Among a number of individuals, depending on situation and needs, trusts may present a very effective option as part of wealth transfer and estate planning. For those who either have a family trust or act in the capacity of trustee, effective planning before the end of the calendar year is particularly important and may yield significant benefits. Because trusts may sometimes involve potentially complex, long-term planning, often including significant expenditures related to legal and professional fees, an awareness of year-end responsibilities is valuable in ensuring the trust is properly administered and achieves the objectives for which it was established.
Depending on the circumstances, consider the following year-end responsibilities
1 - Make interest payments on prescribed rate loans by January 30
If you made a prescribed rate loan to a family trust, ensure the trust makes the annual interest payment by that date, following the end of the calendar year, in order to avoid the attribution rules. (Note: If the trust does not make the interest payment by January 30, even on one occasion, the entire strategy can fail. You can lose the benefit of the prescribed rate loan for the year in question and all subsequent years. The attribution rules would then apply and the income earned by the trust would be taxed in the lender’s hands. If you miss the January 30 payment date, talk to your tax professional.)
2 - Strategize for attribution rules
You can avoid the attribution rules by loaning funds to a properly structured trust at the CRA’s prescribed rate. If the investment income is paid or made payable to a Canadian resident beneficiary by the end of the calendar year, it can be reported in the beneficiary’s tax return and subject to tax at the beneficiary’s marginal tax rate. The lender reports the interest received as income on their tax return, and there is no attribution on any income or capital gains allocated by the trust to the beneficiaries.
3 - Determine if the trust earned capital gains during the year
Individuals, including minor children, with no other taxable income can realize approximately $22,000 of capital gains tax-free each year (the amount varies by province) due to their basic personal exemption. If you have a properly structured trust that realizes capital gains during the year, you may be able to allocate these gains to individual beneficiaries to be taxed in their hands. This may mean little or no taxes will be payable. The trust must make this allocation by the end of the year, so talk to the trust’s tax advisor and plan ahead to ensure you’ve maximized any potential opportunities.
4 - Keep your records up to date
For those who act as trustees, there are a number of annual record-keeping duties. These responsibilities can be time-consuming and sometimes involve additional professional fees, but it’s important to adhere to these rules to ensure the trust is properly administered and is achieving its tax-minimization and income-splitting objectives. These annual responsibilities may include the following:
- Keeping a copy of the original signed trust agreement and the property used to settle the trust (for example, a $20 bill is sometimes used).
- On or before December 31, trustees must make the irrevocable decision to pay net income, including the taxable portion of capital gains earned in the family trust, to the beneficiaries. They must document this decision by a resolution signed by the trustees. The trustees need only determine the percentage allocation to the beneficiaries by December 31. They can confirm the exact amount in March after filing the T3 tax return.
- Documenting payments that were made during the year to beneficiaries or third parties for the benefit of beneficiaries.
- Keeping receipts for payments made to third parties or parents/guardians as reimbursement for expenditure.
- Maintaining promissory notes for income that has been made payable to beneficiaries.
- Ensuring the trust’s tax return is accurate and filed on time. The family trust tax return must be filed within 90 days of year-end (March 31, or March 30 in a leap year). T3 slips must also be sent to beneficiaries by this date.
- If the trust was settled using a prescribed rate loan, it is very important to document and maintain source documents for the interest payments on the loan and any repayments of principal.
Note: It is important to consult your qualified tax and legal advisors if you have record-keeping responsibilities relating to family trusts or loan agreements that involve a prescribed rate loan.
5 - Determine whether the trust has to pay tax by instalments
If the trust owes net tax for the year of more than $3,000 ($1,800 for trusts resident in Quebec) and exceeded this threshold in either of the preceding two tax years, the trust will be required to pay tax by instalments this year. The CRA will send you instalment reminders if the trust is required to pay tax by instalments.
6 - Remember the 21-year rule
Most trusts are required to report unrealized gains on their assets on the 21st anniversary of the date the trust was created, and every 21 years thereafter, to prevent it deferring its capital gains indefinitely. On these dates, the trust must report all accumulated gains on its tax return as if it had actually sold the assets on that date at fair market value. If the trust holds real estate or business assets, valuators may need to be involved to establish correct valuations. This doesn’t mean that the trust must be wound up. After paying the tax due, it will continue to operate as it did before.
If the trust realizes gains as a result of this deemed disposition, the trust will pay tax at the highest marginal tax rate in the province where it is resident. The trust cannot avoid this tax liability by allocating these gains to a beneficiary to be taxed in their hands. However, with proper planning the trust may be able to defer the tax on the deemed disposition. If you are involved in the administration of a trust that’s approaching a 21-year anniversary, you may be able to take appropriate steps to minimize the impact of this taxable event.
As the end of the year approaches, ensuring you comply with your tax filing, interest payment and record-keeping responsibilities in relation to any trusts with which you may be involved should be an essential part of overall planning. In some cases, advance planning may be either beneficial or required to minimize the tax impact of certain events for the trust. Your professional advisors can work with you to develop solutions appropriate to your circumstances and your trust-planning objectives.