Trusts that meet the definition of “testamentary trust” currently benefit from several tax preferences, including being taxed at graduated rates. However, in the 2013 Federal Budget, the government said that it was their intention to “consult on the potential introduction of measures that would eliminate the tax benefits associated with the graduated tax rates enjoyed by certain testamentary trusts”.
The 2014 Federal Budget introduced the framework for the changes contemplated by the government in the 2013 Federal Budget. The graduated tax rates on testamentary trusts will be phased out. Starting in 2016, the graduated tax rates on testamentary trusts will continue to apply, but only for the first 36 months. After this three-year period, testamentary trusts will be taxed at the highest tax rate. Unlike other tax initiatives, there will not be any grandfathering for trusts or estates established on or before the date of the budget. This three-year period should allow time for individuals to consider and implement changes to their estate plans.
One exception to this rule is situations where the beneficiary of the testamentary trust is eligible for the federal Disability Tax Rate. In such situations, the graduated income tax rates will continue to apply to the applicable trusts after the three year cut-off.
What does this mean? It means that individuals who have set up trusts in their wills (such as a spousal trust or a trust for minor children, for example), will need to review their wills and their estate plans with their estate planning advisor to understand what the changes to the tax rates could mean. While there are many purposes for establishing a trust in your will, the preferential tax treatment of testamentary trusts is often one of those purposes, and estate plans have often been set up specifically to take advantage of the preferential tax rules related to testamentary trusts. Because the changes will not be grandfathered, this means that the changes in the 2014 Federal Budget will apply to existing testamentary trusts that have already been established in wills by individuals who have not yet died.
The government has given us three years to deal with the changes to the tax rates. It could mean changing your estate plan, or it could mean leaving things as they are.
As noted above, the tax treatment of trusts established in a will is only one purpose of such trusts. Other purposes that could outweigh any potential tax savings include establishing a trust in your will:
- to benefit minor children and structure any payments to such minor children;
- for gradual release of funds to or for the benefit of a “spendthrift” beneficiary;
- to allow creditor proofing for vulnerable beneficiaries;
- to implement a plan to take into consideration blended families; and
- to provide for disabled beneficiaries.
Upon a review of your will and estate plan, it may be determined that the purposes for your trust outweigh any changes to the taxation rules for such trusts.
If you have a will, please take some time to review it, and contact your estate planning advisor to learn how these changes could affect you and your beneficiaries.
If you do not yet have a will, we would be happy to discuss how we can help you develop an estate plan appropriate for your current and future needs.