Testamentary Trusts and Taxes - Presley & Partners - Presley & Partners

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Testamentary Trusts and Taxes

August 15th, 2017

testamentary_trustTestamentary trusts, unlike inter vivos trusts, are formed by wills and executed when an individual dies.

A trust is a legal structure that allows you to separate the control and management of an asset from its ownership. Trusts involve relationships between three different parties:

  • The settler, who sets up the trust, contributes the first assets and sets the instructions on how to manage the trust and who will benefit from it;
  • The trustee, who controls and manages the assets; and
  • The beneficiaries, who benefit from the assets.

 

The transfer of the assets to the trust is known as the trust settlement.

Trusts can be either:

Discretionary, where the trustees decide who will receive the distribution from the trust, or

Non-discretionary, where the distribution is made according to the trust agreement.

Testamentary Trusts

A testamentary trust is a trust or estate that is generally created on the day a person dies. The terms of the trust are established either by the will of the deceased or by provincial or territorial court order.

Testamentary trusts do not include any trust created by anyone other than the deceased or a trust created after November 12, 1981, if any property was contributed to it other than by an individual as a consequence of the person’s death.

If the assets are not distributed to the beneficiaries according to the terms of the will, the testamentary trust may become an inter vivos trust.

Advantages

Income splitting: Despite the kiddie tax rule, you can still split interest income received from arm’s-length parties and certain other forms of income with a minor.

Taxes: Currently the income of a testamentary trust is taxed at marginal rates so it has significant advantages if the beneficiaries are already taxed at high marginal tax rates. Income splitting between the trust and beneficiaries allows the beneficiaries to reduce taxes significantly.

Beginning in 2016, flat top taxation is scheduled for estates in taxation years that end more than 36 months after death and all grandfathered inter vivos trusts and testamentary trusts created by will. There is an exception aimed at ensuring graduated-rate taxation that continues to apply to trusts with disabled beneficiaries. In addition there are several other exemptions, including the:

  • Elimination of the exemption from the calendar year as a taxation year requirement: The new rules provide that existing testamentary trusts and estates that have existed for longer than 36 months, and that have off-calendar year-ends will have a deemed year-end as of December 31, 2015.
  • Elimination of the exemption from tax installment requirement.
  • Charitable donations treatment: For 2016 and subsequent years there will be more flexibility to the tax treatment of charitable donations made in the context of death after 2015. Donations made by will, and those made by Registered Retirement Savings Plans, Registered Retirement Income Fund, Tax Free Savings Accounts or life insurance policies will no longer be deemed to be made by the individual immediately before the individual’s death.

 

Instead, these donations will be deemed to have been made by the individual’s estate at the time the property actually transferred to the qualified donee within 36 months after death. The trustees can choose the year in which the donation was made so it can be the year of death, an earlier taxation year or the individual’s last two taxation years. The current annual limit will continue to apply.

Only one testamentary trust (even if there are several mentioned in the will) and usually the estate itself is the only trust eligible for graduated rate estate treatment for the 36 months.

Setting up trusts can be complicated so be sure discuss your needs with your accountant.