Canadian business owners, setup a Family Trust in Canada to save taxes. This article will cover how a Family Trust in Canada can result in substantial tax savings for Canadian business owners who are incorporated.
What is a family trust?
A family trust can be described as the relationship that exists between 3 parties:
- The settler (who establishes the trust)
- The beneficiaries (who receive income and capital distributions from the trust)
- The trustees (who manage the family trust for the benefit of the beneficiaries)
A tax return must be filed each year for Family Trusts in Canada. In addition, T3 tax slips must be issued annually to report the profits distributed to each beneficiary during the year. The beneficiaries must include the profit reported on their individual T3 slip in their own income.
Multiplying the Capital Gains Exemption with a Family Trust
The most commonly known benefit of a family trust in Canada is the multiplication of the life-time capital gains exemption (CGE). The CGE, as the name suggests, provides an exemption for $800,000 of the profit realized on the sale of private company shares in Canada (Qualified small business corporation shares).
Where does the family trust fit in? For example, assume that you run a family business, the shares of which are wholly owned by a Family Trust for the benefit of you, your spouse and two children. This business is worth $3,200,000. In other words, if you sold your business today, you would ask the seller for $3.2 million dollars.
Wouldn’t it be nice if you could avoid paying tax legally on the entire amount of the sale? A family trust in Canada can help you do just that. Each beneficiary of the family trust (you have 4 beneficiaries in total) can claim the CGE on their share of the sales proceeds. If you allocated one quarter of the sales proceeds (i.e. $800,000) to you, your spouse, and each of your two children, then the entire gain of $3.2M would be exempt from tax.
If you’re a sole-proprietor, you can visit our webpage on lifetime capital gains exemption the steps required to incorporate your business, so that you can also claim the CGE.
Income-splitting is a powerful attribute of setting up a family trust in Canada.
Let’s continue with the example above, where you, your spouse, and two children are all beneficiaries of a family trust. By using the following steps, you can split the income of your business with your family through a family trust:
- Distribute the profits from your corporation to the family trust by way of a tax-free dividend
- Have the family trust distribute the dividend it received to each beneficiary (if the beneficiaries are 18 are older)
- Each beneficiary will report the dividend they received on their personal tax return. If a particular beneficiary (e.g. your children) have no other source of income, they can receive dividends of up to $39,000 each year completely tax free from the family trust.
Succession & Estate Planning
Consider the following scenarios:
- You have passed-away, and your family is stuck with paying the tax bill for your estate
- You have passed-away, and your family members cannot agree on who gets to keep the family business
The above 2 scenarios are unfortunately very common for most small business owners who have not planned their retirement and affairs properly. Fortunately, setting up a family trust in Canada can help with this process.
Your family trust deed should outline the following:
- How the operating profits of the business are to be paid to your family members (who are beneficiaries of your family trust)
- How the sales proceeds should be distributed to each family member on the eventual sale of the business
- How much you are to be paid annually from the family trust to supplement your retirement income
Visit our webpage on “ Transferring business to a family member in Canada” for more details on this topic
As you can see the benefits of setting up a family trust in Canada are enormous. Since this is a very complex subject matter, you should consult with a professional accountant prior to creating a family trust.
To learn more tax saving tips please visit 20-free-tax-secrets
The information provided on this page is intended to provide general information. The information does not take into account your personal situation and is not intended to be used without consultation from accounting and financial professionals. Allan Madan and Madan Chartered Accountant will not be held liable for any problems that arise from the usage of the information provided on this page.