The Tax Tail On Testamentary Trusts

Beginning 1 January 2016, with a few exceptions, testamentary trusts with graded tax rates disappear.  There can be one for 36 months and they can exist longer for disabled beneficiaries.

Many planners are disappointed because this was a very easy and reasonably effective way to reduce income taxes.  With graduated rates, the trust essentially became another taxpayer.  Income splitting is always a good thing where the jurisdiction has higher rates on higher income.

Testamentary trusts were a way to create taxpayers “at will.”  (The devil made me write that.)

While few are pleased at the loss of the trusts and the attendant tax saving, many are choosing to forgo trusts in their will without thinking through the other advantages.

O’Sullivan Estate Lawyers in Toronto recently produced a thoughtful piece.  You can see it here.  Their point is that the trust dog has value even without the tax tail.  In particular:

  1. Minimize future probate costs.  Capital in a trust escapes probate when the beneficiary passes on.
  2. Concern over creditors of the beneficiary.
  3. Family law issues.
  4. The profligate heir defense.
  5. Some further matters regarding disabled heirs.  Avoiding ODSP loss being one concern.

Trusts are bespoke legal inventions made to fit your specific situation.

People who have such trusts in their wills may find that with the tax advantage gone, their will can become more simple.  Trusts can be more general as the need to avoid some of the old tax strictures becomes unimportant.

People who think through the possibility of trusts and their value in the will may come to a place where they can see the benefit, not only of testamentary trusts, but also of inter-vivos trusts.  While income earned by these would all be taxed at the highest marginal tax rate, that is of little consequence if the income would have been taxed at that rate regardless, or if it could be distributed to lower rate beneficiaries.  The trusts could provide other family wealth building advantages.  Massed financial punch being an important one. Dynasty trusts are becoming more common.

As the O’Sullivan firm points out, the tax change may be the impetus to revisit the full spectrum of benefits available through trusts. 

Try not to dismiss trusts without further thought.

Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

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