Testamentary trusts are a good way to control how assets are administered after one’s death. They’re especially useful when there are minors involved. Until the new changes were introduced in February, income earned within a testamentary trust as well certain grandfathered inter-vivos trusts (living trusts created before June 18, 1971) were taxed at the applicable marginal federal and provincial tax rates just like an individual would be.
Not any longer.
Speaking with tax planning experts Andrea Dickinson and Cindy Chiu, both associates with Morris Kepes Winters LLP, Canada’s largest boutique law firm specializing in tax, WP got a short lesson Thursday on what the changes mean when it comes to estate planning in Canada.
Starting in 2016, grandfathered inter-vivos trusts will be taxed at the top federal tax rate of 29%, the same as those that aren’t grandfathered. More importantly, testamentary trusts will also be taxed at the top rate. The only difference being that testamentary trusts will continue to use graduated rates for the first 36 months upon death; there after any income earned within the trust will be taxed at the highest marginal rate.
The 36-month grace period for graduated tax rates on testamentary trusts isn’t the only situation in which the top marginal tax rate won’t necessarily apply. In addition, graduated tax rates will continue for testamentary trusts intended for persons who are eligible for the disability tax credit.
The Department of Finance introduced these changes to ensure multiple testamentary trusts aren’t being created for a single beneficiary in a will to take advantage of graduated tax rates. While there is a provision available in the legislation that allows the Minister of Finance to consider a number of trusts collectively as one where there is a single beneficiary, the Conservative government’s chosen to close this loophole regardless.
While the elimination of graduated tax rates is the key aspect of the changes, there are other little wrinkles that will also render testamentary trusts less attractive. These include requiring trusts to make tax installments, using December year-ends, and eliminating the basis exemption when computing alternative minimum tax.
While the testamentary trust is certainly less attractive in terms of tax savings, there are certainly reasons why they still should be used, the biggest being to provide greater control of the assets held within the trust. Situations where this could be relevant include minor children, disabled beneficiaries, creditor protection and marriage breakdown.
If your clients might encounter any of these problems in the case of their untimely death, the testamentary trust is still something worth considering, despite the Conservative’s best efforts to do away with them.