Major changes affecting estate planning and testamentary trusts were recently made to the Income Tax Act. These changes were enacted by Bill C-43, the 2014 Budget second bill, passed in December 2014. They take effect January 1, 2016, and will apply to all testamentary trusts as of 2016, regardless of when the death occurred.
If you have a Will, and especially if the Will creates a trust (known as a “testamentary trust”), then you need to have it reviewed in light of these changes, as estate planning done before 2014 may no longer “work” for tax purposes.
For over 40 years, and still until the end of 2015, testamentary trusts have been eligible for special tax treatment in a number of ways. For example:
- Most notably, a testamentary trust pays tax at the same “low” graduated rates on low amounts of income as individuals (though the personal credits are not available). An “inter vivos” trust (created during one’s lifetime), by contrast, must pay tax at the top marginal rate (29% federal tax on all income, plus the top marginal rate for provincial tax).
- A testamentary trust can choose a non-calendar year-end for tax purposes, thus deferring tax for its first year.
- Certain losses in a testamentary trust can be carried back and claimed on the deceased’s final return.
- A testamentary trust can “flow out” certain amounts, such as pension benefits, death benefits and deferred profit sharing plan benefits, so that favourable tax treatment of these benefits is available to the beneficiary. For an inter vivos trust, these payments are simply trust income and do not keep their character (and associated favourable tax treatment) in the beneficiary’s hands.
There are numerous other tax benefits as well, relating to Alternative Minimum Tax, late refund claims, extended deadline for filing a notice of objection, instalment obligations, flow-out of investment tax credits to beneficiaries, and others.
Starting 2016, all these benefits are available only to a “graduated rate estate”, which is essentially the deceased’s estate for the first 36 months after death (provided the estate files a designation with its first tax return).
So if your Will creates any trusts, the tax effects will change substantially starting 2016, and your Will may need review. In some cases it will be better to remove the provisions creating the trust, and let the estate benefit from low tax rates for up to 36 months. Also, if your estate’s affairs are tied up for any reason (e.g. due to litigation) so that the estate cannot be wound up within 36 months, the estate’s income after that point will be subject to high rates of tax.
There are other changes to the trust rules as well. Advice from a professional familiar with estate planning will normally be required in considering changes to your Will.
Note also that existing testamentary trusts that do not use the calendar year will have two taxation years in 2015 and will be required to file two returns, since they will be forced into a December 31 year-end.