As I get older, I’ve found that my clients and I seem to talk more and more about retirement and estate planning. Since no one wants to leave their loved ones with a problem, it’s a good idea to make these plans well before you think you need them.
If your estate plan includes creating a trust in your will or you are a trust beneficiary or an estate trustee, you may be affected by the federal government’s proposals to increase the tax rate for certain trusts, beginning in 2016. These trusts will be taxed at a top tax rate rather than the lower graduated tax rates that some trusts currently pay.
Do the trust proposals affect you?
- Do you have a will?
- Does your will create a testamentary trust or a spousal or common-law partner trust?
- Are you now or will you be a beneficiary of a testamentary or spousal trust?
- Are you a trustee for a testamentary trust?
- Are you an executor of an estate?
If you answered yes to any of these questions, you should revisit your will and estate planning to reflect upcoming tax changes and to ensure your plans will still accomplish your objectives for minimizing taxes and leaving as much as possible to your beneficiaries.
How are trusts taxed?
Family trusts created by a will or estate have played an important role for many years in Canadians’ plans to pass on business and investment assets to their families.
Currently, estates and other trusts created in a will (known as testamentary trusts) pay tax on their income at the same graduated rates as individuals.
The establishment of a testamentary trust under a will creates a “new taxpayer,” which can provide annual tax savings for the trust’s beneficiaries.
A spousal trust created in a will has another tax advantage—assets can be transferred in a will to this spousal trust without the deceased spouse having to pay tax on any capital gains that would otherwise be deemed to be realized on his or her death.
This tax will be deferred until the surviving spouse dies. The principal conditions for a spousal trust are that only the surviving spouse is entitled to receive the trust’s income and no one other than the surviving spouse is entitled to the trust’s capital during his or her lifetime.
On the other hand, a trust that is set up during the settlor’s lifetime, known as an “inter vivos” trust, is treated differently.
These trusts pay tax at a flat rate—the top rate of combined federal and provincial tax for individuals.
Testamentary trusts to pay tax at a top rate
The government announced its intention in the March 2013 federal budget to hold consultations on possible measures to eliminate the tax benefits that arise from taxing testamentary trusts and estates at graduated rates, after a reasonable period of administration for estates.
The Department of Finance announced more detailed proposals in a consultation paper released in June 2013.
Among other things, the proposals would subject testamentary trusts to tax at a flat rate equal to the top rate of combined federal and provincial tax for individuals.
Estates would also be subject to this flat top-rate taxation starting immediately after the 36 months that follow the individual’s death.
Estates could therefore retain access to graduated rates for up to the first 36 months of their administration.
These measures would apply to existing and new arrangements for 2016 and later taxation years. The rollover rules that apply to spousal trusts and common-law partner trusts on the death of the first spouse or commonlaw partner would not change.
Along with applying the top tax rate to testamentary trusts and estates after 36 months, Finance proposes to change the way some other tax rules apply to trusts as well.
The many changes anticipated to the taxation and administration of trusts dictate that you should discuss any such changes with your professional advisor to review the tax-effectiveness of your current estate plan. The rules are changing—“ trust” me!