Successful entrepreneurs understand how important it is to adjust to a changing business environment. When their customers’ demands shift they know they have to adapt quickly or suffer the consequences. But this intense focus on their businesses sometimes comes at the expense of neglecting their estate. That’s a mistake at any time, but particularly now due to new provisions to the Canadian tax code that will soon kick in.
The new tax rules are part of the federal government’s efforts to crack down on the perceived abuse of testamentary trusts and the entrepreneurs who attempt to take advantage of the preferential tax treatment that shielded them from double taxation by using multiple trusts. The new amendments are so broad they might even force you to redesign your entire estate plan, even if you think it is up-to-date.
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As a result, tax-savvy business owners will only be allowed to use a single graduated rate estate, which could possibly throw their existing estate plans into disarray and expose their beneficiaries to potentially higher tax liabilities. While this is a complex area of tax, entrepreneurs need to act now to address significant issues that can arise depending on the size and structure of their estate.
This will have significant implications for tax-conscious entrepreneurs and their family members when these changes take effect January 1, 2016. Anyone with a will that creates a testamentary trust to benefit a spouse or partner, anyone who is an estate executor, or anyone who is the beneficiary of a trust, or who has established an alter ego or joint partner trust, could potentially be hit by this change.
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Two of the most important features of the new legislation from a tax-planning perspective include a curb on the graduated taxation of testamentary trusts and changes to spousal, alter ego and joint partner trusts.
Testamentary trusts have been used as effective tax-minimization tools in the past due to the fact that the income earned within them has been taxed at a graduated rate. Under the new rules, any income earned in these same trusts will be taxed at the maximum federal tax rate of 29%, which when combined with provincial taxes will see total rates range from 39% to 50% depending on the jurisdiction. Those managing testamentary trusts will also be required to remit quarterly tax instalments—adding an extra layer of administrative complexity and, potentially, cost—and will lose the $40,000 exemption from the Alternative Minimum Tax, thereby increasing their potential tax burden.
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Furthermore, under the new rules all taxes related to trust income or capital gains triggered by the death of a spousal beneficiary in a spousal trust, or a settlor in an alter ego trust, will be payable by the beneficiary’s estate directly. That’s a break from the past where taxes were paid by the trust itself.
The implications can be severe for the estate, which may not have the funds to cover these unexpected tax liabilities. To make matters worse, the Canada Revenue Agency has legal authority to recover taxes directly from trustees—many of whom will lack the necessary funds to cover these charges
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While there isn’t much you can do to make testamentary trusts more tax efficient under the new rules—other than limiting your plan to include one graduated estate—you should immediately have your will reviewed to assess the impact of the new legislation. Even the most carefully developed estate plan could require a major overhaul once these new changes take effect.
Case in point: You may be unaware of the many issues that could arise on death, such as double taxation. Because an estate plan, like a financial plan, is highly customized to the circumstances of the individual entrepreneur, next-steps will vary. But you should be prepared to:
- Reassess your entire personal financial infrastructure to locate any tax inefficiencies
- Embrace new strategies to maximize tax efficiency
- Invest the time and expense to re-write your will, if necessary
And remember: most tax issues can be addressed if you plan ahead. If not, these liabilities could potentially cost your beneficiaries more in taxes depending on the size of the estate they inherit.
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While tools such as testamentary trusts could still be effective for tax minimization—through tactics such as income splitting that pays trust income to low-income beneficiaries, for example—designing an effective strategy will require a customized approach that takes into account your personal financial circumstances, as well as those of your prospective beneficiaries.
My advice is to sit down with your tax advisor and review your estate plan before these measures are implemented. Thinking and acting proactively always makes more sense when it comes to personal and professional finances—especially when your family’s financial future could be on the line.
Armando Iannuzzi is a tax partner at Kestenberg Rabinowicz Partners LLP, a Markham, Ont.-based firm that provides strategic tax, accounting and finance services to entrepreneurs.
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