Happy Friday, everyone. As a reminder, this is Part II of a three-part blog series. Part I can be found at the following link: Equalizing an Estate Where One of More Children are U.S. Persons and Planning Strategies Where There Are U.S. Beneficiaries; Part I – All About Estates and Part III, to be posted August 30, 2024, will discuss estate planning in circumstances wherein there are U.S. beneficiaries. As background, provided in Part I, we are considering circumstances where clients, who are Canadian residents, intend to equalize their estates amongst their children (“Equalization Intention”) where one or more of such children are “U.S. Persons” (a “U.S. Child”), estate planners need to consider whether that is possible and if so, how (“whether” and “how”, the “Questions”).  Note that it is not legal advice and to answer the Questions in practice, one must obtain U.S. tax advice.

The answer to the Questions is dependant on the set of facts, including on Client’s assets and the tax and estate planning strategies being implemented during lifetime or post-mortem. I would review Client’s assets as a first step. For example, what are Client’s assets, where and how are they held, and what is the liquidity profile? Part I of this blog series discussed one asset category that may be considered as part of an analysis in answering the Questions, being corporate assets. This Part II discusses assets held in discretionary family trusts.

Trust Assets

What if Client’s family’s wealth primarily is held in discretionary family trusts and Client considers assets held in such trusts essentially their personal assets, available to be considered as part of Client’s estate planning to achieve the Equalization Intention?

Note that it may be undesirable to treat such trusts as an extension of Client’s assets, as funds held in such trusts are not Client’s assets and there are risks associated with treating a discretionary family trust like a Will, which it is not. Further reasoning is beyond the scope of this blog, however, I will move forward in discussing a circumstance where as part of the plan to achieve the Equalization Intention, assets held in family trusts are being considered as available for equalization purposes.

Assume Client’s children form part of the class of discretionary beneficiaries of the trusts. In considering the Questions, my preliminary review may include considering:

• Whether there are restrictions on dispositions in the terms of the Trust Deed such that you cannot distribute to a non-resident of Canada?
  • If ‘yes’, what other assets are available to the Client and their family to equalize the U.S. Child? Are those assets sufficient for the equalization? This raises a risk of inequality.
  • If ‘no’, is it even desirable to make distributions to the U.S. Child? For example, if the assets comprising the trust fund have unrealized capital gains, in distributing same to the U.S. Child, you may not get the rollover out of the trust that you could obtain through a distribution to a Canadian resident beneficiary, thereby triggering potentially significant income tax consequences. The Trustees of the relevant trust(s) would have to consider whether triggering that gain, one cost of which being the time value of money, is worth it to meet the Equalization Intention. Also, with this option, is it fair to Client’s other children that because of U.S. Child’s life choices there may be an immediate financial consequence to the overall family wealth?
• Another consideration is whether there are any other implications of distributing the assets held in such a trust to the U.S. Child. What if the only asset in the trust are shares in a Canadian Controlled Private Corporation? What are the U.S. and Canadian legal, tax and reporting consequences that would result? What financial impact would occur? Some points to consider here were discussed in the first part of this blog series.

The issues raised in this two-part blog series are examples of those to consider in whether and how the Equalization Intention can be achieved, within the context of the first step of review, being of Client’s assets. As mentioned in Part I, they also raise a host of other tax and estate planning considerations. Only by way of example, in addition to asset considerations, if assets are distributed outright to U.S. Child, would they be subject to U.S. Estate tax exposure? Does Client consider this as impacting the Equalization Intention, or would the Equalization Intention be achieved if the initial asset division amongst their children is equal, or as equal as possible?

Takeaway

Ultimately, to assist in achieving the Equalization Intention, to mitigate risks posed by hurdles, some of which were discussed above, I may suggest performing a stress test/fire drill. Imagine Client gets hit by the proverbial bus tomorrow and run through the estate plan. Step-by-step, what would the Client’s executors do, including with each asset. Is equalization possible? Should actions be taken now, during Client’s lifetime (such as a potential reorganization), to establish a structure to better assist in meeting the Equalization Intention upon death?