This publication has been updated as at February 17, 2021.

Trusts offer a very useful estate planning solution for a wide variety of special estate planning situations. Alter Ego and Joint Partner trusts are both forms of inter vivos trusts (trusts that take effect during your life). Alter Ego and Joint Partner trusts became available in 2000 and have become important estate planning vehicles. Here are the answers to five frequently-asked questions about Alter Ego and Joint Partner trusts to help you decide if these estate planning solutions will benefit you.

1. Why are more people now interested in Alter Ego and Joint Partner trusts?

New tax rules implemented in 2016 make it more attractive for people to explore the benefits and opportunities of using Joint Partner and Alter Ego trusts in their estate plans. Until 2016, tax rules treated assets that flowed to trust beneficiaries from an estate (a testamentary trust, created in your Will that only takes effect on your death) and those that flowed from an Alter Ego or Joint Partner trust differently. Practically, these rules made it desirable for people to choose one type of trust over the other: an individual would choose to use an Alter Ego or Joint Partner trust during their lifetime, but no testamentary trust on their death; or a testamentary trust on their death, but no Alter Ego or Joint Partner trust during their lifetime. In 2016, tax rules changed, largely eliminating the distinction between the tax treatment of a testamentary trust and of a non-testamentary trust, and making Alter Ego and Joint Partner trusts a more attractive estate planning vehicle for some. Here’s how:

Pre-2016. Before 2016, any income generated within a testamentary trust was taxed within the trust at the same graduated rates available to individual taxpayers. Because a trust’s income was taxed within the trust, and separate from individual taxpayers, individual taxpayers could effectively income split with the trust and take advantage of their graduated tax rate as well as the trust’s graduated tax rate to reduce their overall tax liability. For example, Wilma is a professional in the top tax bracket and the beneficiary of a trust her late mother, Betty, created in her Will. The trust assets of $1M generate $50,000 in income in the run of a year. The trustee (who could be Wilma) then decides whether to have all of the income taxed in the trust, or to have some of the income allocated to Wilma to be taxed in her hands. In that way, Wilma could take advantage of two sets of marginal tax rates: her own, and the trust’s. However, you can only create a testamentary trust with assets flowing from an estate, not with assets flowing from an Alter Ego or a Joint Partner trust. Since people wished to obtain the tax benefits of a testamentary trust, many favoured testamentary trusts over Alter Ego or Joint Partner trusts during their lifetime.

Post-2016. As of 2016, with certain exceptions, the tax rules changed: income earned in testamentary trusts is now taxed at the highest marginal tax rate instead of graduated rates. This change effectively eliminated testamentary trust beneficiaries’ ability to income-split with the trust. In Wilma’s example, as of 2016, all the income generated in Wilma’s testamentary trust is taxed at the highest marginal tax rate within the trust, or at Wilma’s tax rate (still the highest rate, in her case) if it’s taxed in her hands. As a result, there’s no longer a real difference in the tax treatment of assets that flow to trust beneficiaries through a testamentary trust, and those that flow through an Alter Ego or Joint Partner trust.

2. What are the benefits of Alter Ego & Joint Partner trusts

Many of the benefits of testamentary trusts can be achieved using an Alter Ego or Joint Partner trust. For example, asset protection and planning for blended families can be accomplished using these trusts; upon the death of the Settlor (the individual who established the trust), or upon the death of the Settlor’s spouse, in the case of the Joint Partner trust, assets can continue to be held in trust, allowing for the Settlor’s children to income split with their families in much the same way as a family trust. Alter Ego and Joint Partner trusts also offer these three key additional benefits:

Disposition Tax Deferral. Unlike most types of inter vivos trusts, you can transfer assets into an Alter Ego or a Joint Partner trust on a tax-deferred basis during your lifetime, without the immediate tax consequences of a deemed disposition. Alter Ego and Joint Partner trusts are also not subject to the 21-year deemed disposition rule. An Alter Ego trust will have a deemed disposition of its property on the death of the Settlor. If the trust is a Joint Partner trust, the disposition is deferred until the death of the survivor of the Settlor and the Settlor’s spouse.

No Probate. A key benefit is that upon your death, the trustees won’t need to obtain probate to administer the trust assets or to transfer them to your beneficiaries. Probate is the process of obtaining court approval of a deceased’s Will and their Executor’s authority to act. Financial institutions typically require it to deal with estate assets, and it’s always required to deal with land held solely in the deceased’s name. The main ways to avoid the probate process are joint ownership of assets with the right of survivorship, naming beneficiaries (for RRSPs, RRIFs, TFSAs, and insurance policies), gifts to beneficiaries before death – and inter vivos trusts. Upon the Settlor’s death, in the case of an Alter Ego trust, or the death of the survivor of the Settlor and the Settlor’s spouse, in the case of a Joint Partner trust, the assets held in the trust will be distributed according to the terms of the trust agreement rather than according to a Settlor’s Will, although with proper planning your Will and trust agreement can be coordinated. A grant of probate isn’t required to administer the assets held within an Alter Ego or Joint Partner trust. Avoiding the probate process has three main advantages:

• Reduce Probate Tax. Avoiding probate avoids paying probate tax. If your estate is probated, with some exceptions, it must pay probate tax on your gross estate assets on death. Since assets held in an Alter Ego or Joint Partner Trust won’t form part of your estate assets, they aren’t subject to probate tax.
• Privacy & Confidentiality.Avoiding probate also keeps your estate affairs private and confidential. A Will becomes a public document once it’s submitted to probate, and it and your estate’s assets and value are matters of public record. Unlike the probate process, the trust document that governs an Alter Ego or Joint Partner Trust is private and its contents are not generally publicly disclosed.

• Reduce Delays & Costs. Avoiding probate also eliminates the delays and costs that can be associated with any court process, potentially delaying beneficiaries’ access to your assets for their use. There are also court costs (in addition to probate taxes) involved in the probate process.

Continuity of Asset Management. You can be your own trustee and you can name a trusted family member or professional trustee to ensure smooth administration of the trust after your death and allowing the trustees to continue to manage the assets in the event of your incapacity.

3. Do I have to meet any conditions to establish an Alter Ego or Joint Partner trust?

Yes. In an Alter Ego or Joint Partner trust, the Settlor must be an individual. Further, that individual can only establish an Alter Ego or Joint Partner trust if certain conditions are met, including:

• The Settlor must be at least 65 years of age.
• Only capital property can be transferred to the trust.
• The Settlor and the trust must be Canadian residents.
• The Settlor (and the Settlor’s spouse, if it’s a Joint Partner trust) must be entitled to receive all the income arising in the trust during the Settlor’s lifetime (and the lifetime of the Settlor’s spouse, if it’s a Joint Partner trust).
• Until the Settlor’s death (and the Settlor’s spouse, if it’s a Joint Partner trust), only the Settlor (and the Settlor’s spouse, if it’s a Joint Partner trust) can receive or otherwise obtain the use of any of the trust’s income or capital.

4. Are there any special estate planning considerations when using an Alter Ego or Joint Partner trust?

Yes. Three of the common considerations that come up with Alter Ego and Joint Partner trusts that you will need to take into account when considering them as part of your estate plan include:

Qualified Small Business Corporation (QSBC) Deduction. Any gain arising on the deemed disposition on the Settlor’s (or the Settlor’s spouse’s) death isn’t eligible for the capital gains deduction for qualified small business corporation shares if the shares are held in an Alter Ego or Joint Partner trust. It’s important for business owners to give this careful consideration before contributing shares of a private company carrying on an active business to an Alter Ego or Joint Partner trust.

Post-Mortem Planning. Unique post-mortem planning considerations arise when an Alter Ego or Joint Partner trust is involved. In particular, the transfer of voting control shares of a private corporation to an Alter Ego or Joint Partner trust can limit the future post-mortem planning opportunities. It’s important for business owners to carefully address such post-mortem planning considerations when contemplating use of Alter Ego and Joint Partner trusts.

Charitable Giving. Donation planning can be an effective planning strategy for tax reduction. It’s important to carefully structure charitable gifts to avoid the Canada Revenue Agency (CRA) taking the position that an amount to be paid by an Alter Ego or Joint Partner trust to a charity is a payment in satisfaction of the charity’s interest as a beneficiary of the trust, rather than a gift. For donation planning to work, the charity must not be a beneficiary of the trust and the trustee must have the discretion to pay any part of the trust’s assets to a registered charity of the trustee’s choosing. Essentially, the trustee must be able to make this decision freely for the CRA to view the charitable donation as a gift.

5. Are there any circumstances in which testamentary trusts still make sense?

Yes. There are lots of situations in which testamentary trust planning still makes sense despite the 2016 taxation changes:

Tax Benefits. Tax benefits can still be had with testamentary trusts. Here’s one example: imagine the terms of Betty’s testamentary trust for Wilma include Wilma’s three children as beneficiaries. Wilma’s children are all in university and have no (or minimal) income. If Wilma receives the entire $50,000 of trust income, or leaves it all to be taxed in the trust, it will all be taxed at the highest rate. But, if Wilma divides the trust income and allocates one third to each child to pay school expenses (which she would have assisted with anyway), each child will be taxed on their income at lower, graduated rates, assuming the new TOSI (tax on split income) rules don’t apply, because of their individual low incomes – and Wilma’s tax savings will be significant.

Non-tax benefits. Testamentary trusts were always about more than just taxes; there are other good reasons to use them as part of an estate plan. For example, by using a testamentary trust, a person can control adult beneficiary(ies)’s use of the inheritance income and capital – especially important for large inheritances or spend-thrift beneficiaries – or to protect assets from creditors or marriage breakdown. Further, spousal trusts are still effective to protect and maintain control over the surviving spouse’s use of the trust’s assets, to protect assets if the surviving spouse remarries and to dictate the ultimate beneficiaries when the surviving spouse dies.

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Please contact your McInnes Cooper lawyer or any member of our Estates & Trusts Law Team @ McInnes Cooper to discuss whether you can benefit from an alter ego or joint partner trust.