Testamentary Planning – The Power of a Dollar

“This creative estate planning technique can create a legacy of significant tax savings..”

A person need not always have a great deal of wealth in order to create substantial tax savings for a child or someone else who will be a beneficiary of the estate.

Advisors commonly suggest that high net worth clients create testamentary trusts in their Wills since such trusts provide significant tax savings.  This planning should be considered for less wealthy clients.   Similar tax benefits can be created where an estate contributes the mere sum of one dollar to a testamentary trust created for the estate’s beneficiaries.  This is particularly true where the testamentary trust can then use the one dollar to acquire shares in a family business corporation.  Consider the following example:

Mrs. A has a son with a successful business but Mrs. A does not have her own wealth.  In her Will, Mrs. A provides that one dollar be contributed to a testamentary trust for the benefit of her son, daughter-in-law and their children.

The son could then perform an estate freeze of his family business whereby the son’s common shares would be exchanged for “freeze” shares.  The testamentary trust created in Mrs. A’s Will could then use its one dollar to acquire 100 new common shares in the capital stock of the frozen business.  If these steps are taken, all future growth and rights to dividends on the new common shares will accrue to the trust.

Income earned by a testamentary trust can be taxed within the trust at its progressive marginal tax rates. Although the amount varies by province, the trust could earn $35,000 to $40,000 of dividends annually, and pay little or no tax.  This amount could be in the $50,000 area if the dividends are received from the corporation’s general rate income pool.  Mrs. A’s son could not have achieved this result if he performed his own estate freeze since an inter-vivos trust, which does not receive the benefit of marginal tax rates, would be required.

Since the income is being taxed in the trust, no income is viewed to be allocated to a beneficiary so the “Kiddie Tax” will not apply if there are minor beneficiaries.  Income attribution is not a factor, as the contributor to the trust is deceased (but the corporate attribution rules must be considered). The after-tax earnings of the trust can be distributed to the capital beneficiaries tax free.

The potential tax savings can be multiplied if Mrs. A’s Will creates a separate trust for each potential heir.

Properly executed, this creative estate planning technique can create a legacy of significant tax savings.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

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