The Federal Minister of Finance has announced an increase in taxes for income in excess of $200,000 to 33% for federal income tax. Unfortunately, this will have the effect of further raising rates on income earned in a trust, including trusts created in wills. This will exacerbate the problem of taxing trusts including trusts earning modest investment income at what I would describe as a punitive tax rate.
As I have written before, the previous Conservative government implemented a significant change in the way testamentary trusts (those that arise on death, usually created in a will) are taxed. Up until this year graduated rates were available for income earned in testamentary trust. Beginning this year, graduated rates are available for an estate for up to 36 months, but income earned in the trust will be taxed at the highest marginal rate, unless it is paid to a beneficiary, in which case, the trust can deduct the income, and the beneficiary then includes the income in his or her tax return. Income earned in trusts that were not testamentary has been taxed at the highest rate for decades.
Although there is relief available from the top tax rate in some cases for testamentary trusts if a beneficiary is entitled to a disability tax credit, in other cases testamentary trusts created for socially beneficial estate planning are caught by this high tax rate. For example, a parent may create a trust for the benefit of her son, who has been addicted to drugs. She may be concerned that if she leaves an outright inheritance to him, that he may relapse, and use his inheritance to feed his addiction. Instead, she creates a trust for him, appointing another family member or friend as trustee, and gives the trustee the discretion to pay income or capital to him or for his benefit. Because income earned and taxed in the trust is taxed at the top rate, if the son relapses, the trustee will face the choice of either paying income to the son and risk that it will feed his addiction, or paying a high rate of tax on the income accumulated in the trust.
In addition to the 33% federal tax, trusts have to pay provincial taxes, which vary from province to province. In British Columbia, the combined top rate will be 47.7% in 2016, but in some other provinces the top rate may exceed 50%.
The Minister of Finance announced the new top rate in conjunction with a reduction of the rate of income tax in a lower income bracket from 22% federal tax to 20.5%. This reduction of course will benefit many tax payers, and will to some extent ameliorate the increase for those earning over $200,000 (they will pay more on the excess, but less on that part of their income that falls into a lower tax bracket. But there is no similar relief from tax for trusts, because all of the income is taxed at the top rate.