An alter ego trust can be an effective estate planning tool for Canadians aged 65 and older. During the settlor’s lifetime, the settlor is entitled to all of the trust’s income and is the only person who can receive or use its capital.
But what happens to the trust when the settlor dies?
Unlike assets owned personally by the deceased, assets properly held in an alter ego trust do not simply become part of the deceased’s estate. Instead, the settlor’s death triggers important tax and administrative consequences for the trust, and the trustees must deal with the trust property according to the terms of the trust document.
Does an Alter Ego Trust End When the Settlor Dies?
Not necessarily.
The death of the settlor is an important turning point for an alter ego trust, but the trust does not automatically disappear on the date of death.
What happens next depends largely on the terms of the trust document. Typically, the trust directs the trustees to distribute the remaining trust property to particular beneficiaries after dealing with taxes and other obligations. In other cases, some or all of the property may continue to be held in trust for one or more beneficiaries.
The trustees therefore need to review the trust document carefully and follow its instructions after the settlor’s death.
Who Receives the Trust Property After the Settlor Dies?
The trust document determines who is entitled to receive the property remaining in the alter ego trust.
When the trust is created, the settlor can specify who should ultimately benefit from the trust property after their death. Depending on the terms of the trust, these beneficiaries might include family members, other individuals, charities or a combination of beneficiaries.
The trustees must follow the terms of the trust rather than simply distributing trust property according to the settlor’s Will.
What Happens to the Assets in the Trust?
One of the important differences between an alter ego trust and a Will is that assets properly transferred into the trust are held by the trustees in the trust rather than owned personally by the settlor.
As a result, those assets are generally administered by the trustees rather than by the executor under the settlor’s Will.
The trustees continue to have authority over the trust property and are responsible for administering it according to the trust document. Depending on the assets involved, this may include obtaining valuations, dealing with financial institutions, maintaining or selling property, paying liabilities and eventually transferring or distributing property to the beneficiaries.
Is There Tax When the Settlor of an Alter Ego Trust Dies?
Potentially, and this is one of the most important consequences of the settlor’s death.
For Canadian income tax purposes, the settlor’s death generally triggers a deemed disposition of the trust’s capital property at fair market value, even if nothing is actually sold.
Depending on the assets held by the trust and how much they have increased in value, this often results in lots of tax payable by the trust at that time as the trust is taxed at high rates after death. That tax is generally paid from trust property, which can reduce what is ultimately available for the beneficiaries.
The amount of tax will depend on the trust’s particular assets and circumstances, including whether any available exemptions, deductions or designations apply.
Because the tax consequences can be significant and will vary from one trust to another, trustees should work with an accountant or tax professional before dealing with or distributing the trust property.
Does the Alter Ego Trust Have to File a Tax Return After the Settlor Dies?
The settlor’s death also creates important tax filing obligations for the trust.
Generally, the death of the settlor results in a deemed taxation year-end for the alter ego trust on the date of death. The trust may need to file a T3 Trust Income Tax and Information Return and report income and gains arising from the deemed disposition.
If the trust continues after the settlor’s death, a new taxation year begins and additional returns and trust reporting obligations may apply.
The exact filing requirements will depend on the circumstances, so the trustees should work with the trust’s accountant or tax professional to make sure the required returns are completed.
Do Assets in an Alter Ego Trust Go Through Probate in BC?
One of the reasons alter ego trusts are a great part of an estate plan in British Columbia is that assets properly held in the trust generally do not form part of the settlor’s estate for probate purposes.
Because the assets are held by the trustees rather than owned personally by the settlor, the trustees generally do not need a grant of probate simply to establish their authority over the trust property after the settlor dies. Those assets are also generally not included in the value of the deceased’s estate when calculating BC probate fees.
However, an alter ego trust does not necessarily eliminate the need for probate. If the settlor still owns assets personally when they die, those assets may pass through their estate and probate may still be required. Whether probate is necessary will depend on the assets owned personally by the deceased and the requirements of the organizations holding them.
Sometimes the person establishing the trust holds their real estate in a bare trust for their alter ego trust. This is done for a variety of reasons. Because of Land Title Office rules, real estate held in bare trust typically needs probate to be transferred.
This is why an alter ego trust should be considered as one part of a broader estate plan rather than a replacement for a Will.
What If the Alter Ego Trust Continues After Death?
An alter ego trust does not necessarily need to be wound up immediately after the settlor dies.
The trust document may provide for assets to continue to be held for beneficiaries after the settlor’s death. If so, the trustees must continue administering those assets in accordance with the terms of the trust.
The trustees may be responsible for managing investments or other property, maintaining records, making permitted distributions and complying with the trust’s ongoing legal and reporting obligations.
The terms of the trust document are therefore particularly important. They determine not only who will ultimately receive the trust property, but also whether the trust property should be distributed after the settlor’s death or continue to be managed for beneficiaries.
Why Should Trustees Be Careful About Distributing the Trust Too Quickly?
Trustees should generally avoid distributing all of the trust property immediately after the settlor dies.
Before making a final distribution, they may need to determine the trust’s tax liability, file required tax returns, pay outstanding expenses and ensure that sufficient funds are retained to deal with any remaining obligations.
Trustees may also consider obtaining a clearance certificate from the Canada Revenue Agency before making a final distribution. A clearance certificate confirms that relevant amounts owing to the CRA have been paid or secured and can protect a trustee from personal liability for unpaid amounts covered by the certificate.
Distributing the trust property before dealing with outstanding tax liabilities can expose a trustee to personal liability. This is one reason trustees should coordinate with the trust’s accountant or tax professional before making final distributions.
How Does an Alter Ego Trust Work With the Settlor’s Will?
An alter ego trust and a Will perform different roles, but they should form part of one coordinated estate plan.
The Will generally governs assets owned personally by the settlor at death, while the trust document governs assets held in the alter ego trust.
Problems can arise if ownership of an asset is unclear, an intended asset was never transferred to the trust, beneficiary arrangements have changed, or the Will and trust were prepared without considering how they would operate together.
For this reason, creating an alter ego trust does not eliminate the need for a carefully prepared Will. The trust, Will and ownership of the settlor’s assets should be reviewed together so that each part of the estate plan accomplishes its intended purpose.
What Should Trustees Do After the Settlor Dies?
After the settlor’s death, the trustees will generally need to meet with a trust lawyer review the trust document. Next the trustees identify and secure the trust property, obtain any necessary valuations, determine the trust’s liabilities and work with the appropriate professionals to address tax and reporting obligations.
Once those matters have been addressed, the trustees can determine whether the trust should continue or whether some or all of the remaining property can be distributed to the beneficiaries in accordance with the trust document.
The exact process will depend on the terms of the trust and the nature of the assets it holds.
Need Advice About an Alter Ego Trust in BC?
At Westcoast Wills & Estates, our trust lawyers assist clients across North Vancouver, Vancouver, Burnaby, Surrey, Richmond and surrounding communities with alter ego trusts and other estate planning strategies in British Columbia.
We can also assist trustees with understanding the terms of an alter ego trust and the steps required after the settlor dies. Where specialized tax advice is required, clients may also need to work with their accountant or tax adviser.
To get started or to learn more, contact our office to book a consultation today.
Disclaimer: The information in this blog is for general informational purposes only and should not be relied upon as legal or tax advice. Please review our Privacy Policy.
