Article

Trusts: A Powerful but Often Misunderstood (and Sometimes Misused) Planning Tool (Part 2)

Family Enterprise Canada

Published: Oct 23, 2026

Michael Goldberg, BComm, LLB, TEP, FEA, Partner and Tax Lawyer at Aird & Berlis LLP and founder of “Tax Talk with Michael Goldberg,” a quarterly conference call series about current, relevant and real-life situations for professional advisors who serve high-net-worth clients.

A Primer on Tax and Family Law Issues That Affect Canadian Trusts

Part I of this series reviewed what a trust is and why trusts are often misunderstood. Before turning to how trusts are used in planning, it is helpful to step back and consider a broader point: Canadian estate, continuity and succession planning involving trusts is materially impacted by tax and, to a lesser extent, family law considerations.

This Part II provides a high-level overview of those considerations. The goal is not to provide a comprehensive technical analysis, but rather to outline the framework that helps explain why trusts are used so frequently in estate, continuity and succession planning—and why they are sometimes misunderstood or misused.

Capital Gains — The Starting Point for Much of Canadian Tax Planning

At a high level, a capital gain arises when a taxpayer disposes of a capital property for more than the amount they paid to acquire it.

For example, if a taxpayer purchased shares for $100 and later sells those shares for $1,000, the taxpayer will realize a gain of $900. While the arithmetic is simple, the implications can be significant, particularly where assets have appreciated substantially over time.

It is therefore important to understand what constitutes capital property. Broadly speaking, capital property is property held for long-term investment or use. Common examples include real estate, shares of a corporation, and investment portfolios. This contrasts with income property, including property held for resale or short-term profit, which is typically treated as inventory and gives rise to business income rather than capital gains.

Some find it helpful to think of this distinction using a simple analogy:

the tree represents capital property;
the fruit produced annually represents income.

The eventual sale of the tree may produce a capital gain, while the annual harvest of fruit produces income.

This distinction is fundamental, because Canadian tax rules treat capital gains and income differently—and that difference has a direct impact on planning.

How Capital Gains Are Taxed in Canada

Canada has long taxed capital gains more favourably than ordinary income. Under the current rules, only a portion of a capital gain is included in income for tax purposes (commonly referred to as the inclusion rate). This results in a lower effective tax rate on capital gains than on regular income.

This preferential treatment is often justified as a way to encourage investment and entrepreneurship.

From a tax planning perspective, it is worth keeping in mind that timing and structuring the realization of capital gains can have a material impact on after-tax outcomes.

Another key feature of the Canadian system is the lifetime capital gains exemption (“LCGE”), which can allow qualifying gains on certain types of property—most notably shares of certain qualifying active business corporations—to be realized tax-free within prescribed limits (in 2026 the LCGE limit allows for lifetime sales of up to $1,275,000[1]).

In practical terms, the LCGE can represent significant value, about $340,000 per top tax rate Ontario taxpayer in 2026. As a result, planning that allows a taxpayer, or in appropriate circumstances other family members, to access their LCGEs[2] is often a central focus of planning for privately held Canadian active business corporations.

At the same time, the rules governing eligibility for the LCGE and related limitations are complex. In addition, broader tax concepts—including the alternative minimum tax (“AMT”) regime—can negatively affect the availability or timing of expected benefits in certain circumstances.[3]

Deemed Dispositions — When Tax Arises Without a Sale

One of the most important features of the Canadian tax system—and one that is often not well understood—is that a taxpayer does not always need to sell property in order to trigger a tax liability.

In several circumstances, the Income Tax Act (“Act”) will deem a taxpayer to have disposed of property at fair market value, even though no actual sale has occurred.

The most common example is death.

On death, a taxpayer is generally deemed to dispose of their capital property at fair market value, which can result in a significant tax liability for the taxpayer’s estate. For individuals who have accumulated valuable business or investment assets, this deemed disposition can create substantial post-mortem liquidity pressures.

Similar deemed disposition rules can apply in other circumstances, including:

gifts of property; and
transfers to non-arm’s length persons at less than fair market value.

In these situations, the taxpayer may be required to recognize gains based on fair market value, even where no cash is received to fund the resulting tax liability.

From a planning perspective, these deemed disposition rules are critical as they create the tax pressure points that much of Canadian estate, succession and continuity planning seeks to address.

Why Trusts Enter the Planning Discussion

At a high level, trusts can allow for a degree of flexibility in managing:

the timing of income and capital gains recognition;
the allocation of income and capital gains among beneficiaries; and
the ownership and succession of appreciating assets.

For example, subject to a range of detailed rules, a trust may be able to:

allocate income or capital gains to beneficiaries who are in lower tax brackets; and
distribute appreciated trust assets to trust beneficiaries on a tax-deferred basis and thereby allow the beneficiaries to access their own tax attributes, including LCGEs, in appropriate circumstances.

These concepts are sometimes described as income splitting or multiplication of tax attributes, and they can create powerful incentives to use trusts in planning, so long as they operate as intended.

At the same time, the ability to access these benefits is often constrained by complex rules in the Act that are designed to limit what the Canadian government considers to be inappropriate tax results . For example, the Act includes rules that can:

attribute income or capital gains (as well as losses and capital losses) back to the person who transferred property to the trust (sometimes generically referred to as “Attribution Rules”);
impose tax at high marginal rates in certain situations (for example, at the individual level as a result of the application of the “tax on split income” or “TOSI” rules and at the corporate level by limiting access to the small business deduction as a result of the “association” rules); and/or
deny expected results where statutory requirements are not satisfied (for example, to deny the tax-deferred distribution of appreciated trust property from a trust to its beneficiaries (sometimes referred to as a “Roll-Out”)).

As with many areas of tax law, the opportunities and the limitations need to be understood together.

Taxation of Trusts — A Key Structural Feature

One feature that sometimes surprises people is that a trust is not treated as a separate legal entity in the same way as a human taxpayer or a corporation. Instead, for tax purposes, the Act contains special rules that deem a trust to be a taxpayer and govern how its income is taxed.

In simplified terms:

if income or capital gains are retained in a trust, the income or capital gains are generally taxed at the top marginal rate applicable to the trust in the Canadian jurisdiction it is or is deemed to be resident;
if income or capital gains are distributed or allocated to beneficiaries, the income or capital gains may be taxed in the hands of those beneficiaries.

This creates a framework in which trustees can, in certain circumstances, influence how income and/or capital gains are taxed by determining whether and how income is distributed.

However, as noted above, this flexibility is not unlimited. Rules such as the Attribution, TOSI and Roll-Out rules can significantly restrict the availability of these outcomes in practice.

In addition, the recent expansion of trust reporting obligations has introduced further complexity when utilizing planning involving trusts. For example, trustees are now generally required to provide detailed information to tax authorities regarding the parties to the trust, and failure to comply can result in significant penalties.

The 21-Year Rule — A Distinctive Canadian Constraint

Another distinctive feature of the Canadian income tax system is the so-called “21-year rule”.

In general terms, most Canadian resident trusts are deemed to dispose of their capital property every 21 years at fair market value. This can result in the realization of capital gains within the trust, even where no actual disposition has occurred.

This rule does not require a trust to terminate after 21 years. However, it can create a significant tax liability at that time if no planning is undertaken.

In practice, the 21-year rule often leads to planning in advance of a trust’s 21st anniversary, which may include distributing assets to beneficiaries or otherwise restructuring the trust’s holdings to avoid the deemed disposition.

The existence of the 21-year rule is an important factor in understanding both the benefits and the limitations of trust structures in Canada. It reinforces the point that in tax planning the flexibility offered through the use of trusts can create extremely useful and often valuable decision making and tax deferrals, but in most cases those deferrals will not be indefinite.

A Brief Comment on Family Law Considerations

Although tax considerations are often a motivating factor, trusts are also used for many non-tax reasons. For example, trust planning may affect the application of family law rules to trust beneficiaries.

As family law varies by jurisdiction, the following comments are limited to a high-level overview of Ontario family law principles. Specific family law advice should always be obtained from a qualified family law specialist.

In general terms, Ontario family law provides for a system of equalization of property between spouses, under which the increase in value of certain assets during a marriage may be shared on marriage breakdown or, in some cases, on death.

Since many families have a strong desire that the continuity of their wealth remains with their direct descendants, for example, children and grandchildren, the division of property on a marriage breakdown or the death of a spouse is often a matter of considerable concern for families.

While the best way to avoid the application of the statutory sharing rules is to ensure that all family members enter into properly executed matrimonial agreements, family members may, for a variety of reasons, be unable or unwilling to enter into such agreements.

Fortunately, in Ontario and a number of other provinces, there is an exception to the equal sharing rule for gifts or inheritances received during marriage. This exception generally will apply on a traced basis to substituted property for the gift and, in Ontario, when properly structured, the exception will apply to income earned from the gift as well.[4]

It often comes as a surprise to family members that an interest in a trust is property that can be subject to the statutory equalization regimes in most provinces.

With respect to a trust in Ontario, the date of creation of the trust is considered to be the date of the gift of the interest in the trust. As a result, in Ontario, the interest of a beneficiary in a properly structured trust created after the date of marriage of the family member, any property distributed from the trust to the family member as well as substituted property and even income from those properties should be capable of being excluded from a matrimonial property claim whereas the beneficiary’s interest in a trust that is created before the family member is married as well as any property distributed from the trust to the family member could be subject to a property equalization claim.

Even if an interest in a trust is not excluded property, it is only the increase in value of the interest over the course of the marriage that is subject to equalization. However, valuing an interest in a discretionary trust may be difficult in practice.

Bringing the Framework Together

Taken together, the concepts described above help explain the broader context in which Canadian estate, succession and continuity planning involving trusts takes place.

Capital gains taxation creates potential tax liabilities, particularly on death or other deemed disposition events.
The tax system provides certain incentives, such as preferential treatment of capital gains and access to exemptions such as the LCGE, but also imposes detailed limitations.
Trusts can offer flexibility in structuring ownership and allocating trust income as well as capital gains, but that flexibility is subject to both tax rules and practical constraints.
Family law considerations can further influence planning outcomes in ways that may not always be intuitive.

Understanding this framework is important because it provides the foundation for the planning strategies discussed in the next part of this series.

Conclusion

Canadian estate, succession and continuity planning does not exist in a vacuum. It is shaped by a combination of tax rules, policy objectives, and broader legal considerations, including family law.

Many of the perceived benefits of using trusts in this planning arise from how they interact with these rules, particularly in managing the timing and allocation of trust property, income and capital gains. At the same time, those same rules impose meaningful constraints that must be carefully considered.

In my experience, misunderstandings in this area often arise not from the complexity of any one rule, but from a failure to appreciate how the rules fit together.

In Part III, I will build on this framework by examining one of the most common uses of trusts in Canadian planning: the estate freeze, including the often counterintuitive role of the settlor in Canadian trust structures.

[1] The LCGE limit is indexed and will increase over time.

[2] Often referred to as LCGE “multiplication” planning.

[3] If AMT is applicable, a top rate Ontario taxpayer could be subject to tax rates of up to 32% on certain capital gains, including LCGE capital gains.

[4] If gifted property is used to acquire or improve a matrimonial home it will lose its excluded status.

Michael Goldberg is a partner in the Aird & Berlis Tax and Estates & Trusts Groups, where he advises privately owned Canadian corporations and high-net-worth individuals on domestic and international tax planning, estate planning, business succession and wealth transfer strategies. Known for his dedication to client service and relationship-building, Michael holds the Family Enterprise Advisor designation, reflecting his commitment to serving as a trusted advisor to family enterprises and high-net-worth clients.