TSG (Tax Specialist Group) - Alter Ego And Joint Partner Trusts (Trusts)

Canadian residents who are 65 or older can transfer assets into an “Alter Ego Trust” (AET) or a “joint spousal or common-law partner trust” (JPT) without triggering gains for tax purposes.

In order for the trust to qualify as an AET or JPT, the person contributing assets to the trust (called the “settlor”) or the settlor’s spouse or common-law partner (for a JPT) must be entitled to receive all of the income earned by the trust during their lifetime and no one other than the settlor (or, for a JPT, the spouse or common-law partner), is able to receive or use any of the trust assets.

All the assets of an AET or JPT are deemed to be disposed of by the trust, for tax purposes, at fair market value on the death of the settlor (or the later of the death of the settlor and their spouse or common-law partner, for a JPT). Any gains or losses accrued in the trust assets are thus triggered at that time.

Such a trust can provide estate planning benefits, avoid power of attorney problems if mental incapacity issues arise, eliminate probate fees, mitigate wills variation exposure, and provide confidentiality with respect to assets held in the trust at the time of death, since they will not be part of the estate.

However, there are also various costs, traps and pitfalls, including the following:

Gains triggered on the trust assets on the settlor’s death will be taxed in the trust at top marginal tax rates rather than at personal marginal tax rates, since a non-testamentary trust pays federal tax at the highest rate on all of its income.
The settlor’s capital gains exemption and loss carryforward balances are not available to shelter capital gains realized in the trust.
Any charitable bequests required to be made by the trust on the settlor’s death must be made by December 31 of the year of death in order to shelter tax from the deemed disposition of trust assets resulting from the settlor’s death. There is no provision for the carryback of donations to the year before death as there is for charitable gifts made under an individual’s will.
An annual T3 trust income tax return must be filed even though any income, gain or loss of the trust is normally included in the settlor’s personal income tax so there is usually no tax to pay.
Foreign tax credits do not flow through from the trust to the settlor. As a result, double tax can arise on foreign income earned by the trust. The settlor pays the tax on the foreign income, and the trust cannot claim a foreign tax credit for foreign withholding tax because it has no foreign income against which to claim it.

Overall, Alter Ego and Joint Partner Trusts can be useful planning tools, but only if the practical and tax issues arising from their use are anticipated and planned for effectively.

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The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.