Alter Ego Trusts and Charitable Giving
An “Alter Ego Trust” is an effective estate planning tool. It is a type of trust under the Income Tax Act that enables Canadian residents aged 65 and above to maintain control over assets during their lifetime and to determine how those assets will be distributed upon their death. In an Alter Ego Trust, the person who creates the trust (the “Settlor”) functions as both the trustee and beneficiary. This arrangement boasts significant tax advantages, including, but not limited to, avoiding probate, strengthening privacy of transactions, and benefiting from tax credits.
The Settlor and the Alter Ego Trust are considered separate taxpayers. Therefore, during their lifetime, only the Settlor is allowed to access the assets of the Alter Ego Trust. Accordingly, the Alter Ego Trust cannot directly deal with its own assets. Instead, the trustee must first transfer those assets to the Settlor in their personal capacity, who would then deal with the asset—such as by making a charitable donation. After the death of the Settlor, the Alter Ego Trust directly deals with its own assets and can make charitable donations.
The focus of this article is on ensuring that charitable gifts made by the Alter Ego Trust reflect the Settlor’s wishes while maximizing tax benefits, thereby enhancing the charitable value of the contribution. In particular, it is important for advisors to ensure that the Alter Ego Trust deed is properly drafted; enabling the trustee to act efficiently while maximizing the impact of the charitable gifts.
Requirements
To set up an Alter Ego Trust:
- The trust must be established after 1999.
- The Settlor must be at least 65 years old when the Alter Ego Trust is created.
- The Settlor must be entitled to receive all income generated by the Alter Ego Trust during their lifetime.
- Only the Settlor can access the Alter Ego Trust assets during their lifetime.
- Both the Settlor and the Alter Ego Trust must be residents of Canada.
- The Alter Ego Trust must be deemed to dispose its assets upon the death of the Settlor (i.e., the Alter Ego Trust cannot opt out of section 104(4) of the Income Tax Act).
Donation Tax Credit
To qualify for a donation tax credit, the trustee must have discretion to decide the amount of the donation from the assets of the Alter Ego Trust. This is in contrast to a specific amount being predetermined for the donation. This discretionary choice satisfies the “donative intent” requirement to ensure donations are made voluntarily—a prerequisite for qualifying for a donation tax credit.
Advisors would be wise to suggest carefully planning the structure and timing of donations. Care in this regard can enhance tax benefits and reduce the overall tax burden on the estate. For example, the donation tax credit is based on the fair market value of the gift at the time it is made. Donors can typically claim a credit for up to 75% of the Settlor’s net income for the donation year. However, the credit claimed can increase up to 100% of the Settlor’s net income for the Settlor’s terminal tax return. The credit can be claimed in the year of death or the previous year and can help reduce estate tax—including capital gains taxes flowing from the deemed disposition of assets at the time of the Settlor’s death.
Advisors should also ensure that the donation tax credit is claimed by the proper party responsible for taxes at the time of death—recall that the Settlor and the Alter Ego Trust are distinct taxpayers. For example, if a donation is made through a will but most assets are held in the Alter Ego Trust, both the estate and the Alter Ego Trust may experience deemed dispositions. This could limit the donation credit’s ability to offset capital gains in the Alter Ego Trust.
Discretion for Charitable Giving
The goal of helping fulfil the Settlor’s charitable intentions while allowing for changing circumstances or preferences is supported by giving the trustee discretion to make choices in order to qualify for donation tax credits. This discretion extends to choose not only the amounts to donate, but also which charities to support. But what is the limit of that discretion such that the Settlor’s intentions are honoured?
It is important for advisors to ensure that Settlors clearly outline their charitable goals in the Alter Ego Trust document. Specifically, the Alter Ego Trust should also include guidelines that reflect the Settlor’s intentions, while also allowing the trustee to make amendments. This clarity ensures that the trustee acts according to the Settlor’s intentions—balancing specific goals while providing flexibility. This clarity and flexibility combination ensure the Settlor’s wishes are honoured, even if circumstances change. Overall, a clear outline will ultimately help the trustee to make guided choices about the Settlor’s charitable giving.
Ambiguities or vague language may delay the trustee’s decision-making or potentially lead to misunderstanding about the Settlor’s charitable intentions.
Tax Considerations for Charitable Contributions (and the Critical Timeline for Completing Charitable Gifts)
Alter Ego Trusts follow the calendar year, ending on December 31st, with income tax returns due 90 days later. However, when the Settlor dies, the Alter Ego Trust’s tax year ends. Crucially, if the Alter Ego Trust has any capital gains at that time, charitable donations made within 90 days can earn tax credits. These credits can help to reduce the taxes owing on those gains. Trustees should focus on making donations during this important period to maximize tax benefits and support the Settlor’s charitable intentions without added financial burden. Receipts for charitable donations are provided only after the donation has been finalized.
Advisors who advocate for and carefully draft critical documents can ensure that the Alter Ego Trust’s charitable goals are clear and can be executed effectively and promptly. A poorly drafted Alter Ego Trust deed that does not clearly define charitable gifts can prevent these donations from being made within this narrow window resulting in a loss of opportunity to benefit from tax advantages.
Avoiding Probate
Alter Ego Trusts provide an effective way for individuals to avoid probate. Doing so can enable faster distribution of charitable gifts and increase the privacy associated with those gifts. This is beneficial for clients with complex charitable goals, as it ensures that charitable gifts reflect the Settlor’s intentions, without the delay and public record associated with probate. Avoiding probate can also allow for charities to receive gifts faster, ensuring that funds can be used without the lengthy process of obtaining the probate certificate. Advisors would be well advised to evaluate whether avoiding probate is right for their Settlor.
Conclusion
An Alter Ego Trust is an effective estate planning tool for Canadian residents aged 65 and above who seek to maintain control over their assets, while also availing themselves of powerful charitable giving tools. Through careful planning, clearly outlining charitable goals, and making timely charitable gifts, benefits for the Alter Ego Trust and the charities can be maximized. Well-informed advisors can be critical partners in achieving these goals.
About the Author
Melissa is an associate lawyer at Kimel Law Group practicing in estate, trust, and capacity litigation. She is a lead member of the teaching team for the Lawyer as Negotiator course at Osgoode Hall Law School. Melissa received her juris doctor from Osgoode Hall Law School with a specialization in litigation, dispute resolution, and the administration of justice. She also holds a master of arts from York University, and an honours specialization bachelor of arts from Western University.