Attention, taxpayers! Proposed changes in the tax law could have a major impact on your estate planning relative to the use of trusts created in wills, known as testamentary trusts.
If your estate plan includes a testamentary trust — or if you are a beneficiary or trustee of a testamentary trust — this new law is likely to have a detrimental effect on your existing estate plan and associated tax liabilities.
Current Tax Treatment
For many years, testamentary trusts have been integral elements of Canadian estate plans due to their beneficial tax treatment. Under the old tax law, testamentary trusts paid tax on their income at the same graduated rates as individuals. These rates range from 20 percent to 50 percent, depending on the province where the trust is resident.
Given this favourable tax treatment, it’s no surprise that testamentary trusts have long been a favourite of estate planners. In fact, some estate plans even include multiple testamentary trusts.
Flat Tax Rate Proposed
In the spring of 2013, the government proposed surprisingly drastic changes to this preferred treatment. After the consultation period, the 2014 budget included language that would eliminate the use of graduated tax rates after a three-year administration period, and would subject ongoing testamentary trusts to a flat tax rate equal to the combined federal and provincial tax rate for individuals. This represents the highest individual tax rates, which currently range from 39 percent to 50 percent, depending on the province in which the trust is resident.
To recognize the time required for a normal estate wind-up, the government is allowing a three-year period after the date of death. During this time, the estate would still be able to take advantage of the graduated tax rates. In addition, the graduated rates would still apply to testamentary trusts with beneficiaries who are eligible for the disability tax credit.
The 2014 budget also included other changes that negatively impact testamentary trusts. For example, testamentary trusts will no longer be able to designate investment tax credits to beneficiaries or claim the $40,000 exemption in computing the alternative minimum tax.
Testamentary trusts will also be required to have a calendar year-end for tax purposes, and will have to meet certain conditions to qualify as “personal trusts” and enjoy the tax benefits thereof. There’s some thought that the new law might also require testamentary trusts to pay quarterly tax installments in the future, a practice that has not been enforced to date for any trusts.
Note that there’s no “grandfathering” provision to protect existing testamentary trusts from the new tax law. The new treatment will go into effect in 2016 and will cover both existing and new trusts.
What to Do
While these changes further the government’s aim to prevent estates from “abusing” the advantageous tax treatment of testamentary trusts, they create potentially huge tax issues for existing estate plans. For this reason, it’s imperative to revisit your estate plan now.
If you have a trust in your will, arrange to meet with your tax and financial advisors to discuss these new rules and how they will affect you.
DJB can help you determine next steps for estate tax planning. Contact us today to set up a time to discuss your situation.