Estate Freezes, Alter Ego Trusts, and Bypass Trusts: Three Classic Structures and How Each Breaks When the Family Crosses the Border

Estate planning structures are answers to specific statutes. The estate freeze answers Canada's deemed disposition: exchange common shares of the family company for fixed-value preferred shares, let a family trust subscribe for new growth shares, and the founder's death-tax exposure is capped at today's value while future growth accrues to the next generation — often multiplying access to the lifetime capital gains exemption. The alter ego trust answers probate and privacy: a settlor 65 or older transfers assets to a trust for their own lifetime benefit, on a tax-deferred rollover, and at death the assets pass outside the will — with the deemed disposition happening inside the trust instead. The bypass (credit shelter) trust answers the US estate tax: shelter the first spouse's exemption in a trust so it is not wasted, a design whose urgency faded with portability but which persists in US wills everywhere. Move any of these across the border — a US-person child in the freeze trust, an alter ego settlor who was born in Michigan, a US-drafted bypass trust operating on a couple now in Ontario — and the structure keeps its home-country benefits while acquiring the other country's problems, which is how good planning becomes a filing factory.

Key takeaways

• Freeze + US beneficiaries: the trust holding growth shares is a foreign trust with US beneficiaries — Form 3520 on distributions, throwback if income accumulates, and the company itself may be a controlled foreign corporation as US-person interests grow, putting Forms 5471, GILTI, and Subpart F on the table. A freeze executed without checking the beneficiary class's passports is the most common self-inflicted CFC.
• Freeze mechanics still work for Canada: section 86 or 85 exchange, price-adjustment clauses, the trust's 21-year deemed disposition clock — but the share terms (fixed value, retractable) also matter to US valuation and to how a US person in the structure is taxed.
• Alter ego trusts: Canadian rollover in, deemed disposition at the settlor's death inside the trust, probate avoided. For a US-person settlor it is a grantor trust — the settlor still reports all income personally in the US — and being Canadian-resident, a foreign grantor trust: Forms 3520 and 3520-A annually for the privilege of avoiding roughly 1.5% Ontario probate. That trade is frequently declined once priced.
• US estate inclusion doesn't care about the trust: the alter ego settlor's retained lifetime interest keeps the assets in a US-person settlor's gross estate — the trust changes probate, not the 706.
• Bypass trusts in Canada: Canada has no estate tax to bypass and no rollover into a non-spousal trust — funding a bypass trust at the first death triggers the deemed disposition on those assets (no spousal rollover, since the spouse-only condition fails) and creates a Canadian-resident (or worse, US-resident) trust taxed at top rates on retained income. US couples moving to Canada should have their wills re-read, not just re-signed.
• The 21-year clock: every discretionary Canadian trust in these structures faces a deemed disposition at year 21 — the standard exits (distribute assets out at cost to Canadian-resident capital beneficiaries) work badly when the beneficiaries are US persons, because a distribution of appreciated shares to a US person walks into their US basis and CFC world. Freeze trusts with US kids need their year-21 plan a decade early.

The passport audit before the structure

Every one of these designs starts the same way now: list every settlor, trustee, and beneficiary, and every one of their citizenships and residences — including green cards held years ago and children born in Buffalo. The structure is then drafted to the family that exists: US persons excluded from the beneficiary class or given separate parallel provisions, trustee control kept Canadian, investment and distribution policies set for the US members, and the future funded ("what if a grandchild moves to New York?") with amendment and exclusion powers.

Worked example

A Hamilton manufacturer, 58, freezes his company at $6 million: preferred shares to him, growth commons to a new family trust for his three children. Two facts surface in the passport audit: his eldest lives in Denver on a green card, and his wife — a trustee — is a dual citizen. Unadjusted, the plan makes the trust a foreign trust with a US beneficiary, likely makes the company a CFC as growth accrues (5471s, GILTI on the operating income), and hands the year-21 problem to a beneficiary class that cannot cleanly receive shares. As restructured: the Denver son is excluded from the share-owning trust and equalized through a parallel mechanism (insurance-funded, and preferred-share redemptions directed his way as cash), the trust's deciding trustees are the two Canadian children with the wife's role kept below control, the freeze proceeds and caps the founder's Canadian death tax at $6 million of value, and the year-21 memo — written now — plans distribution of growth shares to the two Canadian children at cost before the clock. The structure still does everything it was bought for; it just stopped doing the four US things nobody ordered.

Official sources

The CRA states that "Bare trusts are not subject to the trust reporting rules and are therefore not required to file a T3 return, including Schedule 15, for taxation years ending on or after December 31, 2024 and before December 31, 2026" (and were exempted for 2023 as well); other affected trusts must file a T3 with Schedule 15 for tax years ending after December 30, 2023. The T3 late-filing penalty is "$25 a day... from a minimum of $100 to a maximum of $2,500," and the gross-negligence penalty is "the greater of $2,500 and 5% of the highest amount of the fair market value of all the property held by the trust at any time in the year." — Canada Revenue Agency, New trust reporting requirements for T3 returns, https://www.canada.ca/en/revenue-agency/services/tax/trust-administrators/t3-return/new-trust-reporting-requirements-t3-filed-tax-years-ending-december-2023.html

Article XXIX B provides relief from double taxation at death, including a pro-rated unified credit for a Canadian-resident decedent — the credit "reduced by the proportion of the unified credit... as the value of property situated in the United States bears to the value of his worldwide estate" — an additional marital credit for property passing to a surviving spouse, and foreign tax credit coordination between the US estate tax and Canadian income tax arising on death. — Canada-United States Tax Convention, Article XXIX B, https://www.canada.ca/en/department-finance/programs/tax-policy/tax-treaties/country/united-states-america-convention-consolidated-1980-1983-1984-1995-1997.html

Practitioner note

These three structures generate most of the cross-border estate cleanups we do, and the pattern is identical: the plan was correct for the country it was drafted in and nobody re-ran it when a family member crossed the border. The habit that prevents it costs one page — a passport-and-residence schedule in the planning file, updated at every review — because in cross-border estate work the client is never one person; it is everyone the trust can pay.

See also: Browse every cross-border tax topic guide, organized by situation.

Next step

Fairlight prepares the structure review before and after the border enters the family — freeze design with the beneficiary passport audit, alter ego pricing for US-person settlors, and will rebuilds for US couples in Canada. See cross-border pricing or book a call.