Monday, December 02, 2013

CBA Wills and Trusts Section Responds to Proposal to Tax Testamentary Trusts at the Highest Tax Rate

The National Wills and Estates Section of the Canadian Bar Association has submitted a response today to the Federal Department of Finance's proposal to eliminate graduated tax rates for testamentary trusts. The effect of the proposal would be that the tax rate on income retained in a testamentary trust, including trusts created in wills, would be at the highest tax bracket, a very large tax increase.

I have written about the proposal here, and the invitation to provide responses here.

The Wills and Estates Section has expressed its opposition to the proposed elimination of graduated tax rates, noting that this will discourage good estate planning. Testamentary trusts are employed for spouses during their lives with gifts of what is left to children, for disabled beneficiaries, for young beneficiaries, for beneficiaries with addictions, and for beneficiaries who don’t handle money well. In many situations it makes sense to allow trustees to accumulate income for the future in years when the beneficiaries do not require all of the income. The Wills and Estates Section points out that a high tax rate will discourage such planning.

Although the section opposes the proposed changes in its submission, it suggests ways of reducing the harm if the Government is determined to change the tax rate. One proposal is to allow income that is accumulated in a testamentary trusts to be allocated to a beneficiary, with the beneficiary paying the tax at the beneficiary’s marginal tax rate if certain conditions are met. This is set out as follows:

We suggest an election of general application, with restrictions to meet concerns that tax-motivated trusts would be created to allocate income to low income beneficiaries, which would ultimately be capitalized and paid to high income beneficiaries. To meet these concerns, the following criteria could be applicable to the trust:
1. A testamentary trust could be created for only one beneficiary during that beneficiary’s lifetime.
2. The trustee may have discretion to pay income or capital to the beneficiary, but no one other than that beneficiary would be entitled to any income or capital during the beneficiary’s lifetime.
3. On the beneficiary’s death, any capital or accumulated income could then be paid to the remainder beneficiary(ies) set out in the trust, or a beneficiary selected pursuant to a power of appointment.
This arrangement would be flexible to meet the circumstances described in the above examples, together with other circumstances that may be unique. In our view, this approach is preferable to pigeon-holing the beneficiaries and imposing arbitrary eligibility criteria, such as specific tests of disability or specific ages in the case of young beneficiaries.

The proposal would be in addition to the preferred beneficiary election for disabled beneficiaries, which I discuss in my post on the preferred beneficiary election here.

The CBA Wills and Estate Section urges that graduated rates be retained for testamentary spousal trusts, even if the rates are changed for other testamentary trusts, given the important role of spousal trusts in estate planning. As set out in the submission:

The loss of graduated tax rates for testamentary spousal trusts would in many cases lead to negative consequences for a surviving spouse, such as:
• OAS claw back.
• Loss of eligibility for long-term residential care subsidies.
Testamentary spousal trusts achieve significant planning goals in the family and society:
• protecting elderly or vulnerable widowed spouses
• addressing the complexity of blended family situations
• protecting assets in the event of remarriage or common-law relationships
• deferring the tax consequences of the death of the first spouse
• preventing the duplication of probate fees, and
• supporting and encouraging charitable intentions. 

The proposed elimination of graduated tax rates for testamentary spousal trusts will make estate planning in the best interests of the family and society more costly and therefore less likely to be implemented. The societal costs of this change, particularly in the seniors community, are difficult to calculate but are undoubtedly considerable and will impact a segment of society that can be particularly vulnerable to financial abuse.

You may read the complete submission on the Canadian Bar Association, Wills and Estates Section Website here. The submission also addresses the proposal to require testamentary trusts to have a calendar year end, and the proposal that the top rate begin 36 months after death.

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