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Possible Changes to Graduated Tax Rates for Testamentary Trusts

Subject: Testamentary Trusts and Estates Number: 13-11 Date: 8/2/2013

the tax and estate planning landscape will be significantly changed for many Canadians

As discussed in Tax Tip 09-24 a testamentary trust (a trust created upon death) is subject to beneficial tax rates on the income it retains (and does not pay out to beneficiaries in the year).  Such a trust pays the same graduated rates as apply to individuals, such as 15% instead of 29% federal tax (plus provincial tax) on the first $43,561 of taxable income (in 2013).  This is in contrast to a trust created during one's lifetime, which is subject to the highest rate (29% federal tax plus provincial tax) on all of its taxable income.

Currently, a deceased’s estate is given the same treatment as a testamentary trust, during the period after death until it is wound up.

The eligibility for graduated tax rates has made testamentary trusts a significant tool for tax and estate planners.  Following up on its comments in the 2013 Federal Budget, the Department of Finance (Finance) released a consultation paper on June 3, 2013 addressing its concerns that the graduated rate system for testamentary trusts is not fair and that it negatively affects government tax revenues.

Some of the tax planning opportunities Finance associates with testamentary trusts include:

1. The use of multiple testamentary trusts;
2. Tax motivated delays in completing the administration of estates; and
3. The avoidance of the Old Age Security Recovery tax.

In the consultation paper, Finance proposes, among other things, to eliminate graduated tax rates for testamentary trusts, as well as for estates, after the third year, if they have not been wound up by three years after the date of death.  These changes are proposed to apply to existing and new trusts from the 2016 and later taxation years.

The consultation paper states that the proposed changes for testamentary trusts will not change the preferred beneficiary election rules, or the rules that apply to trusts with minor children.  Nor do the proposals change the “rollover” rules that apply on the death of a spouse or common-law partner.  However, a testamentary trust will be required to use a calendar year end as will an estate that is not wound up within three years.  At present, testamentary trusts and estates can adopt non-calendar tax years, which can offer certain opportunities to defer tax.

Many organizations will be making submissions to Finance regarding the proposed changes, by the December 2, 2013 deadline; stay tuned.  If such proposals become law, the tax and estate planning landscape will be significantly changed for many Canadians, even if their estate plan has already been implemented.

Your TSG representative would be happy to discuss these proposals with you.

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The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.