As I have mentioned in previous blogs, the 2014 Federal Budget introduced new rules for testamentary trusts. Beginning on the 1st of January 2016, testamentary trusts will be subject to top flat income tax rates. There are two important exceptions to this rule: one is a Graduated Rate Estate and the other is a Qualified Disability Trust (QDT).
As the name suggests, the QDT is a trust for a disabled person. To qualify, the trust must:
(1) be a testamentary trust, (2) be resident in Canada, and (3) have an electing beneficiary who is eligible for the Federal Disability Tax Credit.
So someone planning to use a QDT for a disabled child would need a trust in his will or in a life insurance trust. In the first year following the parent’s death, the executor or insurance trustee and the beneficiary child would have to file a joint election with Canada Revenue Agency, designating the trust as a QDT. If the child cannot make the designation herself, she may need a family member to become her guardian in order to make the election.
The electing beneficiary must qualify for Disability Tax Credit, meaning her disability must be severe and prolonged. A QDT can have any number of beneficiaries, as long as one of them is an electing beneficiary, but each electing beneficiary can have only one QDT. So, if a parent and a grandparent each leave a trust for the disabled child, only one of those trusts will be eligible for the lower tax rates. Or if a parent wants to leave a life insurance policy and her estate for a child, either the estate or the life insurance will be a QDT, but not both.
QDT trustees need to keep accurate records of income paid and retained in the trust. When the disabled child dies and funds remaining in the trust are distributed to other beneficiaries, the trust is no longer a QDT. The trust must pay a penalty called a recovery tax on income retained in the trust that received preferential tax rates in previous years. The calculation of recovery tax is complex and will require full records and a good accountant.
The QDT may assist some families planning for a disabled child. The eligibility is different than for “Henson” trusts set up to plan around the Ontario Disability Support Program, however. Add to that the complexity of the recovery tax, and the limitations of only one trust per beneficiary. Before making a plan for a QDT parents should carefully weigh the pros and cons with their advisors.