Family Trusts Face Higher Tax Rates
June 26, 2013
If your estate plan includes creating a trust in your will or you are a trust beneficiary or an estate trustee, you may be affected by the federal government’s proposals to tax certain trusts at a top tax rate rather than the lower graduated tax rates that some trusts currently pay, beginning in 2016.
How are trusts taxed?
Family trusts created by a will or estate have played an important role for many years in Canadians’ plans to pass on business and investment assets to their families.
Currently, estates and other trusts created in a will (testamentary trusts) pay tax on their income at the same graduated rates as individuals. The establishment of a testamentary trust under a will creates a “new taxpayer”, which can provide annual tax savings for the trust’s beneficiaries.
A spousal trust created in a will has another tax advantage — assets can be transferred in a will to this spousal trust without the deceased spouse having to pay tax on any capital gains that would otherwise be deemed to be realized on his or her death. This tax will be deferred until the surviving spouse dies. The principal conditions for a spousal trust are that only the surviving spouse is entitled to receive the trust’s income and no one other than the surviving spouse is entitled to the trust’s capital during his or her lifetime.
On the other hand, a trust that is set up during the settlor’s lifetime, known as an “inter vivos” trust, is treated differently. These trusts pay tax at a flat rate — the top rate of combined federal and provincial tax for individuals. This rate ranges from 39% to 50%, depending on the trust’s province of residence.
Testamentary trusts to pay tax at a top rate
The government announced its intention in the March 2013 federal budget to consult with stakeholders on possible measures to eliminate the tax benefits that arise from taxing testamentary trusts and estates at graduated rates, after a reasonable period of administration for estates.
The Department of Finance announced more detailed proposals in a consultation paper released in June 2013. Among other things, the proposals would subject testamentary trusts to tax at a flat rate equal to the top rate of combined federal and provincial tax for individuals.
Estates would also be subject to this flat top-rate taxation starting immediately after the 36 months that follow the individual’s death (top-rate estates). Estates could therefore retain access to graduated rates for up to the first 36 months of their administration.
These measures would apply to existing and new arrangements for 2016 and later taxation years.
The proposed measures would not change the preferred beneficiary election rules that apply to trusts for disabled beneficiaries or the rules that apply to trusts for certain minor children.
Also, these measures would not change the rollover rules that apply to spousal trusts and common-law partner trusts on the death of the first spouse or common-law partner.
Other tax changes for trusts
Along with applying the top tax rate to testamentary trusts and estates after 36 months, Finance proposes to change the way other tax rules apply to trusts.
Income tax installments
Alternative minimum tax
Taxation year and fiscal
Personal trust status
Unlike commercial trusts, personal trusts are eligible for special treatment — their beneficiaries are eligible for a rollover when they receive certain assets from the personal trust in satisfaction of their capital interest in the trust. As such, the beneficiaries do not pay tax on any capital gain until they dispose of the assets.
Tax administration rules for
· During which the CRA may refund an overpayment of tax
· For objecting to a tax assessment
· For filing an agreement to transfer forgiven amounts under the debt forgiveness rules, and
· During which, at the trust’s request, the CRA may reassess or make determinations in respect of certain income tax liabilities.
The proposed measures would limit the relief under these rules to estates that have not yet become top-rate estates.
We can help
Your KPMG adviser can help you assess the effect on your estate plans of the proposed changes to the taxation of trusts and point out ways to take advantage of any benefits arising from the changes or help mitigate their impact. For details, contact your KPMG adviser.
Information is current to June 25, 2013. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.
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