A Glimpse at the Tax Proposals for Testamentary Trusts

In the 2013 Federal budget, the government announced a review of the income tax provisions with respect to testamentary trusts. On June 3, 2013, the Department of Finance released a consultation paper that outlines proposed changes to the taxation of testamentary trusts. This consultative process gives Canadians the opportunity to review the proposals and provide the Department of Finance with feedback and input by December 2, 2013.

The Department of Finance considers that changes are necessary to “level the playing field” by eliminating what it views as an inequity in the current trust regime. By initiating the consultative process with a series of proposed changes, the Department of Finance is indicating the direction it wants to follow.

One of the most significant changes is the proposal to apply flat top-rate taxation to all existing and new testamentary trust arrangements starting in the 2016 taxation year. A significant tax advantage for testamentary trusts and grandfathered inter vivos trusts (pre-1971 inter vivos trusts) under the current rules is that trust income is subject to tax at the same graduated rates applicable to individuals. As such, individuals can currently structure their wills to leave their family the opportunity for income splitting among several testamentary trusts and surviving family members.

Since testamentary trusts are treated as separate taxpayers, a testamentary trust can retain some of its income and pay tax based on graduated tax rates. With planning, the beneficiary can split income with the testamentary trust and realize a positive tax savings every year. However, if adopted, the proposed new flat top-rate tax means the end of the graduated tax rates for testamentary trusts, with the exception of a short window of time for new estates.

The proposal would allow estates to continue to be taxed based on the graduated rates, but only for a reasonable period of time. The proposal allows a maximum of 36 months as the period during which an estate could utilize graduated tax rates, following which the estate becomes subject to the flat top-rate on all income. The rationale behind “36 months” is to provide the estate’s executor with sufficient time to administer and wrap up the estate, with assets being passed on to the beneficiaries.

The proposal confirms that the intention is for the transfer of assets from the deceased to a testamentary spousal trust for the benefit of the deceased’s spouse to continue on a rollover (tax deferred) basis. The rollover allows a deceased spouse to pass property to a qualifying spousal trust for the benefit of the surviving spouse on a tax-deferred basis.

The proposal contains a number of other related tax measures:

  • Testamentary trusts will be subject to the same income tax instalment rules as individuals. Currently, testament trusts do not need to make instalments with respect to their income tax liability.
  • The $40,000 exemption in calculating alternative minimum tax will no longer be available to testamentary trusts. This means testamentary trusts could be subject to alternative minimum tax more often.
  • Testamentary trusts will have to use the calendar year for their taxation year. Currently, testamentary trusts can choose a year-end at any time in the first 12 months following the death of the testator. The proposal did not comment on the application of the ability of an estate to carry back a capital loss to the testator’s terminal tax return.

The intent of the proposals, in the view of the Department of Finance, is to level the playing field by eliminating tax preferential treatment afforded to testamentary trusts under the current regime. If passed into law, the proposals will significantly change several estate planning strategies from a tax perspective. It is, however, important to note that while tax planning opportunities will change, testamentary trusts will continue as planning vehicles that can facilitate testators’ wishes for their beneficiaries.

Change is inevitable. The Department of Finance is inviting comments with respect to the proposals. It is important for individuals and groups to take the opportunity to comment.

E.O. & E.

Disclaimer:

This commentary is published by the Institute in consultation with an editorial board comprised of recognized authorities in the fields of law, life insurance and estate administration.

The Institute is the professional organization that administers and promotes the CLU and the CHS designations in Canada.

The articles and comments are not intended to provide legal, accounting or other device in individual circumstances. Seek professional assistance before acting upon information included in this publication.

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(The Institue”), CLU, CHS, FHF.C and APA are trademarks of the financial advisors Association of Canada (TFAAC).

The institute is a wholly-owned subsidiary of Advocis. Copywrite TFAAC. All rights reserved. Unauthorized reproduction of any images or content without permission is prohibited.

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Contributors to this edition:

James W. Kraft, cpa, ca, mtax, tep, cfp, clu, ch.f.c.
Deborah Kraft, mtax, tep, cfp, clu, ch.f.c.

About The Author

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Mark Schneider
Mark Schneider is one of Canada's leading Chartered Financial Planners. For over 30 years he has helped hundreds of regular Canadian families grow small fortunes through consistent planning and wise advice. He holds the following designations: CFP, CLU, CHFC, CFSB

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