Gifts and inheritances received during marriage by one spouse are excluded from being equalized upon separation so long as those interests have not been used or shared with a spouse.FG Trade/AFP/Getty Images
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The family trust is a central feature in many estate plans. It can offer its beneficiaries privacy, income splitting, and some creditor protection, among other benefits.
While many good reasons exist to use a family trust as part of a client’s estate plan, family law issues must be considered before a trust is settled.
There’s a common misconception that if a married individual is a trust beneficiary, the value of those assets is protected on the breakdown of that individual’s marriage. In Ontario, that’s only sometimes true.
When spouses separate in Ontario, they’re entitled to an “equalization” of their net family properties, according to the Family Law Act, which is essentially a division of the increase in their collective net worth throughout the marriage.
Timing is everything
Gifts and inheritances received during marriage by one spouse are excluded from being equalized upon separation so long as those interests have not been used or shared with a spouse.
An interest in a trust is considered a gift if that trust came into existence during the marriage. In simple terms, this means if a family trust was settled the day before a beneficiary’s marriage, the increase in value of the beneficiary’s interest in that trust is considered property to be valued on marriage breakdown and subject to the equalization calculation. However, if that same family trust was settled the day after the beneficiary’s marriage, the trust interest is treated as excluded property and not subject to the equalization calculation.
Determining the value of the trust interest
If it’s determined a separated spouse has an interest in a trust that existed at the date of marriage, that interest must be valued at both the date of marriage and the date of separation.
This is not a straightforward analysis and depends on various factors including the terms of the trust, the history of distributions to the beneficiary, the degree of control the beneficiary has over the trust and its trustees, and the number of other beneficiaries.
Lawyers who draft family trusts should consider the powers, if any, that are given to a beneficiary in a trust deed. If a beneficiary is a sole trustee, he or she certainly has the power to control distributions, which will likely result in a higher value attributed to that trust interest upon separation. If a beneficiary is one of two trustees, he or she effectively has veto power in all decisions and, therefore, may also have the power to control distributions. If a beneficiary is one of three trustees with a majority provision, that beneficiary likely cannot control the trust distributions unless the other two trustees are merely “figureheads.”
Imputing income
In a marriage breakdown, a separated spouse could owe spousal and child support to their former spouse. These amounts are calculated, in part, based on the support payor’s income.
It’s important to note that even if a trust interest is excluded for the purposes of an equalization payment, it may be looked upon to impute income to a support payor if the spouse has control over the trust. Furthermore, a pattern of distributions to that beneficiary is also a reason a court may impute income for the purposes of support payments.
Choosing trustees
Often, when a family trust is settled during a marriage, spouses appoint themselves as co-trustees. This structure works while spouses get along, but it can be problematic if the relationship sours.
Accordingly, it’s better planning to always have three trustees with a majority provision or to have a mechanism whereby one or both of the spouses are forced to resign in the face of a marriage breakdown.
Ultimately, if a family trust has been or will be settled by one spouse’s family, the best way to protect that interest is through a marriage contract, which can be done before marriage or during marriage.
At the very least, advisers should focus on family law principles when considering the features and timing of a family trust.
Jessica Feldman Chittley is partner at estate and family lawyers Bales Beall LLP in Toronto.
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