Estates and Trusts are subjects most clients don’t truly understand in terms of the implications and responsibilities related to handling an estate & it’s beneficiaries . There are some upcoming changes to the taxation of estates and trusts – here is a brief primer on how these work and what changes to be aware of.
Once we leave from this earth, a testamentary trust is established (ie. The Estate of John Doe) and in some cases, people have opted to establish multiple trusts in order to accommodate their chosen beneficiaries and individual circumstances. All of our assets pass to this trust(s) on death and then are distributed to all of our beneficiaries by our designated executor based upon our wishes covered in our will. We can’t stress it enough – please make sure you have a will and it is up to date.
From a tax filing perspective, we file a personal income tax return for the calendar year up until the day we pass. Thereafter, if there are income generating assets remaining in a trust (even for a short period of time until given to a beneficiary), a trust return is required to be filed for the estate in order to report the income earned and assess any related income taxes. These trust returns are required to be filed annually up until such a time as all income generating assets are transferred out of the trust’s ownership. We have had several clients who have accepted the role of executor for loved ones and are unaware of this requirement.
Historically, testamentary trusts were taxed based on graduated tax rates for all filing years, exactly the same as individuals (ie. the more income you earned, the higher the marginal tax rate.) We are sad to say this all changes on January 1st, 2016. The Canada Revenue Agency is now initiating a change that will permit only one trust per taxpayer to qualify for these graduated tax rates and only for a 36-month period following death. This legislation presumes that this timeline will, in the majority of cases, allow adequate time for executors to appropriately disperse and settle estate assets.
After that time period has passed, any income generated from testamentary trusts will be taxed at the highest tax bracket which nears 50% at present. There is an exception to this rule if the trust is established for a beneficiary who is a disabled relative.
You may now be asking….how does this change impact me? Let’s give you a couple of examples to ponder. This change will impact anyone who has identified their desire to have multiple trusts created upon their passing as only one of them qualifies for the graduated tax rates. What if you have three children and your will presently states that there will be a separate trust formed for each child upon your death? Which child’s trust will get the graduated rate and which two will be paying tax at the highest tax bracket if they want to keep the assets in the trust? You can see how these changes can give rise to some family discourse down the road. We would suggest being proactive and although no one likes to discuss and review their will, it could save some family conflicts after you are gone. Ensure you review your will and consider amending it if it currently makes mention of multiple trusts being created upon your death.
Also, for those who committed to a friend or family member to be their executor upon passing, take heed of this change and the 36-month time line. Three years sounds like plenty of time to settle one’s estate, but sometimes there are roadblocks encountered that add to this process whether it be time to process through probate, delays in the collection of life insurance proceeds for one reason or another and in some cases court proceedings that crop up out of the woodwork as remaining friends and relatives dispute estate distributions. This timeline adds a further degree of pressure for executors to act in the best interest of the estate and ensure that as much of the estate’s proceeds are distributed as intended without the tax man getting an unexpected share.
This change can also impact bequests to registered charities after your death and the tax benefits of doing so. The new trust and estate taxation rules present a more flexible tax treatment provided the transfer to the qualified charity is done within this 36-month timeline.
There are transitional provisions for testamentary trusts already in existence and vary depending upon the date of death. We can help guide you through those provisions should they apply to you.
As we say, knowledge is power and we hope that passing along the information regarding this legislative change as part of Bill C-43 has been helpful to you. If you require any further information as to how these changes may impact your personal circumstances, please feel free to contact us.