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Valuations of Interests in Family Trusts

Posted under: FMV

A family trust is created as either an inter vivos trust, established during the lifetime of the donor, or a testamentary trust, established in connection with a will. The retained income in an inter vivos trust has always been and will continue to be taxed at the flat top-tax rate; however, testamentary trusts receive favorable tax treatment. With the exception that they are not eligible for the personal exemption, testamentary trusts can currently take advantage of the progressive tax rates extended to individuals. The 2013 Federal Budget announced a review of this tax advantage and on June 3, 2013 outlined proposed changes with a consultative process up to December 2, 2013. The main proposal is to apply flat top-tax rates to all existing and new testamentary arrangements from the 2016 taxation year. The proposal also allows a period of up to 3 years for new trusts arising from future estates. Testamentary trusts may also more often be subject to alternative minimum taxes as it is proposed that they will lose the $40,000 exemption and will be taxed on a calendar year basis.

These proposals, if put into law and when permitted by the trust deed, may cause trustees and trust beneficiaries to wind up testamentary trusts. In such instances, an actuarial valuation of the percentage interest of each trust beneficiary will be required. Our firm is able to offer such services and in addition, through our medical underwriter, use appropriate mortality assumptions based on the health of each trust beneficiary. As this work is complex and can be time consuming, trustees and trust beneficiaries are encouraged to obtain their actuarial valuations well in advance of the end of the 2015 calendar year.

How it Works

Upon wind up of a testamentary trust, the trustees must protect the interests of each trust beneficiary. A typical trust will elect two types of beneficiaries, whose interests are opposed to each other. The income beneficiary, or beneficiaries, may enjoy income from the trust together with the life interest in a house or other property. The capital beneficiary, or beneficiaries, will share in the balance of the trust assets following the death of the income beneficiary or beneficiaries. In some instances, the capital beneficiaries may also be eligible to receive a portion of the investment income of the trust during the lifetime of the interest beneficiaries. A family tree is usually created at this stage of the process and the valuation of individual beneficiary interests in a testamentary trust is then conducted as follows:

  1. The property of the trust is valued at fair market value. Where a house or other property is involved, a real estate appraiser will be retained and upkeep costs, taxes and real estate fees on the sale of the property charged against the appropriate class of beneficiaries.
  2. The date of birth, sex and state of health of the income beneficiaries is then required in order to calculate their life expectancies. This work requires the use of a life underwriter and actuary. The latter will also be required to conduct calculations using appropriate mortality tables, discount rates and future rates of inflation. The interests of the income beneficiaries will then be expressed as a percentage of the total trust assets, and;
  3. The capital beneficiaries will then share the balance of the trust assets. Depending on the specific wording of the trust, their interests may be equal to each other, or if deceased, either reverts to their issue or to the surviving capital beneficiaries. It is probable that their interests may also depend on their ages, sexes and dates of birth and the same procedures would apply as to the income beneficiaries, as above.