Aug 13, 2018

Creating a Trust Sandwich

Sandwiches are a great invention. You can hold them in one hand, there’s no end of ingredients you can use and when it comes to your business, a trust sandwich is a great way to protect your assets.

Food jokes aside, a trust sandwich is when you use different financial strategies for estate planning and the protection your assets. This includes trusts and wills, which I talked about in previous videos.

I’ll take you through what ingredients make up a trust sandwich (sorry, food puns are hard to resist) and what options are out there that you can use.

Professional Incorporation: Should I set up a trust?

Trusts are one of the most misunderstood vehicles in financial planning. Far from being a tool reserved only for aristocrats and the super wealthy, a trust can be a very effective tool for reducing your tax bill today, and for your estate in the future.

Now that we’ve talked about incorporating your practice, and how to decide between taking a salary or dividend from your company, I’d like to talk about how a trust can help you manage your professional corporation more effectively. I’m Peter Guay and this is ‘Do It Together’ Financial Planning.

In my previous video, I talked about the benefits of adding family members as shareholders of your professional corporation. As a first option, that can already save you a bunch of tax. When you take the extra step of adding a trust into the mix, you get all those tax benefits, but with a lot more flexibility.

A trust is a distinct legal entity, created to hold and administer assets on behalf of a set of beneficiaries. In the case of professional corporation, a trust is typically created to hold the common shares of the company. Most often, the beneficiaries of the trust are you, your immediate family members (including your parents and even uncles and aunts if you want) and your company.

Before I go any further, it’s important to understand that this is a relatively complex structure, that requires a fair amount of money and time to set up and maintain. Expect an extra $5,000 to set one up and a few hundred to a few thousand dollars a year to file the tax returns for it (Yes, a trust has to file its own tax returns.) There is a value to simplicity, so if the benefit isn’t absolutely clear in your case, you can always wait to set up a trust later on.

Should the trust own the common shares?

That being said, having a trust own the common shares of your professional corporation makes the whole structure very flexible for a number of reasons:

  • Reason 1: The structure can be unwound at any time. When your spouse or children are shareholders of your professional corporation directly, it is more complicated to redeem their shares and collapse the company if have to. When a trust owns the shares, so long as you are also a beneficiary under the trust, the shares can be distributed right back to you and the whole thing gets dismantled as if you owned the shares from the start.
  • Reason 2: Less tax when you die. When the trust owns shares of the corporation, the growth of the corp in your lifetime can be passed on to your heirs (provided you’ve named them as beneficiaries of the trust), without triggering tax on your death. Don’t get me wrong, your heirs will have to pay tax eventually on the shares of your company, but it defers that tax until they need the money inside your corp.
  • Reason 3: You can split income with your family. Without having to make your family members direct owners of the shares of your corporation, so long as they are beneficiaries of the trust, you can allocate them dividends from your corporation, to be taxed at their lower tax rates. This is called ‘dividend sprinkling’. This is why you might want to include your parents or even aunts and uncles. If they’re in really low tax brackets and you might have to support them down the road, a trust is really tax efficient way of getting money into their hands. Now, don’t try this with kids under 18… If you do, CRA will turn around and tax those dividends at the top marginal rates, killing any benefit. This is what’s known as the ‘kiddie tax’.

 

So for these reasons, and several others, putting a trust in your corporate structure can help you save a lot of tax, but also keep your whole system very flexible. Again, this isn’t a simple set up, so if you don’t foresee taking advantage of the benefits I’ve just mentioned, it may cost more than it’s worth.

One more caveat: The federal government announced in their last budget that they were going to review professional corporations with the potential of reducing their tax effectiveness. We’ll have to wait until the fall budget update to find out what that means, so if you’re still considering putting this in place, you may want to wait until then to make sure it still makes sense.

Peter Guay
Peter Guay

Peter joined PWL Capital in 2004 and learned the firm’s client-first philosophy from the ground up. Eighteen years and many designations later, he is now a seasoned Portfolio Manager and Financial Planner working with families across the country.

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