When Timing Matters: Trust Dividend Designations and Part IV Tax

Why Year-End Timing Can Cost You Extra Corporate Tax

Many business owners use family trusts to move dividends from their operating company into a holding company. Done properly, this can help manage cash flow and reduce overall taxes. But there’s a timing trap that can surprise people—and it could mean paying extra Part IV tax.

The Timing Problem

Here’s the issue: when a family trust pays a dividend it received from a company over to a corporate beneficiary, the trust has to make a special designation in its tax return. That designation only takes effect on the last day of the trust’s tax year (often December 31).

If by that date the dividend-paying company and the corporate beneficiary are no longer “connected” (for example, because the business was sold to a third party), the dividend won’t qualify for the usual connected-company exception. Instead, the beneficiary company may owe Part IV tax on that dividend.

A Common Scenario

Imagine this:

• Your family trust gets a dividend from your operating company in June.

• It then pays that dividend to your holding company.

• By December 31, you’ve sold the operating company to someone else.

At year-end, the two companies are no longer connected. That means the holding company gets hit with Part IV tax, even though everything looked fine at the time the dividend was paid.

What This Means for You

• Timing matters. Even if the trust receives and pays out a dividend mid-year, the tax result is tested at the trust’s year-end—not when the money moved.

• If you’re planning to sell your business, be careful about how and when dividends flow through a trust.

• Corporate beneficiaries with different year-ends can make things even more complicated.

  
  

The Takeaway

Dividends routed through a trust can be a great tool—but only if the planning lines up with year-end rules. If ownership changes or corporate connections don’t last until the trust’s year-end, you may face an unexpected tax bill.

Before paying dividends through a family trust—especially in a year when you’re planning a major transaction—make sure to get advice. The difference in timing could save (or cost) you thousands in tax.