Sometimes in life there are terrifi c opportunities that people avoid because the steps required to take advantage of the opportunities are a little complex and take some time to fully comprehend.

Alter ego trusts fall into this category and have therefore remained fairly unknown, misunderstood and too frequently overlooked when planning for one’s estate. Yet, this relatively new type of trust, allowed under the Income Tax Act, off ers some very interesting tax and estate planning opportunities under the right circumstances.

Sadly, very few tax and estate professionals are willing to consider or even mention the alter ego trust as an option.

Th is newsletter will therefore focus a light on the tax and estate planning options available and the resulting potential benefi ts that may be realized when an alter ego trust is implemented correctly and, further, when implemented correctly in conjunction with a testamentary trust.

WHAT’S AN ALTER EGO TRUST?An alter ego trust is set up by an

individual settlor (the owner of the assets) who becomes the sole income benefi ciary of the trust.

Th ere are several structural requirements to be followed when creating an alter ego trust:• the settlor must be sixty-fi ve

years of age or older• the settlor must be entitled to

receive all of the income generated by the trust in each taxation year during his life

• no other individual other than the settlor may receive any of the income or the capital while the settlor is alive

On the death of the settlor, the trust can designate benefi ciaries to receive property outright or in continued trusts (those continued trusts would be considered inter vivos trust). Th e alter ego trust would provide for such benefi ciaries, just as a last Will and Testament would, and the distribution of the assets would be made in accordance with the Deed of Trust.

Since at the time of death the settlor would not personally own the assets that have been given to the alter ego trust there is no ‘estate’ and, therefore, there would be no need for probate which can result in signifi cant savings for the estate and the benefi ciaries.

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Th ere are other advantages in using an alter ego trust such as ensuring immediate and continuous access to the assets by the trustees, thus, preventing any delay in the management and/or distribution of the trust on the illness or death of the settlor. Also, the use of an alter ego trust allows the settlor to maintain privacy about his assets on his death, as a will subject to probate becomes a public document while the terms of the trust and the specifi cs concerning the distribution of assets are generally not a matter of public record.

TAX IMPLICATIONSTh e tax implications at the time an

alter ego trust is created are unique. One of the key characteristics of an alter ego trust is that it is deemed to have acquired the assets at the same cost base as the settlor.

As a result, the settlor does not have to pay taxes at the time he transfers the assets into the trust thus deferring a capital gain until the death of the settlor. However, the settlor may opt out of this tax treatment thereby triggering capital gains and losses at the time the alter ego trust is set-up.

Another interesting characteristic of the alter ego trust is the fact that it is exempt from the 21-year deemed disposition tax rule for trusts. Such exemption provides a level of comfort to the settlor that he may establish a longer term estate

planning without being concerned about the deemed disposition of the trust.

As mentioned earlier, alter ego trusts are useful for avoiding any probate fees on the assets held by the trust.

Th is is diff erent from the more frequently used “Dual Will” strategy which facilitates the avoidance of probate fees on corporate shareholdings and debts that are separated out from the rest of the assets of an estate. In the Dual Will scenario probate fees would be paid on these ‘other assets.’

Alter ego trusts, on the other hand, allow for avoiding probate fees on all assets held by the trust, such that the deceased’s entire estate may be completely exempt from probate fees.

Given the clear fi nancial benefi t of this relatively new type of trust permitted under the Income Tax Act, it is clearly worth understanding and considering implementation of an alter ego trust.

ALTER EGO TRUSTS VERSUS TESTAMENTARY TRUSTS (AND HOW THEY CAN GET ALONG)

We oft en read that one of the biggest drawbacks of alter ego trusts is that they do not permit the traditional post mortem income splitting that is a benefi t of testamentary trusts.

Indeed, for many tax and estate professionals, testamentary trusts

are the preferred post mortem option since testamentary trusts enjoy graduated tax rates on income retained in them.

Access to these graduated rates makes it much more benefi cial to retain income and gains and have them taxed in the trust rather than taxed in the benefi ciaries’ hands, thus allowing for income splitting for the benefi ciary that translates into tax savings for such benefi ciary.

One key diff erence between a testamentary trust and an alter ego trust is that the former must be established as a consequence of death whereas an alter ego trust is established during the life time of the deceased.

Many therefore disregard alter ego trusts as a tool as it is view as a “lost opportunity” for the post mortem income splitting through that the graduated tax rates the testamentary trusts provide; two major components of a proper estate planning.

However, debating which of the two options is more valuable is really unnecessary because there are ways where one can take advantage of both options. One could settle an alter ego trust naming oneself as trustee and the lifetime income and capital benefi ciary and also naming his children as the income and capital benefi ciaries on their death and the successor trustees of the alter ego trust.

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Th e settlor/trustee would then loan his assets/funds to the alter ego trust and receive in return a non-interest bearing promissory note. Th e assets/funds would be held and invested in the alter ego trust and the capital gains earned inside the trust would be attributed back to the settlor/trustee and taxed in his hands (as a result of subsection 75(2) of the Income Tax Act).

Upon the death of the settlor, the assets held inside the alter ego trust would be subject to the deemed disposition and any capital gains would be taxable to the trust. Once the taxes are paid, the alter ego trust would repay the promissory notes to the estate and thus the loan would be a loan asset of the estate.

With good estate planning, the testator would have used the Dual Will strategy whereby the secondary Will would only cover “any loans payable to the estate” and, as a result, such assets would not require probate; thus saving the probate fees on the value of the loans.

Th e assets/loans would be dealt with by the estate trustees in accordance with the terms of the Will which would inevitably provide for testamentary trusts for the benefi ciaries and, therefore, provide such benefi ciaries an opportunity for the highly desirable income splitting.

CONCLUSIONWe can see that whether utilizing

an alter ego trust or testamentary trust, or a careful combination of both, estate planning such as that described above requires informed planning by the settlor/testator’s lawyer and accountant but may translate into really signifi cant tax savings. Th e prudent client should ensure that their professional advisors consider both avenues to enjoy the maximum benefi ts available under the current regulations and to be sure that no opportunity is missed.

Such estate planning is not the custom and is no doubt more complex to implement than simply having a standard will drawn up by your advisor.

However, the potential tax-saving combined with the certainty of knowing your assets/estate will not be subject to probate, thus avoiding any delays from the administration of your estate may be well worth it.

Tierney Stauff er LLP would be glad to assist and advise you in the context of alter ego trust. If you have any questions, please do not hesitate to contact us.

Disclaimer: Th is article is provided as an information resource and is not intended to replace advice from a quaifi ed legal professional and should not be relied upon to make decisions. In all cases, contact your legal professional for advice on any matter referenced in this document before making decisions. Any use of this document does not constitute a lawyer-client relationship.

Sébastien Desmarais

LL.B., LL.L., J.D.613-288-3220E-mail: sdesmarais@tslawyers.ca Blog: http://ottawalawyers.wordpress.com/

CALL TO THE BARLaw Society of Upper Canada, 2007

EDUCATIONAL BACKGROUND• University of Ottawa, LL.L., 2007• University of Ottawa, LL.B., 2005• Michigan State University, College of

Law, J.D., 2005

PRACTICE SUMMARY:

Sébastien joined Tierney Stauff er LLP as an Associate in the Wills, Estates & Trusts Planning & Administrative Practice Group in 2009. His practise focuses on estate planning, will draft ing and personal and corporate taxation. Sébastien has experience in resolving disputes with the Canada Revenue Agency (CRA), fi ling voluntary disclosures, assisting individu-als with their tax related issues and tax planning for families and businesses. Sébastien is bilingual and practices in both offi cial languages. He has spoken at various seminars on estate, trust and tax matters. Sébastien discussing legal issues. He is a tutor for the Law Society of Upper Canada for the Estate Practice section.

Other Articles of Interest by Sébastien Desmarais at www.tslawyers.ca• Net Worth Assessment - Avoid It At All Costs• Succession and Tax Planning for Farmers• Trustees Controlling the Corporation - A Challenging Situation• Trusts and the 21-Year Rule• Estate Planing and the Use of the Henson Trust and RDSP