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Testamentary Trusts and Graduated Tax Rates: The End is Near

23/08/2013


Many of the tax plans we put into place for owner-managed businesses involve the use of income splitting. Income splitting allows a family group to take advantage of the lower tax brackets, deductions and credits available to each family member, particularly those that are making less income. Over the last few years, the Department of Finance has become concerned about the use of this method and has legislated a number of changes to make it more difficult to income split amongst family members (e.g. changes to the ‘kiddie tax’ rules, rate changes on personal service corporations, etc.)

To date, testamentary trusts have been a helpful tool for taxpayers to achieve income splitting, albeit on a post-mortem basis. These trusts are created when an individual dies for the benefit of another living person, generally a spouse, child and / or grandchild. For tax purposes, a testamentary trust has its own set of graduated tax rates. From a tax perspective, this is like having another family member to split income with. In B.C. this can result in tax savings of almost $18,000 when compared to an individual who is taxed at the high rate. This is different than an inter-vivos trust, which is set up while a person is alive and taxed at the top rate.

As outlined in the 2013 federal budget, the government indicated they will consult on measures to eliminate the tax benefit of graduated tax rates for testamentary trusts as well as grandfathered inter-vivos trusts. In June of this year, the government delivered on their promise by issuing a number of proposed changes to the tax treatment of these trusts and is inviting comments on these measures.

If you or your clients have been using testamentary trusts as part of an income splitting strategy, expect significant changes to be coming soon. The trick is to start planning for the worst now, and revisiting other income splitting tactics to minimize your exposure.

The proposed changes can be found on the Department of Finance’s website at: http://www.fin.gc.ca/activty/consult/grt-itp-eng.asp. The closing date for comments is December 2, 2013.