Testamentary Trusts
Testamentary trusts are created as a consequence of the death of the testator in accordance with the testator’s will. The terms are set out in the will and determine the timing and quantity of distributions to each beneficiary.
Unlike inter vivos trusts and life interest trusts that are subject to a flat highest marginal rate of tax applicable to individuals, testamentary trusts are subject to marginal rates applicable to the individuals. Availability of this graduated tax rate is restricted to the first 3 years of the existence of the estate (Graduated Rate Estate or GRE), other than an estate for a disabled beneficiary. After 3 years the trust is subject to the highest marginal rate of tax.
Take Advantage of Graduated Rate Estate
The GRE designation of a testamentary trust brings key benefits such as:
- Access to the lower marginal tax rates;
- Simpler and more flexible donation rules;
- Postmortem tax planning in the context of ownership of private company shares – the ability to reduce the potential for double or even triple tax on death. With proper planning, when the corporation is wound up, the estate could end up with a capital loss and pay a tax-free dividend to the beneficiaries of the estate. That type of tax planning is not allowed for non-GRE estates under what is known as stop-loss rules.
Proper estate planning can lead to large income tax savings, particularly for shareholders of private company shares.
Do not lose the GRE status
If a GRE loses its status as a testamentary trust, the GRE status will be lost along with the benefits. Without proper planning, a testamentary trust can be tainted by actions such as another person contributing to the estate which could happen if a beneficiary borrows money from and then re-contributes to the trust or the trust borrows money from related persons to pay the deceased’s debts.
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