Taxation of personal trusts

A trust is an arrangement under which a trustee holds property for the benefit of one or more beneficiaries. It can be created through your will at any time, including on death. Trusts are taxed as separate taxpayers. A trust created on death used to be taxed at the same rate as an individual while other trusts would be taxed at the highest marginal individual rate of tax (which now ranges from 44.5% to 54%, depending on the province or territory in which the trust is taxed). However, starting in 2016 new rules also assess the highest marginal rate of tax to trusts created on death.

These new rules provide that flat top-rate taxation applies to existing and new testamentary trusts for the 2016 and later taxation years. Exceptions exist for the first 36 months of certain estates (Graduated Rate Estates) and for testamentary trusts created for the benefit of disabled individuals who are eligible for the federal disability tax credit t (see topic 80).

Testamentary trusts that do not already have a calendar year-end will have a deemed taxation year end on December 31, 2015 (or the year in which the first 36-month period ends).

Flexibility in taxation

The income of the trust will be subject to tax, but there’s some flexibility in the determination of exactly who gets taxed. If the trust agreement requires the income to be paid to beneficiaries, the general rule is that the beneficiaries will pay the tax. But it’s possible to make an election to have some or all of the income taxed in the trust. However, new rules effective for 2016 and later years will limit the use of this election to circumstances where a trust uses tax losses from other tax years to reduce the trust’s taxable income to nil. Alternatively, the trust agreement may provide that the income stays in the trust for a set period of time. In this case, the general rule is that the trust will pay the tax.

Tax tip: Consider creating a trust to hold investments for the benefit of a child or parent with a physical or mental disability. If the trustee makes a preferred beneficiary election, the income can be retained in the trust but taxed in the hands of the lower income beneficiary. This reduces taxes while allowing the trustee to control the investments.

The 21-year rule

Under this rule, most trusts are deemed to dispose of all their property every 21 years for proceeds equal to the fair market value of the property.

Tax tip: If you’re the trustee of a trust that will soon be subject to the 21-year rule, you should contact your tax adviser to determine what strategies are available to avoid or defer the tax on the deemed disposition. If the trust document permits, it might be advantageous to transfer out of the trust to the capital beneficiaries the capital property with the accrued gains. If there are no accrued gains on the property, the 21-year rule is not an issue and the property can remain in the trust.