Important changes are coming into effect this winter in the world of trusts. The majority of us think we have little or nothing to do with this world, and thus can ignore these changes. However, we all die one day, and upon our passing a trust likely will be created in our absence: a testamentary trust. You may be involved presently with testamentary trusts extant, or your own will may create one, or in the future you may be the beneficiary or executor involving one. .. and so you may need to pay attention to these changes.
Presently, a testamentary trust will receive your assets upon death, if they have not been bequeathed using joint tenancy and/or designated beneficiary elections. Normally, this trust exists for the short duration of time that it takes for your executor to execute your will. Sometimes the will stipulates that a long term trust, or trusts, will be created from the testamentary trust. Historically, the tax system has provided a “tax goodie” to create this kind of trust—by way of enjoying a favourable tax rate structure and the ability to have a non-calendar year-end. That soon will be gone, effective January 1, 2016.
For testamentary trusts created from deaths after December 31, 2015
The executor needs to designate the trust as a graduated-rate estate (GRE). This allows the old tax treatment for up to, and no longer than, 36 months after death. If the trust continues after that, the GRE status is lost and the trust must convert to a calendar year-end starting in that year, and pay any trust taxes at the top tax rate, not at the marginal scale.
If the deceased created multiple wills, thus each one creating its own testamentary trust, only one such trust can be designated as a GRE. Note that, if this estate strategy with multiple wills involved multiple beneficiaries and executors, some conflict may arise as to who enjoys the one GRE status.
For testamentary trusts already existing on December 31, 2015
These trusts effectively are grandfathered for the new 36 month rule after death. Three fiscal years may be filed enjoying the marginal rate scale, even if this carries on past December 31, 2015. In the calendar year in which the third year is completed, the trust must file a stub-year to prorate to December 31st of that year, and pay tax at the top rate going forward.
For testamentary SPOUSAL trusts already existing on December 31, 2015
These trusts will have an immediate impact. Their pre-existing fiscal year-ends must convert, by way of a 2015 stub-year, to December 31st. The trust will pay taxes at the top marginal rate, commencing with the 2016 trust tax year.
Long term trusts that are created from a testamentary trust are not eligible to be designated GREs. As such, they fall into the December 31st year-end regime and pay tax at the top rate. There is a element of time “control” here where such trusts are created out of the testamentary trust because the executor will decide when the assets are moved from the temporary trust to the long term trust.
The core impact of this new law is to shut down long term access to the marginal rate scale for long term trusts created out of a will. This alone invites review of long term estate strategies. However, two things must be kept in mind. First, the trust income can be allocated out annually to the beneficiaries, and taxed instead at their marginal rates. Second, retaining wealth in these long term trusts may serve to control this wealth until the beneficiaries come to financial maturity.