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tax matters

Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books.

Modern medicine is quite amazing. I think we're getting closer to the day when a human being can be cloned. Setting aside the ethical and legal conundrum this might pose, I can think of many good uses for a second "me."

Could it be that the "other me" might actually enjoy taking out the garbage, picking up after the dog in the backyard, or massaging my wife's feet? Could I program the "other me" to long for those tasks?

The "real me" would be hard at work improving my golf game, diligently testing various beverages and food items, and actively pursuing the sleep required to function optimally. A win-win for everyone.

While scientists still work on the cloning process, the Department of Finance long ago made it possible to clone yourself from a tax perspective.

I'm talking about alter ego trusts. It's time to revisit this invention.

The definition

Alter ego trusts are trusts, created after 1999, where the settlor (the person who creates the trust) is the sole person who has a right to all the income of the trust each year. Further, no one but the settlor can have a right to the capital (assets) of the trust while he or she is alive. It's possible to set up a "joint partner trust," which is the same as an alter ego trust except that both partners (married or common law partners) have a right to the income of the trust annually, and no one but those two individuals has a right to the capital of the trust while either of them is still alive.

The rules

Alter ego trusts are special in that it's possible to transfer assets to the trust without triggering tax on accrued gains on the assets. This is not the case with transfers to most trusts.

Now, the trust is taxed like other inter-vivos trusts (trusts created during the settlor's lifetime) at the highest marginal tax rate. Each year, the income of the trust will be taxed in the settlor's hands, and upon the settlor's death (or the death of the second spouse or partner in the case of a joint partner trust), there will be a deemed disposition of the assets of the trust, creating a tax liability at that time inside the trust. The bottom line? Alter ego trusts don't offer tax benefits. But there may still be good reasons to use them.

The benefits

  • 1. Avoid probate fees. Assets that you place into an alter ego trust during your lifetime will fall outside of your estate at the time of your death, allowing you to avoid probate fees (both domestic and potentially foreign probate if you own assets, such as real estate, outside of Canada). Probate fees are charged by the courts in each province (except Quebec) to grant “letters probate,” which certify that your will is valid and your executor has the authority to administer your estate.
  • 2. Reduce delays and professional fees. Since the assets in the alter ego trust won’t form part of your estate on death, there won’t be delays resulting from preparing a court application to probate the will, or waiting for the court order. Legal fees for this task can also be avoided. So, your assets can be managed and distributed without these delays and costs.
  • 3. Ensure continuity and liquidity. If you set up an alter ego trust, your trustee simply continues to manage your assets upon your death. Nothing changes in this regard. This also means that your trustee can convert certain assets to cash at any time, if desired or necessary, to pay taxes or make distributions to heirs.
  • 4. Preserve privacy. Once you’re gone, and your will goes through probate, it becomes a public document. The value of your estate may also become public. A trust agreement, however, is not public and will guard the privacy of this information.
  • 5. Protect against litigation. It’s possible for the terms of your will to be challenged by a disgruntled family member or other person. A trust agreement is much more difficult to challenge and can provide greater protection here.
  • 6. Replaces a power of attorney. One advantage a trust has over a power of attorney over property is that a trust agreement continues after your death, while a power of attorney does not. Further, the trust is more comprehensive in detailing specific duties and powers to be exercised by your trustee. Finally, a trust agreement offers the settlor greater protection against being unduly influenced by family or friends. The settlor is no longer the owner of the assets because they are now controlled by the trustee.