No One Uses Family Trusts Anymore… Right?
Debunking the Myth and Exploring Why Family Trusts Still Matter in Canada
Disclaimer: The information provided below is for general knowledge and discussion purposes only. It is not intended as legal or tax advice. Always consult with qualified professionals regarding your specific situation.
Setting the Stage
I recently attended an estates and trusts event where a well-respected lawyer spoke about non-tax considerations for Estates and Trusts. While the session was excellent overall, one offhand remark caught my attention: she mentioned that “people don’t really use family trusts anymore,” suggesting that the Tax on Split Income (TOSI) rules had rendered them obsolete.
This blog post isn’t meant to single anyone out or undermine the quality of that presentation—because it really was a great one with a lot of excellent discussions. And the fact of the matter is, this isn’t the first time I’ve heard this suggestion, just happens to be the first time I heard it since I created a platform to express my thoughts. However, that comment bears further exploration because the reality is that family trusts are still highly relevant—and not just for tax reasons. While TOSI has indeed limited certain income-splitting strategies, many Canadians continue to utilize trusts for a variety of valid and often critical reasons.
Before diving in, it’s worth noting that establishing and maintaining a trust comes with its own set of challenges—an additional annual tax return, new trust-reporting rules and other legislative changes, and of course the 21-year rule—all of which can reduce the “secrecy” or “convenience” once associated with trusts. Nevertheless, for many families and business owners, the potential benefits far outweigh these drawbacks.
Additionally, much—though not all—of what I wrote below applies to your more typical “Family Trust,” which is a type of personal trust. However, there are many different types of trusts in Canada, each with their own unique qualities, legislation, pros, and cons. (Spousal trusts, disability trusts, and alter ego trusts are just a few examples.). Your tax advisor should be able to tell you which Trust structure, if any, will best for your specific situation.
1. Multiplying the Lifetime Capital Gains Exemption
Arguably the best-known reason for using a trust in a business context is the ability to multiply the lifetime capital gains exemption (LCGE) among multiple beneficiaries.
How It Works
If your small business corporation shares are held in a family trust and those shares are eventually sold, the resulting capital gain can be allocated among the trust’s capital beneficiaries. Each beneficiary may be able to claim their own LCGE—assuming the shares meet the requirements in the Canadian Income Tax Act (subsection 110.6(1)) to be “Qualified Small Business Corporation Shares.”
Real-Life Example
In 2013, John and Sarah (a married couple) quit their jobs to start their own commercial cleaning business. On the advice of their tax advisor, 100% of the common shares of the business were issued to a newly settled Family Trust, established for the benefit of their family. John and Sarah serve as co-trustees. The beneficiaries (income and capital) include John, Sarah, and their two children, Sam (age 8) and Jason (age 5).
In 2023, after a very successful 10-year run, John and Sarah received an aggressive offer to purchase their business (via a share sale) from a large national competitor. After much deliberation, they accepted the offer. Upon selling the company, the trust realized a substantial capital gain. Because the shares were Qualified Small Business Corporation Shares, John and Sarah were able to utilize their respective LCGEs. To further realize savings, they allocated a portion of the capital gain to both Sam (now age 18) and Jason (now age 15).
Although there was enough proceeds to fully utilize the children’s exemptions, John and Sarah felt that allocating close to $1 million to each child would not be the most responsible choice. Instead, they allocated $300,000 to each child, with the proceeds set aside to pay for post-secondary education and eventually to provide each child with a down payment on their first home.
Why It Matters
Properly executed, this strategy can lead to substantial tax savings when selling a qualifying small business. However, it must be done with professional advice (both tax and legal) to ensure compliance with the relevant legislation and the specific terms of your trust agreement. Remember that as a Trustee your role is to manage the assets of the Trust for the benefit of the beneficiaries.
2. Keeping Assets Out of Your Estate
A core advantage of trusts is that assets held in a trust do not form part of your estate when you pass away.
Why This Matters
Probate Savings: In provinces where probate fees can be significant, holding high-value assets in a trust can reduce or eliminate these fees.
Privacy: Trust assets generally bypass the public probate process, keeping certain financial matters more confidential.
Creditor Protection: In some circumstances, a trust can shield assets from creditor or legal claims, provided the trust is structured properly and not set up to avoid known creditors.
Legal Note: Since creditor protection and other estate concerns are complex legal matters, seek professional legal advice. Every province has different rules, and there are multiple moving parts in any asset-protection strategy.
3. Corporate Tax Deferral Opportunities
Even after TOSI, a family trust can still provide tax-planning opportunities when combined with corporate beneficiaries (e.g., a holding company).
How It Works
Dividends from the operating company can be directed to a holding company beneficiary via the trust. When income is paid to a trust, it maintains its form when distributed to a beneficiary—i.e., dividend in → dividend out. When you allocate dividend income to a corporate beneficiary, it is as if the corporate beneficiary received the dividend directly from the dividend payor. This allows you to maintain the same tax-deferral benefit that a standard holdco-opco structure achieves. Combine this with Section 1 (multiplying the LCGE) and you have a structure that may benefit from future LCGE opportunities and corporate tax deferral.
Important Considerations
Safe Income: As described above, when a corporate beneficiary receives a dividend through a trust, it’s as though it received the dividend directly from the payor corporation. Safe income thresholds and other corporate tax rules must be carefully reviewed.
Passive Income Rules: Keep in mind that passive income earned within a corporate group can affect the small business deduction. If passive investment income exceeds certain thresholds, it can reduce the small business limit. You do not get around this rule by using a trust structure.
Professional Guidance: Because the rules are intricate, always consult a tax advisor to avoid unintended consequences.
4. Flexible Estate Freezes (But Don’t “Kick the Can” Too Far)
Family trusts are a common component of estate freeze strategies. In simple terms, an estate freeze locks in the current value of your shares, allowing you to transfer future growth to other family members (or a trust for their benefit).
Why It’s Beneficial
You don’t need to decide immediately how future shares (and their future growth) will be allocated. The trust acts as a holding vehicle, providing time and flexibility for more definitive succession decisions.
Word of Caution
This is not an excuse to perpetually delay major decisions. While it’s understandable that finalizing succession plans can be daunting, waiting too long can create bigger headaches—especially as you approach your later years. From experience, finalizing these plans in your 60s is often less difficult than doing so in your 80s.
Help Exists
There are many businesses right now in Canada that have common shares held by a trust simply because the business owners and their families weren’t ready to have crucial succession conversations and their advisors were quick to offer a “band-aid” solution without providing the necessary guidance on how the family can address their issues. If this sounds like your family or that of a client, I’d be happy to chat about the work we do at Blackwood Family Enterprise Services. We specialize in helping families navigate these challenges.
Real-Life Example
Joan and Chris sold their business five years ago for a “generationally life-changing” sum of money. The majority of the proceeds now sit in a holding company, where those funds have been actively managed—yielding excellent returns. Joan and Chris have three adult children, all of whom are living “middle-income” lives by most standards. Although the kids know their parents are wealthy, they don’t appreciate just how much wealth will eventually come their way.
Joan and Chris worry this money could adversely affect their children’s lives and asked how they might prepare them to be “stewards of wealth.” To help with this process, a freeze was put in place and a trust established to hold the common shares. When Joan and Chris are ready, they plan to seed-fund a separate corporate beneficiary for each child with a smaller yet respectable amount of money. They’ll then work with each child to educate them about managing wealth and selecting the right advisors.
In their words, “Our advisors are old like us; we need our kids to find their own guides.”
Their ultimate goal is to eventually “lift the veil” on the family wealth—hopefully with the kids well-prepared to manage that wealth collectively so it can benefit the family for generations to come. But as with anything, it begins with small steps, and the trust provides a vehicle to facilitate this transition.
5. Asset Protection and Governance
Trusts can serve as a mechanism for managing and safeguarding family wealth, but proper legal advice is critical.
Why It’s Beneficial
Family Governance: A trust can centralize decision-making and ensure assets are professionally managed, invaluable if younger beneficiaries aren’t yet financially savvy.
Creditor Protection: As noted, a carefully established trust can sometimes protect family assets from claims. However, misuse or last-minute transfers aimed at defeating creditors can be challenged in court.
Matrimonial Protection: For many years, a popular belief was that holding shares in a trust could protect an inheritance from a child’s future spouse. Family law and trust and estates lawyers often point out that this “benefit” may be more myth than reality, depending on the circumstances and jurisdiction. Always seek proper legal advice if this is one of your goals.
6. Protecting and Providing for Your Family—During Life and After
A key function of any trust is to ensure financial well-being for your loved ones, both while you’re alive and after you’re gone.
Tailored Distributions
Minor Children: Distributions can be staggered by age or life milestones (university tuition, buying a first home, etc.).
Adult Beneficiaries: The trust can set parameters for how and when they receive funds, helping safeguard against impulsive spending or mismanagement.
Special Needs or High Risk Situations
Trusts can protect beneficiaries who rely on government programs, ensuring they remain eligible for benefits while still receiving supplemental financial support. It can also help protect beneficiaries from themselves if they suffer from severe mental health, drug or alcohol addictions.
Blended Families
With rising divorce and remarriage rates, trusts are increasingly used to manage and direct funds among stepchildren, biological children, or multiple marriages, ensuring each individual is treated fairly according to your wishes.
7. Philanthropic Intentions
Some families use trusts to facilitate ongoing charitable donations or to create a lasting philanthropic legacy. However:
This Can Be Done in a Will: Charitable bequests can also be made through your estate in your will, so setting up a separate family trust solely for philanthropy might not be necessary—unless there’s a specific strategy requiring a trust’s ongoing oversight (e.g., a private foundation structure).
8. Downsides and Key Considerations
No planning tool is perfect. Here are some important trust-related pitfalls:
Additional Compliance: A family trust is its own taxpayer, requiring an annual T3 tax return—meaning additional accounting fees and administrative work.
New Trust Reporting Rules (e.g. Schedule 15): Recent legislation demands increased transparency about trustees, beneficiaries, and settlors, reducing the “privacy” factor once associated with trusts.
The 21-Year Rule: Perhaps the biggest “gotcha.” Every 21 years, most trusts are deemed to have disposed of their capital property at fair market value, potentially triggering tax on accrued gains.
Solution: Before the trust’s 21st anniversary, assets can often be rolled out to beneficiaries on a tax-deferred basis, but you need to plan well ahead to avoid unintended tax consequences.
Changing Laws: Trusts frequently become targets for legislative changes. TOSI is a prime example on the tax side; more recently, here in Alberta, the revised Trustee Act increases transparency by requiring trustees to provide more information than before. This is why it’s exceptionally important to work with qualified professionals.
Final Thoughts
While TOSI may have curbed some income-splitting tactics, family trusts are far from obsolete. From multiplying the LCGE to keeping assets out of your estate, providing for family members, and facilitating a smoother business transition, there are numerous reasons to consider a trust.
Of course, every situation is unique. If you’re thinking about setting up—or maintaining—a family trust, seek out qualified legal and tax professionals who can help you navigate the complexity and ensure your trust truly meets the needs of your family and your legacy.
Wondering if a Trust might benefit your corporate structure and/or family. Reach out and let’s talk!