Harold Rich is a wealthy man who owns a large portfolio of publicly traded securities. He wants to make provisions to protect his wife Stephanie and their daughter Laura after his death.
Stephanie is 69 and in the early stages of dementia. Stephanie lives a lavish lifestyle and is a big spender. Stephanie is fond of her son from a prior marriage, David. She paid for his post secondary education and loaned him money to buy a house. Harold is concerned that David might take financial advantage of Stephanie after Harold’s death.
Stanley Rich is Harold’s brother and a financial planner. He introduces Harold to alter ego and joint spousal trusts. Harold is particularly interested because of the potential to avoid probate fees and the ability to transfer property to the trust on a rollover basis.
Harold decides that the trust should be a joint spousal trust and that Laura and Stanley should be the trustees. To protect Laura, Harold wants the trust to be able to purchase life insurance on Stephanie. In addition, he wants a “limitation on benefits” provision which will allow the trustees to accumulate income after Harold’s death if Stephanie has any financial difficulties or is not able to manage her property.
Stanley informs Harold that a life insurance provision may prevent the trust from qualifying as an alter ego or joint spousal trust because someone else, in Harold’s case Laura, might benefit (see CRA Views, Conference, 2012-0435681C6 — CALU CRA Roundtable Q2). Harold proceeds without a life insurance clause because having a rollover of his property to Stephanie is more important. Stanley arranges for the lawyer who often works with his office to draft the trust deed and Harold executes it. Harold then transfers his portfolio of securities to the trust on a tax-deferred rollover basis.
Some time later, Stanley informs Harold that a colleague identified a possible error in the trust deed. The trust deed included the limitation on benefits provision allowing the trustees to accumulate income after Harold’s death. As a result, Stephanie may not be entitled to all the income each year. Stanley tells Harold that this means that the CRA may not consider the trust a joint spousal trust.
Harold asks an independent lawyer to review the trust deed and advise him about the consequences of the error. The lawyer confirms that the trust does not appear to be a joint spousal trust for the reasons Stanley’s colleague identified. The lawyer also advises that it may qualify as an alter ego trust because Stephanie’s entitlements do not begin until Harold’s death. Harold is entitled to all income each year and he is the only one who may benefit from the income or capital before his death. However, the lawyer also informs him that an alter ego trust would not provide a rollover to Stephanie after Harold’s death and that distributions to her would be taxable.
The Technical Details
Basics of Alter Ego and Joint Spousal Trusts
The Income Tax Act (the “Act”) sets out the criteria for alter ego and joint spousal trusts. The conditions for an alter ego trust are that:
- the trust must be created inter vivos after 1999,
- the taxpayer who created the trust had reached 65 years of age at the time the trust was created,
- the taxpayer was entitled to receive all of the income of the trust arising before death, and
- no person except the taxpayer could, before the taxpayer’s death, receive or otherwise obtain the use of any of the income or capital of the trust.
The provisions for joint spousal trusts are similar but also allow the spouse to benefit.
Rollovers into the Trust
The Act does not contain a general rollover for properties transferred into a trust. However, the Act contains a rollover for certain qualifying transfers. The qualifying transfer provisions are very similar to the alter ego and joint spousal trust requirements. If an attempted alter ego or joint spousal trust fails, the rollover will likely be unavailable. As such, the transfer to the trust would be taxable.
Rollover out of the Trust
Without corrective steps, Harold’s alter ego trust would be subject to a deemed disposition on his death with no rollover to Stephanie available. This result may be worse than if he held the property personally. Property held personally would be subject to the deemed disposition on death but may be eligible for a rollover to a spouse.
These comments are of a general nature and not intended to provide legal advice as individual situations will differ and should be discussed with a lawyer.