Monday, March 4, 2002

Joint Spousal and Alter Ego Trusts

An individual who is 65 or older may use a special form of living trust as an alternative to a will.

The special form of trust is the alter ego trust and the joint spousal trust. Both trusts are very useful for persons who want to avoid probate.

Why are these Trusts Special?

Normally, a transfer of assets to a trust triggers tax on any increase in the value of the assets since the date of original acquisition. However, a transfer of assets to an alter ego trust or a joint spousal trust will not trigger that tax. From an income tax perspective, it will be as if the transfer never occurred. For estate planning purposes, however, the trust will now be the owner of the property. This means that the property can pass to children without having to go through probate.

To illustrate, assume that John owns some assets that have increased in value.

John will be able to gift the assets to an alter ego trust without triggering any capital gains tax. In order for the trust to qualify as an alter ego trust, John must be the sole beneficiary during John's lifetime. Prior to John's death, all income in the trust will be payable to John and John will pay all the tax on that income. As well, John can also access the capital in the trust. On John's death, the trust will hold any remaining assets for the benefit of other beneficiaries named in the trust deed (most likely, the children of John). The trust will be able to distribute those assets to those other beneficiaries without the assets having to go through the probate process.

John could also choose to gift the assets to a joint spousal trust. In a joint spousal trust, the initial beneficiaries must be John and his wife during their respective lifetimes. On the death of the surviving spouse, the trust would start to hold the trust assets for other persons named by John in the trust deed (most likely, John's children). In particular, John's spouse would not be able to change the identity of these ultimate beneficiaries.


The principal advantage of the alter ego and joint spousal trusts is the avoidance of probate. Many clients wish to avoid probate in order to avoid paying the 1.4% probate tax, which is levied on the gross value of assets passing under a will. Other reasons for avoiding probate are as follows.

Under the Wills Variation Act, any child of the deceased can ask the court to rewrite the will if the child is not satisfied with its provisions. The courts then determine whether the deceased fulfilled his or her moral obligation to the child (independent of the need of the child). Litigation has been increasing in this area. Assets held in a living trust (a trust established prior to death) would not be subject to this legislation.

Probating a will is a public process. The probate application must list all the assets of the deceased and the total value of those assets. This list is available to any member of the public on payment of a nominal fee. If the assets are held in a living trust at the time of death, the assets would not be subject to this public disclosure requirement.

In order to avoid probate, many British Columbians have been placing the ownership of assets into joint tenancy with their children. This can have serious disadvantages, as discussed in a separate article, "Pitfalls of Joint Ownership". The alter ego and joint spousal trusts allow parents to avoid these disadvantages.

Control of the Trust Assets

The parents can act as trustees of a joint spousal trust and thereby retain control over their assets. If assets are held in a trust, it is more difficult for creditors and former spouses of the children to assert claims against the assets. And placing the assets in an alter ego or joint spousal trust does not trigger capital gains tax.

Income Taxes on Death

While the alter ego and joint spousal trusts can avoid probate, they do not avoid the taxation of accrued capital gains on death. A deemed disposition of assets for income tax purposes will occur at the same time as that deemed disposition would have occurred if no trust had been established. The alter ego trust is deemed to dispose of its assets on the death of the individual who established the trust, whereas a joint spousal trust is deemed to dispose of its assets on the death of the surviving spouse. This is the same result that would have applied if the assets had been held directly and not through a trust.

Normally, a trust is subject to a deemed disposition of its assets every 21 years. However, the alter ego and joint spousal trusts are exempt from this rule until the death of the initial beneficiary (in the case of an alter ego trust) or the surviving spouse (in the case of a joint spousal trust). Consequently, an alter ego trust and a joint spousal trust need not deal with deemed dispositions during the lifetime of the individual or the spouses (as the case may be). This is good tax policy, as it avoids an 86 year-old being faced with a huge tax bill because he forgot that his 86th birthday was also the 21st anniversary of his alter ego or joint spousal trust.

Use in Estate Freezes

The alter ego trust and the joint spousal trust will make it much easier to avoid probate and can offer additional flexibility to the standard estate freeze. In a typical estate freeze, the parent exchanges common shares for special shares with a fixed value equal to the value of the corporation. A trust for the children then subscribes for new common shares at a nominal value. The common shares held by the children's trust will receive all future growth in value, but the special shares held by the parent typically have a significant current value and a significant inherent capital gain. In order to avoid triggering the inherent capital gain, the parent usually retains personal ownership of the special shares, which can expose those shares to probate.

It will be possible for the parent to gift the special shares to a joint spousal trust without triggering immediate tax on the capital gain. All trust income would be available for use by the parent and the parent's spouse during their respective lifetimes. On the death of the survivor, the assets in the trust would be held for new beneficiaries named in the trust deed (presumably, the children), effectively bypassing probate.

A person may establish an alter ego or joint spousal trust only if the person is 65 years of age or older. While Canadians under the age of 65 can use another method to avoid recognizing capital gains on assets transferred to a trust, that topic must be the subject of another article.

-- Blair P. Dwyer

The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.