Author: Doug

EstateWISE – Taxation of trusts

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. 

EstateWISE – Executing a valid Will

Accepting that a Will is a necessary component of a well-considered estate plan, what steps should or must be taken in order to assure that the Will is validly executed? 

Let’s start with the person making the Will – Who can do that?

  • These comments are generally applicable in the common law provinces, but Quebec may be different as it is governed by Civil Code.
  • The person who makes or executes the Will is called the testator, and that person must understand …
    • the nature and effect of a will
    • the nature and extent of his or her property
    • what is being given under the will, and the relative entitlements of beneficiaries
    • the persons who may be expected to be beneficiaries under the will, and 
    • the potential claims of those who may be excluded from the will. 

Assuming we then have a capable testator, what is the most common form of Will?

  • An “attested Will” is a witnessed Will, and therefore it has that independent evidence to rely upon
  • The testator must sign or execute it at its end
  • There must be two or more witnesses present when the testator executes, and
  • The witnesses must then sign the document in the presence of the testator and one another

If that’s the most common form, is there then an uncommon form?

  • Most jurisdictions will allow a “holograph” Will which is entirely in the person’s own handwriting, and without any particular formalities.  
  • In an emergency this may be the only alternative, but as soon as there is time then an “attested Will” should be prepared.

So if I want to be careful and have an “attested Will”, can anyone be a witness?

  • Generally a witness should not be a beneficiary, executor or trustee, or spouse of any of those people — or for that matter, it should not be anyone who might derive an actual or perceived benefit out of the Will, or otherwise from the testator
  • Using independent witnesses helps avert claims of duress, undue influence, or other concerns about the testator’s state of mind at the time of the execution
  • The risk is that some or all of the Will may be rendered ineffective
  • If the Will is executed under a lawyer’s supervision, these concerns and risks are far less likely to come about 

EstateWISE – What is a trust?

The word trust is a common verb  in the English language.  As a noun, it is one of the greatest creations of English common law that has been around for centuries.  

What is a trust?

  • A relationship among four elements:
  • Settlor – The original owner who creates or ‘settles’ the trust
  • Trustee – New legal owner who makes all decisions to manage the property
  • Beneficiary – New equitable owner who will eventually get the property and earnings
  • Property – Can be any property that anyone might own personally

Why would someone settle a trust?

  • The separation of legal and equitable ownership can have many benefits
  • For minors, allows a more mature person to manage property and delay its distribution until some time beyond the age of majority
  • For the mentally incapable disabled, it will allow a capable person to manage the property and can assist in preserving social support payments now or in future
  • For those with creditor problems, it could insulate against creditor claims
  • For ‘over-spenders’, the settlor could control the purse strings 
  • In addition, any of these uses can be a tax-advantaged structure if created using a Will

So if I have one of these situations, how do I create a trust?

  • Legal requirements are that there be three certainties
    • 1) that it be clear who is to be the beneficiary/ies
    • 2) that the property subject to the trust is ascertained
    • 3) that there is no doubt of the intention  

Is there any particular phrases or procedures necessary

  • It is best if a written trust declaration is used 
  • Can be done at anytime while a person is living — an inter vivos trust
  • Can also be done in a Will — a testamentary trust (can reduce taxes)
  • If there is no written record, there may still be a trust but it may not operate the way the settlor may have intended