A trust is a common structure used in estate planning to hold property, but it is not a legal entity. It is nonetheless a taxable entity, and may present some interesting tax advantages.
Who is responsible for the payment of a trust’s taxes?
- The trustee is required to manage the trust property for the beneficiary, and part of that responsibility is to maintain tax records and to file tax returns when required.
- In fact, it is the residence of the trustee, not the beneficiary, that determines the province that holds taxing authority over the trust property.
- If the trustee is in another country, in principle that country has tax authority … but the field of offshore trusts is a very complicated discussion beyond what we are addressing here.
For a trust resident in Canada then, how is it taxed?
- The main distinction one has to make is whether the trust is “inter vivos” or “testamentary”
- An “inter vivos” trust is one settled during a person’s lifetime, and it is taxed at the highest personal marginal tax rate of the province where the trustee is resident, which can approach 50%.
- On the other hand, a “testamentary” trust is generally created out of a person’s Will and is taxed like an individual except that it does not get personal credits.
- Other than that, it is entitled to marginal tax bracket treatment so that it is taxed at roughly 20% on its first $30,000 or so of income and that tax rate creeps up to the top provincial rate as the trust’s income approaches about $115,000.
Can you give an example of how a testamentary trust can be used to tax advantage?
- A husband dies and leaves his GIC portfolio directly to his wife (in Ontario).
- She’s a doctor and already has a taxable income of $120,000.
- Every dollar she earns in the portfolio will be subject to her personal tax rate of about 46%.
- Had the husband instead set forth a trust in his Will with his wife a beneficiary, the early income of the trust would have been taxed at about 20%, and would not have reached 46% until well over $100,000 of investment income. There would be $10-15,000 tax savings every year.
Does this only work for those with such large income?
- Essentially if the income of the beneficiary and the income in the trust together break over a marginal tax bracket (as low as $35,000) then there may be an opportunity to save taxes.
- The costs of setting this up can be as little as adding a few paragraphs to your Will — but make sure you have your lawyer do it because if it is done incorrectly it may be treated as an inter vivos trust or it may be collapsed immediately thus losing the tax benefits.