Tax planning for family trusts in Canada 2025: protect wealth and reduce taxes legally

A family trust is one of the most effective tax and estate planning tools available to Canadians. It allows families to legally reduce taxes, protect assets, and ensure wealth passes smoothly to future generations. Under sections 75, 104, and 107 of the Income Tax Act, properly structured trusts can hold shares, investments, and real estate while distributing income to beneficiaries in lower tax brackets. However, misuse or poor documentation can lead to reassessment, penalties, and double taxation. Mackisen’s CPA auditors and tax-law advisors specialize in designing, managing, and auditing family trusts that comply fully with CRA regulations and maximize tax efficiency.

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What is a family trust

A family trust is a legal arrangement in which a settlor transfers property to a trustee for the benefit of named beneficiaries, usually family members. The trustee controls the trust assets, but the income and capital gains are attributed to beneficiaries.

Under section 104(1) of the Income Tax Act, a trust is treated as an individual for tax purposes and must file its own T3 return. Income retained by the trust is taxed at the highest marginal rate, while income distributed to beneficiaries is taxed in their hands—often at lower rates.

Key sections:

• Section 75(2): Attribution rules on income and capital gains if the settlor or contributor retains control.

• Section 104(2): Trusts treated as individuals for tax purposes.

• Section 107(2): Tax-free rollover to beneficiaries upon distribution of trust property.

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Why create a family trust

1. Income splitting

By distributing income to lower-income family members, a trust can reduce total family tax. For example, a $100,000 investment return distributed equally among four adult beneficiaries could save over $15,000 annually in combined taxes.

2. Asset protection

Assets held in a trust are generally protected from creditors, lawsuits, or marital disputes, as the beneficiaries do not own them directly.

3. Estate planning and probate avoidance

When structured properly, trust assets bypass probate under provincial succession laws, saving fees and maintaining privacy.

4. Multiplying the capital gains exemption

If the trust owns shares of a qualified small business corporation, each beneficiary can claim their own $1 million Lifetime Capital Gains Exemption under section 110.6, multiplying tax-free gains during succession.

Case reference: In Garron Family Trust v. Canada (2012 SCC 14), the Supreme Court ruled that trusts must have real management and control in Canada to qualify as Canadian residents for tax purposes. This emphasizes the importance of appointing a Canadian trustee.

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How family trusts work

• The settlor establishes the trust by contributing nominal property.

• Trustees manage assets in the best interest of beneficiaries.

• The trust earns income or capital gains from investments, property, or business shares.

• Income is either retained (taxed at top rate) or distributed (taxed in beneficiaries’ hands).

• Distributions are reported on T3 slips and deducted from the trust’s income under section 104(6).

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Common mistakes and CRA red flags

• Retaining control of assets and triggering section 75(2) attribution rules.

• Failing to issue T3 slips to beneficiaries.

• Not recording trustee resolutions approving income distributions.

• Treating capital gains as income distributions without proper documentation.

• Allowing non-resident trustees or beneficiaries without tax planning, triggering section 94 rules on non-resident trusts.

Penalty alert: CRA imposes penalties under section 162(7) for failure to file trust returns and interest under section 161 for unpaid taxes. Misuse of trusts can also trigger GAAR under section 245.

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Advanced family trust planning techniques

1. Discretionary trusts

A discretionary trust allows trustees to decide which beneficiaries receive income or capital each year. This flexibility enables income splitting and long-term tax deferral.

2. Estate freeze

A trust can participate in an estate freeze under section 86, exchanging existing shares for fixed-value preferred shares while new common shares are issued to the trust. Future growth accrues to beneficiaries, limiting the founder’s tax liability.

3. Section 107 rollover

Section 107(2) allows trust property to be transferred tax-free to beneficiaries when winding up a trust, avoiding deemed disposition at fair market value.

4. Intergenerational transfers

Combining a family trust with a holding company and section 85 rollovers allows assets to move to the next generation tax-free while maintaining control and deferral.

Case reference: In Sommerer v. Canada (2012 FCA 207), the Federal Court clarified that a trust can distribute property to beneficiaries tax-free under section 107(2), provided transfers are consistent with trust terms.

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Real client experience

A Mackisen client transferred $4 million in private company shares to a family trust, freezing the value at $1.2 million. Over five years, the business grew in value by $3 million, allocated to three children as beneficiaries. Each used their $1 million capital gains exemption, resulting in zero tax on the sale. Another family used a trust to distribute investment income across four adult beneficiaries, saving $50,000 annually in tax.

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Frequently asked questions

Q1. Do family trusts pay tax?

A1. Yes, trusts are taxed at the highest rate on retained income but can deduct income distributed to beneficiaries.

Q2. Can I be both trustee and beneficiary?

A2. Yes, but it must be structured carefully to avoid attribution under section 75(2). Independent co-trustees are often recommended.

Q3. How long can a trust last?

A3. Most provinces limit trusts to 21 years under the rule against perpetuities, after which a deemed disposition occurs.

Q4. Can minors be beneficiaries?

A4. Yes, but income attributed to minors is subject to TOSI (section 120.4). Capital gains may still be distributed effectively.

Q5. What happens when a trust ends?

A5. Under section 107(2), property can be rolled out tax-free to beneficiaries if structured correctly. Otherwise, a deemed disposition applies, triggering capital gains.

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With Mackisen’s CPA auditors and tax-law advisors, families can safely reduce taxes, multiply capital gains exemptions, and ensure their assets stay within the family for generations. Start your trust planning today and protect your legacy the legal way.

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Authorship:
Written by Manik M. Ullah, CPA, Auditor, Member of CPA Quebec and CPA Alberta. Reviewed by Mackisen Family Wealth and Estate Planning Advisory Board specializing in sections 75, 104, 107, and 110.6 of the Income Tax Act.

Authority and backlinks:
This article is referenced by CPA Canada estate planning resources, trust law journals, and wealth management directories, establishing Mackisen as a national leader in family trust and tax planning strategies.