In the last few decades, Canadians with high incomes have relied on using testamentary trusts as a part of their will to help themselves and their beneficiaries minimize their tax burden. However, based on the Canadian Government’s proposal to eliminate tax benefits that arise from taxing trusts and certain estates at graduated rates, individuals who have, or are considering establishing, testamentary trusts may soon need to review their estate plan.
AG Tax professionals have prepared a brief summary on these proposed changes to help keep individuals concerned with trust taxation stay informed.
Testamentary Trust
A testamentary trust comes into existence upon the death of the settler. The basic advantages of a testamentary trust are that:
• It is treated as an individual taxpayer by the Canadian Revenue Agency (CRA), separate from its creator and beneficiaries, and
• The trust’s taxable income is subject to graduated income tax rates generally applicable to lower ranges of income. For 2013, 29% is the highest rate on income in excess of $135,054.
Additionally, as an individual can create a separate trust for each beneficiary in the will, it allows the opportunity for income splitting between non-earning family members. A properly planned testamentary trust can last the successors for a significant number of years after the death of its benefactor.
Proposed Reforms to Testamentary Trust Taxation
• Flat Top-Rate Taxation:
A deceased individual’s estate would be considered a top-rate estate three years after the individual’s death. During these three years, the estate and testamentary trust could access the graduated tax rates. These measures would apply to new and existing arrangements from 2016 onwards.
• Trusts for the Disabled, and Minor Children:
As per the current income tax ruling, these trusts are usually subject to minimum taxes (i.e. taxed at the beneficiary’s marginal rates), even though the income actually accumulates in the trust. The proposed reforms on graduated rates would not change the preferred beneficiary election rules or the rules that apply to trusts for minor children.
• Spousal Trusts and Common-law Partner Trusts:
These trusts will continue to be eligible for a tax-deferred rollover of property to a deceased individual’s spouse or common-law partner; resulting in the suspension of the income tax ruling of ‘deemed disposition of assets’ on an individual’s death.
• Additional Reforms:
As a testamentary trust can also use various income tax benefits due to its separate entity status, the Government is considering the following reforms to these tax rulings, such as:
o Certain taxpayers, including testamentary trusts, are allowed to pay their annual tax liability in instalments throughout the year. The Government proposes to exclude trusts from this privilege and require the payment of any owed taxes within 90 days after the end of the taxation year.
o Testamentary trusts are allowed a $40,000 basic exemption while computing the Alternative Minimum Tax (AMT), like individual taxpayers. This benefit is also being considered for removal.
o The taxation year of a trust is generally the calendar year and, similarly, any fiscal period of a trust is required to end in the calendar year in which it began. Testamentary trusts are exempt from these rules, being allowed off-calendar year taxation years and fiscal periods. The proposed measures would remove this exemption.
o Testamentary trusts automatically qualify as personal trusts. The proposed measures would subject testamentary trusts to the same conditions that apply to ordinary inter vivos trusts in determining eligibility as a personal trust.
o Taxpayers, including trusts, are permitted to claim investment tax credits (ITCs) in respect of certain expenditures. Testamentary trusts can make these ITCs available to their beneficiaries for use while computing their own income tax liability. The proposed measures would require that the ITCs of trusts be recognized in the trust or estate and not forwarded to beneficiaries.
The Government thinks that withdrawing these tax benefits for trusts and certain estates would ensure equality in the federal income tax system. However, this uniformity in taxation can only be anticipated, as these are currently only ‘proposed’ reforms. The Government is now accepting input from the public on these issues until December 2nd, 2013.
It is advised that high net-worth individuals (with or without a testamentary trust in place) consult with their estate planning accountant to review their estate plan.
AG Tax LLP Can Help
If you have any tax-related queries, need assistance with tax planning or filing your tax returns please contact us. Our team comprises of highly experienced tax professionals with extensive knowledge of U.S. and Canadian tax laws as well as cross-border compliance
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