Recently, a few clients have asked the same question if an in-trust bank account can be used to save some taxes. My answer to them is maybe. I think it is worthwhile sharing the key points on this subject with you as well.
First of all, how an in-trust account is set up?
An in-trust account is so easy to set up. Clients go to his/her financial institutions and ask to set up the account in the name of a parent “in-trust”. The child is designated as the beneficiary. The account is sometimes also called an informal trust. In Ontario, the child will not get the money until they turn 18.
So, what are the tax implications?
When the beneficiary takes money out of the in-trust account, they will not be taxed as the money that parents have put in is after-tax dollars. Then, how about the investment income generated by the in-trust account? Depends, the tax impact varies based on the nature of the investment income.
Scenario 1:
If capital gains are generated by in-trust accounts, this type of investment income will be taxed on the hands of the beneficiary, NOT on the hands of the parent who put in the money initially. In other words, capital gains generated by the account are not attributed back to parents.
Scenario 2:
If interest, dividends or royalties are generated by in-trust accounts, this type of investment income will be taxed on the hands of the parents who put in the money at the beginning.
As you can see, the income generated from the account is subject to the application of the attribution rules prescribed by the Income Tax Act. If significant capital growth is expected to be generated from the account, income splitting will save more taxes as compared to assets in parents’ names.
Another point that needs some attention is when parents transfer an investment asset (instead of depositing cash) in their names to an in-trust account, the transfer is considered a “deemed disposition” of the investment asset and may result in paying taxes on capital gain triggered by the “deemed disposition”.
On the other hand, CRA may take a different view on this informal trust. That means the in-trust account may not be considered a valid trust and parents will run the risk of paying all the taxes on the income generated by the account. Scary!
What is the legal implication?
We always like to hear our lawyer’s opinion as the legal impact cannot be ignored, either. While having great tax planning opportunities, parents must give up beneficial ownership of the trust property as once the in-trust accounts are established, the assets belong to the beneficiary and may be used only for the beneficiary.
Conclusion
The setup of an in-trust account may be straight-forward but the impact cannot be underestimated. As always, do your homework and talk to your advisors, accountants and lawyers before making any decisions.
If you have any accounting/tax questions, drop us a line or give us a call. We are happy to help!
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