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March 2, 2024

Tax Perspectives

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Please note that these publications may not be up-to-date as taxation matters are subject to frequent changes.

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Fall 2001
Volume 1, Number 2

The information in Tax Perspectives is prepared for general interest only. Every effort has been made to ensure that the contents are accurate. However, professional advice should always be obtained before acting and TSG member firms cannot assume any liability for persons who act on the basis of information contained herein without professional advice.

Alter Ego Trusts: A New Estate-Planning Strategy

By Jonathan L. Richler, MA, LLB, TEP
Richler and Tari, Tax Layers (Toronto)

Estate planners have been provided with a new tax planning tool-the alter ego trust. This vehicle offers significant benefits for those who wish to avoid probate fees or the public disclosure associated with the probate process. In Ontario, probate fees are 1.5% of the gross estate (0.5% on the first $50,000). For example, on a $5 million estate, probate fees are approximately $75,000not exactly an incidental cost. The new rules are likely to boost interest in inter vivos trusts, such as alter ego trusts, as an alternative to wills.

An alter ego trust is a trust created by an individual age 65 or over in which the individual (the settlor) is entitled to receive all of the income that arises before death and no other person may receive income or capital before that time. Accordingly, the settlor has complete enjoyment of the trust assets during his or her lifetime. In the trust deed, the settlor can designate alternate beneficiaries who will receive the income and/or capital of the trust assets following the settlor's death. This allows for estate planning through inter vivos trusts in much the same way as through wills.

Unlike other trusts, in which a transfer of assets to the trust can trigger a gain for income tax purposes, a transfer of assets to an alter ego trust is tax-free. This feature, combined with the client's ability to maintain full control of the trust assets during his or her lifetime and to pass them on to beneficiaries of choice, while avoiding probate fees on death, makes the alter ego trust an attractive estate-planning option.

The settlor continues to be taxed on all of the income and capital gains arising from the trust during his or her lifetime. On the settlor's death, the trust is deemed to sell its assets at fair market value (which is identical to what occurs on the death of an individual). A variation of the alter ego trust, the joint partner trust, allows the settlor and his or her spouse to share in the plan. Tax is postponed until the spouse's death.

There are other potential issues to be addressed with alter ego trusts. For example, where real estate is proposed to be transferred, land transfer tax consequences need to be considered. Also, where appreciating assets are held in the trust, the tax liability in certain cases could be greater than it would have been if the individual had retained the assets. The taxes paid by the deceased in the year of death on his or her terminal return are taxed at the deceased's marginal tax rate, after claiming personal exemptions, whereas any gains held in an alter ego trust will be taxed at the highest tax rate with no personal exemptions.

These caveats aside, there will be a large number of situations where the alter ego trust (and its close cousin, the joint partner trust) is a useful estate-planning strategy. The key is proper planning to ensure that the trust is appropriate for the individual and fits into his or her overall estate plan. The professional costs of setting up the trust (drafting the trust deed) and yearly trust reporting (financial statements and T3 trust tax returns) will be more than justified by the probate savings for estates exceeding $2 million.

A technical paper on alter ego trusts is available on our Web site.