Part Three – Family Trust Structure

Protecting Corporate Assets

In this three-part series, Lott and Company outlines initiatives that you can proactively take now to protect and safeguard against future threats to corporate assets and retained earnings of your company.  

If you have not yet reviewed part one where we covered the advantages and limitations of using shareholder loan structure, we encourage you to read it here.

As noted in part two of this series, the holding company structure works very well to protect assets from creditors and defers the payment of personal tax until funds are withdrawn from the corporation.  However, if the plans are to sell the shares of the operating company in the future and utilize the Lifetime Capital Gains Exemption (LCGE), a holding company structure may not be your best option.

The LCGE can only be claimed by an individual.  If the holding company sells the shares of the operating company, the LCGE cannot be used and any capital gain will be taxable in the holding company.  Alternatively, the holding company shares could be sold in an attempt to use the LCGE.  However, if the holding company holds investments and other non-business assets, then its shares may not be eligible for the LCGE either.  The buyer will not be interested in buying non-business assets and will likely refuse to buy the holding company shares.  If retirement assets are being accumulated in the holding company, you would not want to sell the holding company shares, in any event.

The solution to this problem is a family trust.  Family trust structures work very well to deal with this issue and also provide the opportunity to expand the use of the LCGE to other members of the family.  This can be a significant tax saving for a business that grows substantially in value.

In the family trust structure, it is the family trust that will own the common (growth) shares of the operating company.  This allows for dividends to be paid from the operating company to the family trust to protect retained earnings from creditors and to move excess cash out of the company.

Family trusts are taxed at the highest marginal tax rate, therefore any income that the trust receives during the year will normally be allocated to its beneficiaries.  In this structure, the beneficiaries are determined when the trust is created and normally include family members and at least one corporation, the family investment company.

All of the dividends that are not needed for personal purposes will be allocated by the family trust to the family investment company.  When the family trust and the investment company are properly structured, these dividends will flow through to the investment company with no additional tax, just as in the holding company structure described in part two of this series.

The benefit of this structure comes into play when the shares of the operating company are sold.  In this case, the capital gain is realized by the family trust.  If the shares of the operating company qualify for the LCGE, the capital gain can be allocated by the trust to various family members with each of them using their individual exemption limits.  In 2021, the LCGE limit is $892,218.  This allows for a large amount of the capital gain to be sheltered from tax if there are several family members that the gain can be allocated to.

Setting up a family trust structure is more complicated than setting up a holding company structure and will require legal and accounting assistance.  The annual costs of maintaining the structure are a little more than for the other structures, but the potential benefits can be significant if there is the potential to sell the shares of the operating company for a substantial gain.

The introduction of a family trust provides additional benefits including flexibility in dealing with family members, succession planning and estate planning.

Lott & Company has extensive experience in working with clients to review their company’s current and future situation and assess unique needs and goals in protecting corporate assets. There are costs and benefits associated with each of these structures that we consider when working with you to determine the optimal structure to meet your needs.  Please contact us for more information.