Tax Changes to Testamentary Trusts

Testamentary Trusts are a valuable tool used in estate planning – they allow individuals to financially protect their beneficiary (such as a spouse or a child), they provide the testator with the ability to control the use of the trust funds, and in the past, they have provided for significant tax savings. Prior to 2016, testamentary trusts received preferential tax treatment as they were treated as individual taxpayers and earnings from invested trust funds were taxed on graduated marginal rates. Commencing in 2016, and as a result of changes to the Income Tax Act, testamentary trusts will now be taxed at the highest federal personal tax rate of 29%.

There are exceptions to this new rule. Qualified Disability Trusts and Graduated Rate Estates will continue to be subject to graduated tax rates. A Graduated Rate Estate is any testamentary trust in the first 36 months after the date of death of the testator. This means that for the first three years of a testamentary trust, the trust will benefit from the lower graduated rates, and after the 3 years, the 29% taxation will begin to apply.

In light of these important changes, which do not allow for existing trusts to be grandfathered, estate plans involving testamentary trusts should be reviewed.