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Preferred Beneficiary: Tax planning for Business Owners with Disabled and Infirm Family Members

Hands reaching to each other representing a person making arrangments to care for a disabled family member

By Roman Belenky, CPA, CGA

Financial pressures are among the most difficult challenges that families face when caring for disabled and infirm family members, especially children. Therapies, schooling, medical, and equipment costs can easily amount to $40,000 annually.

As they grow older and begin to plan for their own retirement, parents are faced with the additional burden of caring for adult family members with disabilities, including paying for group home and private caregivers, a formidable task by any standards and all the more so for an aging caregiver. Many existing publicly funded supports and programs are either insufficient or difficult to access.

Any family facing these struggles unfortunately knows this reality all too well.

In this article, we will explore the topic of income splitting with disabled and infirm family members as a way to:

  1. Reduce current taxes;
  2. Pay for current expenses; and
  3. Provide for future support.

Why a Trust?

A Trust provides the separation of control and ownership of assets. This is especially important for disabled or infirm individuals, where their direct ownership of assets is not desirable.

Trustees (usually the parents or grandparents) manage the property and make all the financial decisions in relation to the trust property, while their children will retain a beneficial ownership interest and benefit from the increase in the value of the property.

When, or if ever, direct ownership by the beneficiaries is desired in the future, the Trustees can “roll-out” the property on a tax-deferred basis to any of the beneficiaries.

Reducing the Tax Burden: Preferred Beneficiary Election

The preferred beneficiary election is an exception to two significant tax rules:

First, the election allows the Trust to allocate income to the “preferred beneficiary”, i.e. the disabled or infirm child, whereupon the trust can take a deduction and the amount is included in the income of the preferred beneficiary. This has the advantage of keeping the money in the trust to pay expenses while taking advantage of preferred beneficiaries’ lower tax rates.

Second, the preferred beneficiary election is an exception to the “Tax on Split Income” (“TOSI”) regime. Normally, income caught under TOSI is automatically taxed at the highest marginal tax rates unless certain exclusions are met. The Election allows splitting income with preferred beneficiaries without the need to meet any other exclusion.

Types of income that may be allocated to beneficiaries without attracting TOSI, include, but are not limited to, income from shares of a private corporation, rental income, and capital gains on the disposition of these properties.

As a result, significant tax savings could be achieved if the disabled beneficiary’s income is significantly lower than that of the family member currently paying for expenses.

Maximum Tax Savings

To illustrate the maximum tax savings, a person earning income at the highest marginal tax rate in Ontario (54%) will have earned $86,000 of pre-tax income to pay for $40,000 of expenses for their disabled family member. A preferred beneficiary of a Trust will need only $47,000 to pay for the same $40,000 of expenses.

However, where individuals are in middle-income tax brackets, tax savings are reduced significantly.

Who is a Preferred Beneficiary?

Both the Trust and Disabled or infirm individual must meet the following criteria:

  • The beneficiary is an individual resident in Canada who is a beneficiary of a trust;
  • Who has either:
    1. a severe and prolonged impairment in physical or mental functions that qualifies for the disability amount, or,
    2. if at least age 18, is dependent on another individual because of mental or physical infirmity and whose income does not exceed an amount referenced to the basic personal tax credit for single status; and
  • The preferred beneficiary must be: (1) the settlor of the trust; (2) the spouse/common-law partner or former spouse/common-law partner of the settlor; or (3) a child, grandchild, great-grandchild of the settlor or a spouse/common-law partner of such persons.

It is therefore critical that the trust be settled with the appropriate individual, and to monitor income levels of an infirm dependant who does not qualify for the disability tax credit.

Getting the Right Trust – Government and Other Support Programs

A “Henson Trust” is a type of Discretionary Trust that gives the trustee absolute and sole discretion with respect to payments from the trust to the beneficiary. The trustee is further under no obligation to pay or make the funds available for the beneficiary.

The advantage of this trust is that trust assets are generally excluded for the purposes of receiving the Ontario Disability Support Program (ODSP), however, there are income and spending restrictions. (Legal advice should be obtained in connection to any provisions of the ODSP Act).

Families of individuals receiving ODSP and other income or asset-based programs must weigh the cost of potentially losing support and subsidy compared to any tax savings and non-financial considerations of holding income-producing assets in a Trust.

For families not dependent on support programs, tax savings and flexibility of holding assets in Trust will be the key drivers.

Tax Tips and Traps

Discretionary Trusts with preferred beneficiaries are subject to the same rule as all other inter-vivos Trusts, including reversionary, attribution, and the 21-year deemed disposition rule. To that end, the Trust must be properly set up and capitalized, Trust tax returns filed, and annual legal compliance maintained.

In addition, the preferred beneficiary election must be filed annually and on time. CRA will accept late elections under some circumstances.

Finally, dividends allocated to the preferred beneficiary from a private corporation are still subject to TOSI, however, the CRA has confirmed that those dividends may be designated as “other trust income” when allocated to preferred beneficiaries and be exempt from TOSI. CRA has provided compliance guidance on this matter.

Other Considerations and Planning:

Registered Disability Savings Plan (RDSP)

RDSPs are an excellent savings vehicle for disabled individuals. Government grants and bonds supplement contributions to the plan, and income earned in the plan is taxable only when taken out.

However, RDSPs are prohibited from holding shares in closely held private corporations as well as other property.  Business owners should consider to what extent RDSP is sufficient to support the living expenses of their disabled family members.

Consider first making sufficient contributions to maximize the annual government grant and bond, and a Trust structure to hold the shares of private corporations and real property.

End of Life Planning

Families who plan to leave income-producing property or appreciable assets to their Estate should consider providing in their Will for a “Qualified Disability Trust” (QDT) in favour of their disabled family members upon their death.  These trusts benefit from lower “graduated” tax rates, and like any other trust provide for protection of the asset in favour of the disabled individual. Very specific criteria must be met to qualify for (QDT) status.

A Partial Checklist – 10 Considerations:

  • Does the business or property generate sufficient income, or future gains, to benefit from income splitting?
  • What property will the trust own? How will it own the property? What type of income will be generated?
  • How long will the trust own property?
  • Who will provide the initial capital to fund the Trust?
  • Who will be the trustees? Will there be other beneficiaries?
  • Does the individual have a disability tax credit?
  • How will assets held in trust and income allocated to beneficiaries affect disability supports and funding programs?
  • Are there non-financial reasons to keeps assets in Trust? Do they outweigh the potential loss of supports and subsidies?
  • Are annual contributions to the RDSP maximized?
  • Who and how will the disabled individual be supported in the future?

Final Thoughts

Trusts will not benefit everyone. Every business is different, each disabled or infirm individual is different, and every family has different circumstances and goals.

Holding shares of your business or rental property in a Trust is not a simple consideration, but one that may provide very significant tax savings and asset protections under the right circumstances. Depending on the age and stage of both a business and the primary caregivers, non-tax considerations may warrant considering a trust even if tax savings are not immediately achieved.

Tax law and compliance for trusts are extremely complex. Speak to an experienced tax and estate practitioner before setting up any trust structure.

Roman Belenky CPA, CGA, is a Tax Specialist at Sloan Partners LLP specializing in tax planning and advisory for business owners and their families. You can reach Roman at roman@sloangroup.ca

At Sloan Partners LLP, we are experts at corporate reorganization and tax advisory. We work directly with business owners as well as small and medium accounting Firms to implement tax planning strategies and achieve the most favourable tax results for small business owners and their families. If you would like to discuss how you can make a tax plan that will better benefit your family and/or business, contact us to schedule a consultation. Please reach out to us online, or by phone at 416-665-7735.

Disclaimer: This article is intended for educational and informational purposes only. It is not intended in any way whatsoever to provide tax advice. The reader should be aware that legislation and administrative policy are subject to change at any time. None of the persons involved in the preparation of this article accepts any responsibility for its contents or the consequences that arise from its use.

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