Estate, trust and tax planners have long favoured testamentary trusts as vehicles to pass along assets to beneficiaries or heirs. A testamentary trust is generally a trust or estate that is created the day a person dies. Commonly, these trusts are established in a testator’s will.
A significant benefit to testamentary trusts had been that income earned and retained in the trust received the same graduated rate of income tax as an individual tax payer. Unfortunately, under the terms of Bill C-43, after January 1, 2016, all income retained in the trust will now be taxed at the highest rate of tax applicable in the province in which the trust is resident.
There will be two exceptions to this new rule – The Graduated Rate Estate (GRE) and a Qualified Disability Trust (QDT).
Graduated Rate Estate
Anyone who has ever acted as an executor can tell you that it can take a considerable length of time to settle the estate. How much time is reasonable? Under the new act, the government is telling us that the appropriate amount of time for an estate to be settled is 36 months. To support this, they point to statistics that suggest the majority of estates are wound up by then. As a result for the first 36 months the estate will be classed as a Graduated Rate Estate (GRE) and during this period will be subject to graduated rates of tax as it would have been under the old system. If at the end of this period, the trust still exists, it will now be taxed at the top rate.
The important points to consider are:
Even though testamentary trusts have lost their preferred tax treatment, they will still present significant estate planning benefits for situations involving spendthrifts, special needs beneficiaries and blended families among others.
Qualified Disability Trust
A QDT is a testamentary trust that will continue to enjoy graduated rates of tax. The basic conditions of a QDT are as follows:
The rules surrounding the Qualified Disability Trust are complicated so if you are preparing your Will with a disabled dependent in mind, please make sure to obtain professional help.
Life Interest Trusts
Appearing in the final legislation of Bill C-43 without prior warning was a change in the manner in which life interest trusts, specifically spousal trusts, alter ego trusts and joint partner trusts will be taxed when the income beneficiary dies. When an income beneficiary (or second death in the case of a joint partner trust) dies, the trust is deemed to have disposed of all its capital assets at fair market value. The income from this deemed disposition has, up to now, been taxed in the trust. As of January 1, 2016, deaths occurring after that date will see the capital gains taxed in the deceased’s beneficiary terminal tax return and not in the trust.
This simple change can have significant implications. If, for example, the deceased beneficiary’s estate does not have sufficient funds to pay the tax liability, the trust is jointly and severally liable. This could create an inequity in situations where the deceased’s estate has different beneficiaries than the trust.
Another significant implication will be felt by post mortem estate plans, such as private company share redemptions that depend on netting capital losses against capital gains. With the new legislation, capital gains which arise from the deemed disposition will be reported by the deceased, but the capital loss created by the redemption will be realized in the trust.
Any planning which has been implemented using these vehicles should be reviewed. There may be required revisions or additional planning to deal with situations which are affected negatively by these new changes.
All the changes discussed here, take effect after 2015 and it is important to note that there is no grandfathering of existing plans. If you have concerns that you may be affected by this new legislation regarding the taxation of trusts it is important that you discuss your situation with a qualified professional advisor.
Alex Chan, RHU, CHS, CFSB, CPCA, EPC, CFP, CLU | Certified Financial Planner & Chartered Life Underwriter
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