Until 1988, the Income Tax Act required that any income earned by an estate be allocated to beneficiaries after the first two years. In 1988 the Act was amended to permit estates and trusts to pay income taxes within a trust. As a result, testamentary trusts (trusts established by your Last Will and Testament) have the potential to permit your beneficiaries to save substantial amounts of income tax long after your death.
Many couples have arranged their affairs so that they are able to split their income during their lifetime. For example, if each spouse had taxable income of $30,000.00, their total tax would be $9,009.28. If one of the spouses died, the surviving spouse would have taxable income of $60,000.00 and the tax bill would be $15,622.74. If the assets were left in the estate so that the estate generated taxable income of $30,000.00 per year, and the surviving spouse continued to pay tax on his or her regular income, the saving, by splitting income with the estate, would be approximately $3,018.10 per year. The higher the income of the couple, the greater the saving. If, for example, both spouses have taxable incomes of $50,000.00, the saving by income splitting is approximately $7,527.92 per year. Not only does income splitting with the estate reduce tax, but by reducing the survivor’s income it may also prevent the clawback of Old Age Security. These savings are available to all other beneficiaries as well.
If you are a very high income earner, it is possible to establish multiple trusts so as to multiply the number of times a taxpayer can take advantage of the graduated rates of taxation on the first $31,000.00 of taxable income. For example, if a spouse’s taxable income was $50,000.00 and the tax payer’s taxable income was $125,000.00, and if all the income went into the name of the surviving spouse on the death of the taxpayer, the total tax bill would be $57,069.61 per year. If left to a multiple trust, which the surviving spouse could access, the annual saving in income tax would be close to $11,428.12 per year!
A testamentary trust will is also used to create testamentary family trusts for surviving children who already have taxable income. If left to a separate trust for each child or beneficiary, the child could choose to shelter the income in the trust to take advantage of the lower rates of taxation, or even allocate income to one of his or her own children to avoid paying any tax whatsoever! If the child ever needed the capital, he or she could wind up the trust and remove the funds.
