Trust loans
Have you heard of a Trust Loan?
It's a tax planning maneuver with two components:
An inter vivos family trust.
A prescribed rate loan to the trust.
What is an inter vivos family trust?
A trust is a legal relationship where one person (the trustee) holds property in trust for another person (the beneficiary).
An inter vivos trust that is created during the lifetime of the settlor or trustee. Specifically, an inter vivos family trust is one that can allow for income splitting strategies but the trust must be structured in a way that avoids "attribution rules."
#ProTip: Be sure to consult with a lawyer or notary before deciding on this strategy.
What is a prescribed rate loan?
One way to avoid attribution rules when loaning money to another family member is by charging interest at the prescribed rate or higher.
Every quarter, the Canada Revenue Agency decides on the prescribed rate. When drafting loan terms, you can choose to lock-in the prescribed rate for a predetermined period of time. If you need to subsequently adopt a more favorable interest rate, you will have to call the loan and make a new one.
What makes a trust loan tax efficient for a business owner?
As an incorporated business owner, you probably have accumulated assets in your corporation. If you were to transfer assets out of the corporation to yourself or a family member, this would be considered taxable income.
By loaning money from the corporation to the trust and charging interest at the prescribed rate, you can avoid having to pay income taxes!
Are trust loans the right strategy for you?
There are certainly some PROs and CONs to this strategy.
Here are a few to consider:
Income distributions will be taxed in the hands of children but the distributions should be made to cover reasonable expenses, like sports, private school, etc. (not living expenses).
Income that is NOT distributed must be loaned back to the trust. ⚠ When a minor beneficiary turns 18 they CAN call back the loaned money from the trust ⚠
Any capital gains will be taxed in the hands of the children. These can be triggered along the way to benefit from the marginal tax rates of minor children.
Paying the loan can be a cumbersome, particularly if the asset has lost value.
Any capital losses incurred cannot be flowed out to the beneficiaries.
