determination may need to be made based on your life expectancy and whether the cost of years of additional tax filings outweighs the Probate savings. Although Alter Ego Trusts are only available to those 65 years of age and older, today, people live longer than ever. This longevity means you may have 30 or more years of required tax advice and filings ahead of you – in addition to your personal tax return.

2. The strict rule of who may Benefit

Generally, you can do with your assets as you please during your life without restrictions.  Assets held in an Alter Ego Trust, however, carry a strict rule of who can benefit from the trust assets during the life of the settlor – more specifically, no one other than the settlor.   This may seem trite and unproblematic, but consider this example:

Woman settles an alter ego trust at the age of 78.  She has a 3 million-dollar home.  She is now 90 and re-locating to a nursing home. She has a few million dollars in other assets as well – enough to sustain her for the remainder of her life.  The home is sold.  She wants to distribute the proceeds of the sale to her grandchildren – but that would put the trust offside. 

Of course, one option is to revoke the trust, but as you can see, the cost and many years of tax filings for this particular lady will have been lost.

3. Treatment of Charitable Donations

If upon the death of the settlor, he or she intends to make a charitable donation using assets of the Alter Ego Trust to offset capital gains or other tax implications of the trust arising at death -the donation must be made clear in the drafting of the trust so as to distinguish it from a general capital distribution.  Further – donations from an alter ego trust can only be used to offset up to 75% of the income of the trust (versus 100%) if applied against the Estate.[2]

Another limitation to be aware of is the timing of the donation.  Charitable donations from an alter ego trust must be made within 90 days of the end of the calendar year of the year in which the settlor died. For settlers who die near the end of the calendar year, there may be difficulty in making the donation within the required window.

SHOULD I? OR SHOULDN’T I?

As this article hopes to convey, the Probate savings is not the only factor to consider when evaluating whether or not an alter ego trust is a strategy that will be to your benefit. A careful cost-benefit analysis should be undertaken with qualified professionals.

We at NIKA LAW LLP, are always happy to consult and review your individual situation to walk you through the pros and cons of this seemingly “too good to be true” trust.

Looking for a Will Lawyer, Probate Lawyer, Elder Abuse Lawyer, or Estate Litigation Lawyer in Mississauga? NIKA Law LLP can help. We offer expertise in estate law, trusts, and power of attorney law.

We pride ourselves on providing a compassionate and sensitive approach to dealing with your legal issues.

Disclaimer: The content of this post is not intended to serve as legal advice, but rather a general guide regarding the subject matter.

[1] For example, see Income Tax Act s. 104(4)(a)(ii. 1). Some Trusts may elect out of their first taxation year, but Alter Ego trusts must file annual tax returns. When creating Trusts, we recommend engaging Professional Tax Planners to ensure full compliance with this complex area.

[2] Subject to limited other circumstances where private company shares are disposed of by the trust.

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