Canada Estate Planning Attorney

Question: I am a Canadian who is looking for information to help me with my estate planning. What kind of planning is involved if my primary goal is to protect my beneficiaries from having to pay significant estate taxes?

Answer: You might consider the benefits of a testamentary trust. These trusts have special treatment under the Canadian Income Tax Act.

Like all trusts in Canada, a testamentary trust is a legal relationship between the grantor (in this case, the deceased), a trustee and the beneficiaries named in the trust. Upon the death of the grantor, a testamentary trust is set in motion through a will. Income to the beneficiaries can be provided through payments or transfer of capital – or both.

The trustee is the executor of the will and the trust. The trustee owns the property (i.e. bank account, stocks, bonds, real estate, etc) held in the trust and controls it. The beneficiaries own an interest in the trust, but have no decision-making authority. This responsibility is granted to the trustee who makes all decision regarding investments, preparing tax returns, etc.

The "T" Word

A testamentary trust is considered a separate entity (taxpayer) under the Canadian Income Tax Act. The trustee files an income tax return that lists income and disbursements to the beneficiaries. The year-end for the trust does not have to coincide with the calendar year.

Testamentary trusts often receive favorable tax rates in Canada, especially if the assets are income producing. These trusts pay taxes using a graduated rate on income retained in the trust. Therefore, it is advantageous to retain income and gains in the trust. For example, a trustee can elect to have income and gains taxed under the umbrella of the trust even if these amounts have been paid to the beneficiary. Depending on the beneficiary's tax situation, he or she might receive substantial benefit under this scenario because their income from the trust would be taxed at a graduated rate and not at the higher rate they would pay under ordinary income (assuming they have substantial personal income). Therefore, a portfolio worth $750,000 and earning $60,000 in income at 8% per year $60,000 might realize $8,500 in tax savings each year at current (2009) rates.

Some Special Canadian Estate Planning Considerations:

In Canada, all assets are disposed of at fair market value upon the death of the grantor. The capital gain could be significant, which would result in a high capital gain tax within the grantor’s estate. Therefore, in order to maximize the benefits of a testamentary trust, it is important that all of the assets in the trust be owned by the grantor at death.

Probate tax must be paid on the fair market value of the assets that are a part of the trust. The probate tax is usually offset by potential income tax savings in the first year. As an example, probate tax in Nova Scotia is currently approximately 1.3%. In our sample portfolio of $750,000, this would total approximately $9,750. Canadian tax law includes a “21-year Deemed Disposition Rule”. The rule states that all assets in a trust must be settled and disbursed if additional capital gains are to be avoided. Similarly, the "Rule Against Perpetuities" prohibits assets from being held in a trust for an indefinite period unless the trust qualifies as a charity.

Costs Associated with Testamentary Trusts

Administrative costs can be significant for these types of trusts. The trustee has responsibilities that include filing tax returns, investment planning, and other duties set forth under the trust agreement. Weighing these associated costs against the tax benefits are an important consideration.

You may be looking for online links to a Canada estate planning attorney directory. There’s a great one at Canada Estate Planning Directory.

If you are in the US, but have Canada estate planning questions, you probably would benefit from advice from an estate planning attorney.

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