Bad News on Trust Taxation
Families of deceased fare poorly in budget
Finance Minister Jim Flaherty delivered his 10th, and likely last, federal budget on Tuesday. In spite of the gold rush from our Olympic athletes threatening to drown out this news, he still got lots of attention.
On the personal tax front, there are some tinkering improvements that affect limited numbers of people, which I will list later.
However, most of us in the tax and advisory community were hoping for good news on the taxation of testamentary trusts. What we got was clarity, but bad news.
From now on, any income earned within testamentary trusts will be taxed at the top tax rate rather than at the graduated tax rates that have applied until now. This top rate will also apply to estates after their first 36 months of existence and to "grandfathered" inter vivos trusts. (Don't worry -- if you have one, you know it.)
The only good news is they listened to us and provided an exemption for trusts that are for the benefit of a disabled person.
To explain, testamentary trusts are ongoing trusts created out of an estate, which are described in a person's last will and testament but only come into effect after that person dies. These trusts could be for the benefit of a spouse, children, grandchildren or other people.
Until now, these trusts were taxed like a regular taxpayer, with the low, middle and top tax rates applied, depending how much total income was earned by the investments in the trust. The trust did not get the benefit of the personal exemption, however, which allows each of us to earn about $10,000 tax-free each year.
There are lots of reasons to create these trusts other than the tax benefits. They keep inherited assets separate from marital property, so they are not included in the property division if the beneficiary suffers a marriage breakdown in the future.
The trust arrangement can be very valuable for young beneficiaries, those inexperienced with money management, potentially under the influence of another person, or to protect beneficiaries who have gambling, compulsion or addiction issues.
The potential tax benefits certainly made this arrangement more attractive, so this was a strategy we always considered with our high-net-worth clients.
In the first three years after death, an estate will still be allowed the benefit of the graduated tax rates, and we recommend taking advantage of this. …