In the 2014 Budget, the government has greatly curtailed the benefits of using testamentary trusts to split income and take advantage of graduated tax rates. However, testamentary trusts are still valuable in lots of situations to solve problems or create opportunities.
Graduated Rates for Testamentary Trusts Get Zapped
In 2013, the Harper Government warned it was considering measures to effectively end a popular income splitting tactic using testamentary trusts, and on February 11, 2014, it made good on its threat. The graduated tax rates which apply to testamentary trusts will in future only apply for the first 36 months of an estate, and thereafter, the trust will be taxed at a flat rate equal to the top personal rate of tax.
Until now, we could set up testamentary trusts for adult children in a Will what would allow the children to indefinitely use the testamentary trust as an investment vehicle taxed at the graduated rates, but with graduated rates only being available in the future for 3 years, the value of tactic is largely eliminated.
At least for the testamentary trusts which we have set up for our clients, this change does not require them to rush out and change their Wills. So long as they continue to have the intention to benefit their children, the testamentary trusts which we used for this purpose included an easy-to-use “exit” clause for flexibility, enabling these trusts to be easily unwound by their children at the end of 36 months.
Testamentary Trusts are Still Useful and Valuable
The end of graduated tax rates for testamentary trusts does not relegate testamentary trusts to the scrap bin. There are still lots of great planning reasons to use testamentary trusts. When I counsel business owners and clients generally concerning their estates, we have an eye out for situations and opportunities where testamentary trusts solve client concerns and problems, save money or control risk. Some of these situations include:
→ trusts in a Will let you tailor the management and control of assets to the special circumstances of your family; for example, to protect a disabled child, or a child who has a record of mismanagement of property
→ these trusts are very effective at protecting assets from a beneficiary’s marriage break-up, or from a beneficiary’s creditors
→ testamentary trusts let us time the flow of funds to children by, for example, postponing the age at which children can get control. Postponement of benefits to age 25 are very common, and in larger estates, staged distributions at 25, 30, 35 or even longer are not unusual
→ for my many clients who are business owners, testamentary trusts (as well as inter vivos family trusts) keep open the ability if they should die to multiply the $800,000 capital gains exemption for shares in their qualifying active businesses
→ also for other business owners, testamentary trusts contained in “Secondary Wills” can hold shares of their controlled corporations, which opens up the possibility of timing dividends to the testamentary trust to coincide with beneficiary’s financial needs without catching the full bite of a flat tax at the highest personal rates after 36 months.
Some Other 2014 Budget Tidbits for Trusts
The 2014 Budget had a couple of other surprises for testamentary trusts. They will no longer be exempt from the installment rules, so if as a result of some poor planning, your family is subject to top rates in testamentary trusts after 36 months, installment payments will have to be made. Also, testamentary trusts will have to adopt a December 31 year-end beginning December 31, 2015.
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