Below is a great article written by Tim Cesnick and published in The Globe and Mail.
Family trusts and life insurance options are often overlooked when thinking of how to pay for a post-secondary education
Now that my kids have decided they want to be brain surgeons, I’ve been thinking about how to pay for their post-secondary education. Two methods of saving for a child’s education are often overlooked. The first is a family trust, and the second is life insurance.
FAMILY TRUST
A trust is simply a legal relationship between three parties: The settlor (the person creating the trust), the trustee (the person who holds and controls the property of trust) and the beneficiary (the person for whom the property of the trust is being held). The nice thing about a trust is that it’s possible to have the income of the trust taxed in the hands of the beneficiaries, who may pay little or no tax if they are minors and have little or no other income.
Setting up a trust does come with a cost, so it’s not generally going to make sense unless you’re willing and able to commit a sustantial sum to the trust over a short period of time. You can make this a loan to the trust if you want, so that you can take back your capital again later, as a repayment of the loan.
Once the money is in the trust, any interest and dividend income earned in the trust will be attributed back to you to be taxed in your hands while the beneficiaries of the trust are minors (unless you charge the taxman’s prescribed rate of interest on a loan to the trust), but capital gains can be taxed in the hands of the beneficiaries. Also, any second generation income (that is, income on the income, even if it’s interest or dividends) can be taxed in the hands of your children.
You can pay for all or part of your child’s education costs out of the income or capital of the trust. The taxman will consider payments to third parties, including reimbursements to you, as being paid to the beneficiary as long as those payments were clearly for the benefit of your child. To the extent that little or no tax has been paid on the income of the trust over the years (by having income taxed in your child’s hands), you’ll effectively be using pre-tax dollars to pay for the child’s education.
The benefits of the trust include: protection of the assets of the trust from creditors, splitting income with your children, maintaining control over the assets, and flexibility to use the trust funds for things other than education. There’s a lot to consider when setting up a trust. Visit a tax pro for help.
LIFE INSURANCE
Life insurance is an interesting tool because you can accumulate investments inside a policy on a tax-sheltered basis. Further, if it is the life of your child that is insured, you’re able to transfer ownership of the policy, including the accumulated investments inside the policy, to your child free of tax once he or she reaches age 18. Your child can then make withdrawals of those investments from the policy to pay for education. While those withdrawals are generally going to be taxable to your child, he’ll likely pay little or no tax if he has little or no other income.
One of the benefits of choosing a whole life insurance policy is that the returns have been incredibly stable over the years, even throughout 2008. The reason for this is that the insurance companies are allowed to smooth, or average, the returns you receive over a period of years.
Consider some numbers. If you pay $2,750 annually into a whole life policy each year until your child is 18, there could be $70,000 to $75,000 in the accumulating fund to be accessed (varies by insurance company), assuming a 5 per cent annual return inside the policy. If you set aside the same $2,750 in a tax-free savings account (TFSA) you could end up with approximately $84,000 earning that same 5 per cent, but this would assume a portfolio that is largely in equities that is subject to the volatility of the markets. If you earned, say, 6 per cent in the TFSA, you’d have close to $92,000 in this case, with the volatility.
Life insurance also offers asset protection, flexibility to use the assets for any purpose, and a death benefit ($265,000 in my example) over and above the investment component of the policy if your child passes away prematurely. Insurance is just another tool to consider.
As usual, please do not hesitate to contact me should you have any questions. hugues.boisvert@andrewsrobichaud.com or +1.613.237.1512 x 255
Tuesday, September 21, 2010
Tuesday, September 14, 2010
Family Trust Audits Highlight Need for Proper Trust Records
Today, I would like to share an excellent article written by BDO Canada - As usual, please let me know if you have any questions.
Family Trust Audits Highlight Need for Proper Trust Records
A family trust can provide significant benefits as the
legalities and benefits of ownership can be separated. A
discretionary trust allows the benefits of ownership to flow
to beneficiaries while the trustee maintains control and ownership
of trust property and can ultimately decide on who will receive the
property at a later date. Due to this, family trusts are a powerful tool
in terms of income splitting and capital gains splitting, including
multiplying access to the capital gains exemption.
As is often the case, beneficial tax planning vehicles often carry a
greater recordkeeping and compliance burden, and family trusts are
no different. In particular, one of the key benefits of a discretionary
family trust is the ability to allocate income in different shares to
different beneficiaries, or to retain the income in the trust. For a
discretionary family trust, it is important to note that the default
position is that all of the income belongs to the trust and will be
taxed there if no further action is taken. If it is beneficial to have
income taxed in the hands of a beneficiary, that income can be
allocated in one of two ways:
• It can be paid to them during the year, or the trustee(s) can
declare that the income is payable to the beneficiary at the end
of the year. In other words, the income belongs to the beneficiary.
• It can be allocated by way of a special tax rule called the
preferred beneficiary election (under this election, it is possible to
allocate income to a beneficiary of the trust that is mentally or
physically infirm or disabled without giving them a right to that
income).
Most likely due to the popularity of family trusts and the tax
benefits they provide, the Canada Revenue Agency (CRA)
implemented an audit project on these trusts. The CRA’s audit work
on trusts is focused on the following:
• Has the trust been properly formed? If your trust was set up in writing by a lawyer, this should not be a significant issue.
• Where trust income has been allocated, was the income actually
paid or is there a bona fide obligation to pay that income to a
particular beneficiary? The CRA will be looking for documentation
such as trustee resolutions that allocate the trust’s income, proof
of payment for income paid during the year and promissory notes
or other proof that the trust has made the income payable to the
individual beneficiaries.
• Where the trustees make payments to third parties, was the
payment made for the benefit of the beneficiary? It is also
possible to “pay income” to a beneficiary by making payments
to third parties for the benefit of that beneficiary. In this case,
the trustee will need to document the payments made and
also provide evidence that the payment benefited a particular
beneficiary. For example, if a parent is reimbursed for expenses
incurred on behalf of a child who is a beneficiary, receipts for the
expenses should be retained to prove the child benefited from the
payment and not the parent.
In addition to these particular issues that arise for family trusts, the
CRA will also be reviewing the records of the trust in the same way
it does for other taxable entities to determine whether income has
been calculated and reported properly. So, you should ensure that
bank and investment accounts are set up as needed and proper
records are maintained. Also, your trust agreement and the property
used to settle the trust should be kept in a safe place.
Family Trust Audits Highlight Need for Proper Trust Records
A family trust can provide significant benefits as the
legalities and benefits of ownership can be separated. A
discretionary trust allows the benefits of ownership to flow
to beneficiaries while the trustee maintains control and ownership
of trust property and can ultimately decide on who will receive the
property at a later date. Due to this, family trusts are a powerful tool
in terms of income splitting and capital gains splitting, including
multiplying access to the capital gains exemption.
As is often the case, beneficial tax planning vehicles often carry a
greater recordkeeping and compliance burden, and family trusts are
no different. In particular, one of the key benefits of a discretionary
family trust is the ability to allocate income in different shares to
different beneficiaries, or to retain the income in the trust. For a
discretionary family trust, it is important to note that the default
position is that all of the income belongs to the trust and will be
taxed there if no further action is taken. If it is beneficial to have
income taxed in the hands of a beneficiary, that income can be
allocated in one of two ways:
• It can be paid to them during the year, or the trustee(s) can
declare that the income is payable to the beneficiary at the end
of the year. In other words, the income belongs to the beneficiary.
• It can be allocated by way of a special tax rule called the
preferred beneficiary election (under this election, it is possible to
allocate income to a beneficiary of the trust that is mentally or
physically infirm or disabled without giving them a right to that
income).
Most likely due to the popularity of family trusts and the tax
benefits they provide, the Canada Revenue Agency (CRA)
implemented an audit project on these trusts. The CRA’s audit work
on trusts is focused on the following:
• Has the trust been properly formed? If your trust was set up in writing by a lawyer, this should not be a significant issue.
• Where trust income has been allocated, was the income actually
paid or is there a bona fide obligation to pay that income to a
particular beneficiary? The CRA will be looking for documentation
such as trustee resolutions that allocate the trust’s income, proof
of payment for income paid during the year and promissory notes
or other proof that the trust has made the income payable to the
individual beneficiaries.
• Where the trustees make payments to third parties, was the
payment made for the benefit of the beneficiary? It is also
possible to “pay income” to a beneficiary by making payments
to third parties for the benefit of that beneficiary. In this case,
the trustee will need to document the payments made and
also provide evidence that the payment benefited a particular
beneficiary. For example, if a parent is reimbursed for expenses
incurred on behalf of a child who is a beneficiary, receipts for the
expenses should be retained to prove the child benefited from the
payment and not the parent.
In addition to these particular issues that arise for family trusts, the
CRA will also be reviewing the records of the trust in the same way
it does for other taxable entities to determine whether income has
been calculated and reported properly. So, you should ensure that
bank and investment accounts are set up as needed and proper
records are maintained. Also, your trust agreement and the property
used to settle the trust should be kept in a safe place.
Tuesday, September 7, 2010
Business owners: why you MUST use separate corporations.
USE OF SEPARATE CORPORATIONS
The use of separate corporations to carry on different businesses is a basic creditor proofing technique that should always be considered when starting a new business. Separate corporations generally have limited liability, which will help insulate the assets associated with one business from any risks associated with another business. The use of separate corporations is also recommended where a business has used accumulated earnings to acquire significant liquid and/or investment assets or perhaps real estate. For example, it is desirable for real estate and/or equipment which is used in the business to be owned by a separate company(Holding Company), rather than be owned by the operating company. In this manner, the real estate can be protected from direct creditors of the operating business.
If the operating company already owns real estate, it may be possible to separate the real estate by means of a tax deferred corporate reorganization. Where the real estate is owned separate from the operating company, the company owning the real estate would generally charge the operating company a fair market value
rent.
This type of arrangement may also provide ancillary tax benefits with regard to the potential for a more rapid deduction of the leasehold improvements incurred by the operating company.
In addition to real estate assets, other liquid assets(such as cash) accumulating in an operating company should be separated from the company to the extent there are accumulated earnings. For example, term deposits owned by an operating company could be separated and transferred to a holding company by having the operating company pay a tax-deferred dividend to the holding company. In the future, if the
operating company requires the funds, the holding company could then loan the funds back by way of a registered debenture, so that, in the event of a business failure, the holding company’s right to realize on the loan would precede the rights of any general unsecured creditors of the operating company.
If a holding company does not currently exist, a relatively simple re-organization6 could take place to establish a holding company and protect the investment assets of the operating company.
As usual, you should seek professional advice before implementing your new structure - call me or email me if you have any questions.
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