This is the first of a series blogs dealing with the changes to the Income Tax Act treatment of will trusts in the 2014 budget.

Under the existing rules, if a will (or a gift of life insurance) created a trust, it could qualify as a testamentary trust. This was important because the trust would get lower tax rates on its income; instead of paying the top marginal rate (which has hovered around 46% in Ontario), the income in a testamentary trust could be taxed at rates as low as around 20%. On $10,000 of income, that split amounted to a roughly $2600 a year saving. It’s no wonder, then, that planners were advising will makers to use testamentary trusts to reduce the tax their children (or other beneficiaries) would pay. It’s also no wonder that the Minister of Finance looked at shutting down what some perceived as a tax loophole.

But many people used trusts in their wills for reasons other than saving taxes. For example, someone with young or immature beneficiaries would want funds held until they were old enough to manage for themselves. Someone with a disabled child would create a trust to prevent the child losing his provincial disability benefits. Someone who wanted to have the capital go to charity eventually might create a charitable remainder trust. And someone in a second marriage might use a trust to look after her second spouse, but make sure the money went eventually to her own children.

In all of these situations, the tax changes in the 2014 budget create problems. The new regime has done away with graduated rates for testamentary trusts, and replaced them with a new “graduated rate estate”, with lower rates, but just for the first three years after the death of the will maker. As a result of the changes:

• Funds set aside in a will for adult children will be subject to higher taxes, in many cases even if the child is disabled;
• Spouses of a second marriage may have to pay from their own estates for the taxes generated by income they will never receive; and
• Donors will pay a premium to make a gift to a charity if the gift is not made within the first three years after death.

I’ll be writing more about all of these issues in future blogs, but meanwhile, if you see yourself in any of these scenarios, you should visit your lawyer soon. The new rules come into effect on the 1st of January 2016