ALTER EGO AND JOINT PARTNER TRUSTS SOLVE PROBATE AND OTHER PLANNING PROBLEMS
Much time and effort in recent years has been devoted to avoiding the need for probate. Probate is a court process whereby the Court verifies that a person has died and confirms the Will. This covers the banks and others, and releases them from any concern about the identity of the proper beneficiaries. Without a certificate from the Court, a bank, for example, could be at risk of having to pay more than once – as long as they pay in accordance with a Will that has been probated, they are in the clear. For the privilege of covering the backside of the banks, the Ontario Courts will charge 1.5% of the value of the estate in excess of $50,000. The Province recently eliminated probate fees for any amount under $50,000. These charges are now called the Ontario Estate Administration Tax (OEAT). The following will give you an idea of the cost of probate:
Certain types of property do not need probate. Insurance policies and insurance based financial products do not need to be probated. In addition, property held in joint ownership does not need probate – it simply passes to the surviving joint owner. Many people transfer property into joint ownership with their children to avoid probate. From a tax point of view, a transfer to a child triggers a deemed disposition of the interest in the property and fair market value, and taxes are payable. From a liability point of view, the interest in the property would be subject to claims by a child’s creditors. Aside from the fact that this can yield significant tax and liability issues which far outweigh the cost of probate, such a transfer is likely not effective to avoid probate.
The Supreme Court of Canada, in the 2007 case of Pecore, dealt with the issue of transferring property into joint ownership. The Court held that there is a presumption that a transfer to joint ownership with a spouse is a true transfer to joint ownership but a transfer to joint ownership with an adult child is not. The presumption, although it can be rebutted with clear evidence, is that the transfer to joint ownership to an adult child simply results in the child holding the property in trust for the parent and would, therefore, not be effective to avoid probate.
Based on the Supreme Court decision in Pecore, it is clear that simply transferring assets into joint names with one’s children is not sufficient to actually transfer those assets, and the value of those assets would still be subject to probate. It is also clear that a transfer of an asset to a “bare trust” will not help to avoid probate.
In Ontario, in 1998, the Granovsky case held that one could have multiple Wills. Under the terms of one Will one could include all assets which require probate, such as portfolio investments, bank accounts, real estate and the like. Under the terms of a separate Will one could include assets in respect of which probate is not necessary, most notably, shares of private companies and personal effects, including artwork and jewellery. Presumably your family does not need protection of the Ontario Court’s blessing to transfer your assets as would a bank or other third party.
In December, 1999, the Department of Finance introduced legislation which opened up a number of planning opportunities, primarily the avoidance of probate. The legislation introduced two new forms of inter vivos trust – the alter ego trust and the joint partner trust. Where the trust is for the exclusive benefit of the taxpayer, both for distribution of income and capital, it is referred to as an alter ego trust. Where it is for the benefit of the taxpayer and his or her spouse or common law partner, it is a joint partner trust.
For a discussion of Trust Basics see my memo.
In order to qualify, an alter ego trust or joint partner trust, as the case may be, must have been created after 1999, by a taxpayer who is at least 65 years old.
Either form of trust will allow an individual to transfer property into the trust without a deemed disposition for income tax purposes. The property will be registered in the name of the trust. Since it is not in the individual’s name, there is no need for probate in order to transfer the property after death. Although a “bare trust” looks like it would meet the same condition, not being in the individual’s name, it has been clearly decided over the years that it does not.
During the life of the individual, in the case of an alter ego trust, only the individual can receive income or capital from the trust. Upon the individual’s death, the trust is deemed to dispose of the property and taxes are exigible. The trust will set out how the property is to be divided, in the same fashion as a Will, but without the need for probate and without the document becoming public. In a joint partner trust, only the individual and his or her partner can receive income or capital during their lifetimes. The deemed disposition does not take place until the second death. This mirrors the tax consequences in respect of property held directly by an individual or an individual and his or her spouse. The joint partner and alter ego trusts are really just designed to avoid the need for probate.
These forms of trust allow for some other planning opportunities, particularly when dealing with private company shares. When dealing with arm’s length shareholders, the most common planning has been to provide for insurance on the lives of the shareholders and to have the company redeem the shares of the deceased shareholder, electing to have the deemed disposition arising on the redemption to come out of the capital dividend account, and thus received by the estate on a tax-free basis. In the good old days, the capital loss triggered on the disposition would offset the capital gain on the terminal return. The stop loss rules were enacted a number of years ago to restrict the ability to carry back the capital loss and the overall tax bite could be greatly increased. Although the specifics are beyond the scope of this discussion, if the shares are transferred to an alter ego or joint partner trust, the stop loss rules can be avoided.
One problem with private companies has always been the potential involvement of a surviving spouse in the ongoing business. Although, from a tax point of view it may make sense not to immediately purchase or redeem all of the shares of a deceased shareholder, from a business point of view the surviving spouse can be a problem. The use of a joint partner trust may solve that problem. If relationships are good, the inclusion of the surviving business partner as one of the trustees (or even the sole trustee) of the joint spousal trust, will allow the business to proceed unimpeded while still maximizing the tax position of the estate and the surviving spouse. From a cost point of view, the cost of insurance on the joint lives of the spouses will be considerably lower than the cost of insurance on just one of them.
In the past, the major drawback to the use of the joint partner or alter ego trust has been that it is treated as an inter vivos trust, rather than a testamentary trust. A testamentary trust pays tax at graduated tax rates, whereas an inter vivos trust pays tax at the top personal rates. With the change in the trust rules to limit a testamentary trust’s ability to use the graduated tax rates to three years after death, this problem is not as significant.
A properly drafted alter ego trust or joint partner trust can provide many tax and business advantages, in addition to the avoidance of probate fees. But for a large estate, the avoidance of probate fees is significant.
- Charles M. Rotenberg