In the 2013 Federal Budget, the Department of Finance announced that it was going to consult with the public on proposed changes to the Income Tax Act regarding the taxation of certain trusts and estates.
Currently, trusts that arise on the death of an individual, such as trusts created under a person’s Will and the estate of a deceased person (these are known as “testamentary trusts”), are taxed using the graduated marginal rates that individuals enjoy. By contrast, trusts created by an individual during his or her lifetime are taxed at the highest marginal rate regardless of the amount of income the trust earns. Because of the beneficial tax treatment given to testamentary trusts, there are some tax-saving opportunities using these testamentary trusts that estate planners regularly use.
The Department of Finance is proposing to amend the Income Tax Act so that, subject to some exceptions, testamentary trusts are taxed at the highest marginal rate applicable to individuals. This will impact much of the estate planning that is currently being done to take advantage of the existing favourable tax rates.
One of the unfortunate consequences of the proposed amendments is that leaving an inheritance to someone in trust (for non-tax reasons) instead of giving that inheritance outright may be penalized in the form of increased tax rates. For example, consider the situation in which a parent wants to leave a portion of his or her estate to a child who is struggling with a drug addiction. In this situation, there is often the concern that the child will use the inheritance to purchase drugs that will lead to an overdose and the solution is to leave the funds in trust so that they are managed by a trustworthy person and paid out to the child as and when appropriate. If the child receives the inheritance directly (i.e. not in a trust), he or she will be taxed on the income generated by that inheritance at his or her marginal tax rates; on the other hand, if the inheritance is left in a trust, the trust will pay the highest marginal tax rate on its income. Using a trust in these circumstances could, therefore, result in increased tax.
The proposed amendments are a significant shift in the current regime of the taxation of trusts and the Department of Finance is interested in hearing the public’s views on such amendments. The deadline for making those submissions is December 2, 2013. For more information, please see the Consultation Paper at www.fin.gc.ca/activty/consult/grt-itp-eng.asp
Melodie Lind can be reached at (250)869-1210 or at [email protected]
