Denika Heaton, BBA, JD, TEP, CEA Tax and Estate Planning Specialist, Private Wealth

Chris Hanley, CPA, CA, CFP, TEP Tax and Estate Planning Specialist, Private Wealth

Despite their reputation, trusts are neither exotic nor reserved for the ultra-wealthy. At its core, a trust is a relationship involving three roles. A trustee holds and manages property that was contributed by a settlor for the benefit of the beneficiaries. In a family context, a trust can allow income and capital to be allocated across family members, potentially benefiting the family as a whole, while control remains with the trustee.  

From an income tax perspective, the appeal is straightforward. Canada’s tax system is progressive, so income taxed in the hands of a lower-income family member generally attracts less tax than in the hands of a high earner. That flexibility is the source of much of a trust’s usefulness and, for many business-owning families, this was the primary reason the trust existed.

However, several independent changes over recent years have chipped away at the advantages that once made family trusts a more common recommendation. None eliminated the use of trusts outright, but together they have narrowed the circumstances in which a trust delivers a tax saving and raised the cost of maintaining the trust structure. 

The most consequential change arrived in 2018. The tax on split income, or TOSI, was designed specifically to curtail income sprinkling, the very strategy that motivated many family trusts. In broad terms, TOSI taxes certain income received by an individual at the top marginal rate, regardless of that individual’s own income level. When TOSI applies, the lower-bracket advantage disappears entirely.

TOSI captures most taxable dividends and certain other amounts derived from a “related business”, including amounts flowed through a family trust. Several exclusions are provided, and they define where splitting still works. These include income from an excluded business (where the individual is 18 or older in the year and is actively engaged on a regular, continuous, and substantial basis, or was so involved for five years); income from excluded shares (broadly, a direct holding (not through a trust) of at least 10% of the votes and value of a non-service corporation, by an individual 25 years or older in the year); a reasonable return for individuals aged 25 or older; and a carve-out tied to the business owner reaching age 65, or for inherited shares. Capital gains on the sale of qualified small business corporation (QSBC) shares are also excluded, a point that becomes important in our next article.

A once-popular structure, the prescribed rate loan trust, has been squeezed by rising interest rates. The strategy works by having a high-income family member lend funds to the trust at the CRA’s prescribed rate; the trust invests the funds, pays the lender interest at that rate, and distributes the net income (after interest) to lower-bracket beneficiaries.

Paying interest at the prescribed rate keeps the arrangement onside of the rules that would otherwise attribute the income back to the lender.

The economics depend heavily on the spread between the trust’s investment return and the prescribed rate, and that rate has moved dramatically. The rate has climbed from 1% during 2020 to 2022 to a peak of 6% in early 2024 before easing to 3%, where it currently sits as of Q4 2026. A loan is locked in at the rate in effect when it is made, so loans made during low-interest rate periods are markedly more attractive. The strategy is not gone, but the margin for error has shrunk, and a portfolio must now work considerably harder to justify the structure. 

Another pressure comes from the alternative minimum tax (“AMT”), a parallel calculation that ensures a minimum level of tax is paid regardless of the deductions, exemptions, and credits available under the regular tax system. If the AMT result exceeds regular tax, the taxpayer pays the higher amount. The excess is generally recoverable as a credit over the following seven years, if there is sufficient regular tax in those years.

In 2024, tax reforms reshaped AMT in ways that fall heavily on certain trusts. The AMT base was broadened by allowing only 50% of certain expenses to be deducted, including interest on investment loans. The federal AMT rate also rose from 15% to 20.5%, and, critically, the generous basic exemption that shields most individuals (roughly $181,000 in 2026) does not apply to trusts.

As mentioned above, prescribed rate loan trusts used for income splitting borrow funds from a family member to invest, and allocate all of their net income to beneficiaries. These trusts therefore have no taxable income under regular tax rules and no regular tax against which AMT can be compared, so even a modest disallowed deduction for interest costs can create an AMT liability where none existed before. We covered this in detail in our earlier article, Trust Issues: New Alternative Minimum Tax Changes = Maximum Headaches.

A further restriction allowing only a 50% deduction for investment counsel and management fees for AMT purposes, left in limbo for over a year, was passed into law in 2026 and made retroactive to 2024. Many trusts that pay investment management fees now face an AMT liability for years already filed and must amend their returns, with no automatic interest relief offered. For a family trust that holds a managed investment portfolio or pays interest on a prescribed rate loan, or both, AMT has become a recurring cost. 

Finally, the cost and constraints of maintaining a trust structure have both risen. Expanded trust reporting rules now require many trusts, including trusts that were previously exempt from filing, to file annual T3 returns with detailed beneficial-ownership schedules, or face penalties for non-compliance.

At the same time, more aggressive planning involving trusts has been targeted by the CRA and Finance, through the courts and through new and proposed tax changes. While it is the more aggressive strategies being targeted, it appears to show the government still views trust planning as an area with loopholes to be closed.

Complying with these evolving and expanding rules adds to the administrative burden and professional fees of maintaining a trust, at the same time that several of its tax benefits have diminished. 

There is no question that the classic tax income-splitting rationale for the family trust has been steadily diluted. TOSI has neutralized income sprinkling in most situations where it was once routine; AMT reforms have turned trusts into more frequent and more expensive payers of minimum tax; higher prescribed rates have decreased the benefits of the prescribed rate loan strategy; and an expanded reporting regime has raised the baseline cost of compliance.

However, our answer is no, family trusts will not be extinct in the foreseeable future. While the changes above have narrowed the tax case for trusts, they do not dismantle the estate, business succession, and asset preservation planning cases. In several common situations, a family trust remains immensely valuable and may be difficult to replicate those benefits in any other way.

In short, the question is not whether a family trust offers advantages, but whether the advantages apply to your situation and justify the cost and complexity of maintaining one. A trust created years ago purely to split income may no longer earn its keep and may be worth revisiting. A trust that anchors a succession plan, a business sale, or the careful stewardship of family wealth may be as valuable as ever. 

Stay Tuned

Where does a family trust still earn its keep under the current ruleset? In the next article in this series, we set out the surviving advantages, one by one, in 4 Modern Uses for Family Trusts.