Family Trusts in Canada: How They Work

A dentist in Hamilton sets up a family trust in 2015 when her professional corporation is worth $400,000. She does an estate freeze; the trust takes new common shares; she keeps fixed-value preferred shares. By 2026 the corporation is worth $1.4M. Her share is frozen at $400,000 — the $1M of growth has accrued inside the trust, with her two adult daughters and her retired spouse as discretionary beneficiaries. When she eventually sells, in principle, four LCGE claims (hers, her spouse's, and her two daughters') can shelter most of the gain. The 2018 TOSI rules complicate this picture, but for an active corporation that still has eligible employees and meets the exception tests, the structure works.

That kind of multiplication-of-the-LCGE play is what brought family trusts into mainstream Canadian estate planning. The rules changed in 2018 (TOSI) and 2023 (T3 reporting) — but the underlying tool is still useful for the families and businesses it was actually designed for.

This guide explains what a family trust is, what it does, what changed, and when it is still worth setting up. For the bigger context, see our inter vivos vs testamentary trust comparison and the estate planning pillar.

What a family trust is #

A "family trust" in Canadian practice is a discretionary inter vivos trust whose beneficiaries are family members — usually the settlor's spouse or common-law partner, children (minor and adult), and sometimes grandchildren, parents, and other relatives. The trust is created during the settlor's lifetime by:

• A trust deed setting out the trustees, beneficiaries, trust powers, and ultimate term (commonly 21 years, with a rollout plan in mind)
• An initial settlement of property (often $100 to the trust to fund the corpus)
• Subsequent funding, typically through corporate share issuance or transfers

The trust is discretionary: the trustees decide how much income and capital each beneficiary receives, when, and in what form. The beneficiaries do not have a fixed entitlement.

Because the trust is inter vivos, it pays tax at the top federal marginal rate on any income retained in the trust at year-end.^[1] Income paid or payable to beneficiaries in the year is taxed in their hands (subject to TOSI).

The estate freeze #

The single most common family trust deployment is an estate freeze of a private corporation. The mechanics:

1. The shareholder (the owner) exchanges their existing common shares for new preferred shares fixed at the current fair market value of the corporation. The exchange is done on a tax-deferred basis under section 86 or 85 of the Income Tax Act.^[7]
2. The corporation issues new common shares (nominal value) to the family trust. These new commons will capture all future growth.
3. The trustees of the family trust hold the new commons; the discretionary beneficiaries are the family members.

The owner's eventual capital gain on death is capped at the value of the preferred shares — the value at the date of the freeze. Future growth accrues outside the owner's personal estate. The owner can keep voting control through retractable preferred shares, special voting shares, or the structure of the corporation's articles.

The freeze is the centrepiece. Without an active corporation that is going to appreciate, most of the planning reasons to set up a family trust disappear.

Multiplying the lifetime capital gains exemption #

Where the underlying shares qualify as qualified small business corporation shares (QSBCS), the family trust can — in the right circumstances — distribute the gain across multiple beneficiaries on a future sale, with each beneficiary using their own LCGE. The 2026 LCGE limit is $1,275,000 per individual (indexation resumed in 2026),^[8] so four eligible beneficiaries could in principle shelter $5,100,000 of gain.

Several technical hurdles apply. The shares must meet the QSBCS holding-period and asset tests under section 110.6 of the ITA.^[6] The trust deed has to allow the rollout of property to the beneficiaries under s.107(2). The 24-month holding period must be satisfied. And the TOSI rules (next section) restrict who can be a beneficiary for this purpose.

This is the multiplication play that drives most private-business estate freezes. It is not available outside QSBCS or QFFP — passive investment portfolios held in a trust do not get the same treatment.

The 2018 TOSI rules #

The Tax on Split Income rules in section 120.4 of the ITA, extended in 2018 to adults, generally apply the top marginal tax rate to "split income" received by a "specified individual" from a "related business" — unless an exception applies.^[5]

For family trusts, the effect was significant. Income (dividends, interest, capital gains) flowed out to adult family beneficiaries who were not actively involved in the business is now generally taxed at the top rate in the beneficiary's hands. The previous strategy of paying out modest dividends to adult children for tax efficiency stopped working for most professional and personal-services families.

The exceptions that family trusts still rely on include:

• Excluded business — beneficiary actively engaged (generally 20 hours/week or more) in the business in the current or any five prior years
• Excluded shares — owned directly by the beneficiary (not via a trust); 10% of votes and value; non-services; non-related-party-income business. Note: because shares held by a trust are not owned by the beneficiary directly, this exception generally does not apply to discretionary family-trust beneficiaries
• Age 65 or older — distributions to a spouse from a business in which the older spouse meets a TOSI exception flow through under the spousal extension
• Capital gains on QSBCS sale — the LCGE multiplication play still works in principle, subject to the rules above
• Reasonable return — based on the beneficiary's labour, capital, risk, and historical payments

The practical effect: TOSI made the income-splitting use case much narrower, but the freeze + LCGE multiplication structure for genuinely active businesses remains usable. Anyone setting up a new family trust should run their plan through the TOSI exception tests first.

The 21-year deemed disposition #

Family trusts face the same 21-year deemed disposition rule as other personal trusts. Every 21 years, the trust is treated as having sold its property at fair market value, triggering accrued capital gains.

Standard responses:

• Rollout to beneficiaries under s.107(2) — distribute the trust assets to beneficiaries at the trust's cost base before the 21-year date
• Sale before the date — realise the gain on the family's terms, potentially using LCGE
• Second freeze — combined with a new family trust to push the 21-year clock further out

Every active family trust needs a 21-year plan starting well in advance (commonly year 18 or 19). The cost of running into a 21-year date unprepared can be substantial.

The 2023 enhanced reporting rules #

Effective for taxation years ending on or after December 31, 2023, most express trusts (including most family trusts) must file an annual T3 return with Schedule 15, disclosing the trustees, beneficiaries, settlors, and any persons exercising control.^[2] Many family trusts that previously did not file (because they had no taxable income) now have to.

Bare trusts were granted relief: they are not required to file the T3 and Schedule 15 for 2024 or 2025, unless CRA specifically requests it.^[3] CRA has indicated certain bare trusts will be required to file for taxation years ending on or after December 31, 2026.

The reporting administration cost is now a real factor in the decision to set up or keep a family trust. For a small trust with limited activity, it can add several hundred dollars per year in accountant fees.

When a family trust still makes sense #

The narrowed-but-real use cases:

• Active private corporation owner wanting to freeze value, pass growth to next generation, and preserve LCGE multiplication on eventual sale — particularly where children or spouse may actively participate in the business
• Farm or fishing family holding qualified farm or fishing property where LCGE multiplication across family members protects a generational sale
• Significant generational wealth where holding assets in trust across multiple generations is a deliberate strategy (with the 21-year planning built in)
• Disability planning — but here a testamentary qualified disability trust often does the job better than an inter vivos family trust
• Creditor protection for vulnerable family members in regulated professions

If none of these patterns fit, a family trust is generally not worth setting up. The legal cost ($5,000-$15,000 typical), annual T3 reporting, 21-year clock, and TOSI complexity rarely pay back for an ordinary salaried family.

What we focus on at It's Simple Will #

It's Simple Will writes wills, captures Life Discovery Kit information, and handles funeral pre-planning. Family trusts are deliberately outside scope — they are bespoke work that needs a tax accountant and an estates lawyer in the room. Where a family trust already exists, the will needs to be coordinated with it so the residue clause does not accidentally undo years of planning.

For wider context see the inter vivos vs testamentary trust article, the estate planning pillar, and the capital gains tax basics. Start your will at the It's Simple Will app.