How Can Small Business Owners Use A Family Trust in Estate Planning?

Many small business owners, once they become successful, incorporate their business. A corporation is a separate legal entity and can outlive you. Canada has several family businesses that have provided for multiple generations with solid estate planning. While you put effort into building a successful business, you also need to put effort into sustaining that business when you transfer it to your family. Hence, many small business owners set up a family trust while incorporating the business and adding the trust as a shareholder to maximize tax savings.5

This article will explain how small business owners can use family trust in estate planning.

Estate Planning in a Nutshell

Estate planning involves a well-thought-out plan to transfer assets, including property, jewelry, and even the shares of a family-owned business, as decided by the asset owner. While there are many ways to transfer assets, such as wills, trusts, and holding companies, family trusts are one of the most tax-efficient ways.

How Does Family Trust Help in Estate Planning?

Maintains Privacy of Assets: In a will, the business owner lists the assets and appoints an executor to transfer them after their demise. However, a will is subject to probate and probate fees. Also, the Will would be on public display for a certain period, and the family can dispute its contents.

A family trust safeguards your estate from all this as it is not subject to probate, thereby maintaining privacy.

Settles Disputes: A business owner (Settlor) transfers the company’s assets and shares to the family trust, names a Trustee, and gives detailed instructions on the distribution of assets to the family members (beneficiaries). The beneficiaries cannot dispute the claims as the right to allocate assets rests with the trustee.

Provide for Dependents: Since the Trustee is responsible for distributing assets, it protects and provides for family members who are minors or mentally infirm and are not capable of making their own financial decisions.

Protects Assets: In a credit liability, all assets owned by the individual or business can be used to repay the liability. Since the trust is a separate entity, the assets transferred to the trust are owned by it, protecting the assets from individual and business liability.

Four Ways Family Trust Can Save Taxes in Estate Planning

While family trust brings non-tax benefits, its key attraction is the tax benefit it brings.

Tax Deferral: When an asset is transferred to the beneficiary after the demise of the asset owner, it is deemed as the sale of an asset at fair market value and attracts capital gain tax. However, when the asset is transferred to a family trust, the capital gain tax liability is postponed by the life of the trust, which is 21 years. The transfer of assets to the beneficiary occurs on the 21st anniversary of the trust, and capital gain tax is payable at that time.  

However, with proper estate planning, you can gradually transfer the assets in small amounts to the beneficiaries and reduce the tax bill.

Income Splitting: A trust can split the dividend income among multiple beneficiaries, allowing you to take advantage of family members’ low tax brackets. If one person has a higher income of $200,0000, he is charged an incremental tax rate of up to 29%. If this amount is distributed among four members, each pays a 15% tax rate.

Estate Freeze. Many Canadians also use a family trust to execute the estate freeze strategy, wherein you convert your equity shares into preference shares and freeze the value of the shares at the current fair market value. You can understand the capital gain tax liability and arrange for that amount. In the meantime, you keep getting the income from preference shares. Over the years, you can sell these preference shares and reduce your overall capital gain tax liability.

Selling a Business: If you plan to sell your business, you can avail yourself of a lifetime capital gain tax exemption (LCGE) of over $1 million. If you want to sell your business for a capital gain of $4 million, one person can only claim $1 million in LCGE. But if the family trust owns the shares, you can use the LCGE of each of your family members and reduce your capital gain tax. However, there are some eligibility criteria your business must meet.

Contact DNTW Toronto LLP to Help You Set Up a Family Trust

While a family trust offers several benefits, the trust laws are complicated. Moreover, trusts have to meet disclosure requirements. A professional accountant and tax consultant can help you navigate these requirements and efficiently transfer your estate tax. To learn more about how DNTW Toronto LLP can provide you with the best tax and estate planning expertise, contact us online or by telephone at 416.924.4900.