The Minister of Finance announced in today’s budget that the Harper Government will be implementing its proposal to significantly raise taxes on testamentary trusts, so that trusts created in a will or life insurance declaration will be taxed at the top marginal rates after the first 36 months, with the exception of trusts created for persons who qualify for disability tax credits.
This follows the Minister of Finance’s consultation, which ended very recently, on December 2, 2013, and which I wrote about here.
Contrary to the tenor of the Budget which implies that these trusts are used primarily to avoid income tax, testamentary trusts are important estate-planning tools in a number of circumstances that have absolutely nothing to do with saving taxes, such as providing for your spouse after your death, making provision for disabled beneficiaries, young adult beneficiaries, those with drug addictions, or those who simply do not manage money well. In a trust created in your will, you may appoint an independent person to manage funds for one or more beneficiaries, and that person may also have discretion about when to make payments to or for the benefit of beneficiaries.
For example, if you have a child with a drug problem, you may want to have funds set aside for that child without giving him control of them. One way to do this is to create a trust for that child in your will. The trust could allow accumulation of funds until those funds may be used to fund something such as rehabilitation or education, or until the child is not using, but under the new rules any income accumulated in the trust will be taxed at the highest marginal tax rate, even if it is only a few thousand dollars of income. Although the last thing you might want is for the trustee to simply pay all of the income to a beneficiary who will likely use it for drugs, the new budget gives a tax incentive to doing just that.
According to Annex 2 of the Budget:
Specifically, Budget 2014 proposes to apply flat top-rate taxation to grandfathered inter vivos trusts, trusts created by will and certain estates (including a number of consequential changes). Two exceptions to this treatment are proposed. First, as proposed in the consultation paper,
graduated rates will apply for the first 36 months of an estate that arises on and as a consequence of an individual’s death and that is a testamentary trust. This recognizes that estates require a period of administration and that estates are generally administered within their first 36 months. If the estate remains in existence more than 36 months after the death, it will become subject to flat top-rate taxation at the end of that 36-month period.
Second, during the consultation the Government heard from a number of stakeholders that the existing graduated rate taxation of testamentary trusts for the benefit of disabled individuals was an important tool in preserving access by these individuals to income-tested benefits, in particular provincial social assistance benefits. In response to these submissions, graduated rates will continue to be provided in respect of such trusts having as their beneficiaries individuals who are eligible for the federal Disability Tax Credit.More detail regarding the parameters of this exception will be released in the coming months.
I am pleased to see that the Government listened to concerns about the affect this tax increase will have on disabled beneficiaries, but the Government appears to have listened to very little else.
I have written before about the Canadian Bar Association, Wills and Estates section submission, and I have read a number of other submissions from other organizations and draft submissions from individual estate-planning lawyers who were concerned enough to take the time to write thoughtful comments for the consultation. Apart from concerns about trusts for persons with disabilities (and even then only those who qualify for the Disability Tax Credit), the Minister of Finance did not address any of the other concerns raised.
The Government is making a number of other changes, some of which will make estate administration more complex and costly. As set out in the Budget:
Also under this proposal, testamentary trusts (other than estates for their first 36 months) and grandfathered inter vivos trusts will not benefit from special treatment under a number of related tax rules, in particular:
• an exemption from the income tax instalment rules;
• an exemption from the requirement that trusts have a calendar year taxation year and fiscal periods that end in the calendar year in which the period began;
• the basic exemption in computing alternative minimum tax;
• preferential treatment under Part XII.2 of the Income Tax Act;
• classification as a personal trust without regard to the circumstances in which beneficial interests in the trust have been acquired;
• the ability to make investment tax credits available to a trust’s beneficiaries; and
• a number of tax administration rules that otherwise apply only to ordinary individuals. Tax Measures Supplementary Information
Testamentary trusts that do not already have a calendar year taxation year will have a deemed taxation year-end on December 31, 2015 (or in the case of an estate for which that 36-month period ends after 2015, the day on which that period ends).
This measure will apply to the 2016 and subsequent taxation years.
I have no idea what extra revenue these changes will bring to the Government, but I do know it will discourage good estate planning, and will impose significant costs, economic and social, on families. This is very disappointing.