The usual rule for an inter vivos trust is that it is taxed at the top marginal rate. This could significantly eat into trust assets, especially if there is income on investments. With Henson Trusts, the settlor names a trustee who is responsible for managing the money. Since the trust should provide for a beneficiary for their lifetime, the money needs to last. Thus, you need a disability planning option that has favorable tax treatment. This is what you get with a Henson Trust.
Trustees Must File a Yearly Tax Return
First, you should know that a trust is its own separate legal entity when it comes to filing a tax return. The trust income would not be accounted for on an individual tax return. Instead, the trust files its own tax return each year. If you are considering a Henson Trust, you should also hire an accountant for the annual tax returns. It is the trustee’s legal responsibility to make sure that the return is filed and that all of the required tax is paid.
Trusts Must Qualify for Favorable Tax Treatment
Favorable tax treatment under a Henson Trust is not automatic. The beneficiary must meet certain legal criteria, and they must be prepared to prove it to the authorities. If they meet requirements, the trust income is taxed at their tax rate, which will be much lower than the top marginal tax rate. This will mean that trust income can largely remain in the trust and will be there to provide for the beneficiary when they need it.
One legal criteria that will allow the Trust to receive this favorable tax treatment is that the Trust makes an annual election to be designated as a Qualified Disabilities Trust (QDT). This would mean that the trust is taxed at the same rate as the beneficiary. Here are some of the requirements for being able to use a QDT designation for tax savings:
- The beneficiary must be eligible for the Disability Tax Credit. This credit has its own unique eligibility criteria that are separate from the criteria of receiving benefits.
- The beneficiary for the tax treatment is the same beneficiary designated for the trust.
- The beneficiary can only make a QDT election for this Henson Trust and not for any other trust.
- The beneficiary must live in Canada throughout the year.
Note: The QDT does not apply to inter-vivos trusts, but only to testamentary trusts.
A QDT Is Not Automatic
Many people assume that a Henson Trust would automatically qualify as a QDT because it is meant for the benefit of a beneficiary. Don’t make that mistake. In fact, the QDT designation is not always easy to achieve, and many Henson Trusts do not qualify for this. However, you should not worry that not qualifying for a QDT designation would harm the beneficiary’sability to receive benefits. The two use different tests.
Also, note that we said above that the beneficiary must make the election. Many beneficiaries are not able to manage their own financial affairs. When that is the case, a court-appointed guardian may make the election on behalf of a child or someone who is incapacitated.
Preferred Beneficiary Election
There is another way of qualifying for more favorable tax treatment, and that is by using a preferred beneficiary election. This must be jointly filed by the trust and the preferred beneficiary. Of course, the beneficiary will be assisted by the person with power of attorney over their affairs. Here are some of the requirements to use the preferred beneficiary election:
- If the beneficiary does not qualify for the DTC, they must be physically or mentally infirm.
- The beneficiary does not have income that exceeds the federal basic personal amount.
- The beneficiary must have one of a number of certain legal relationships with the trust settlor.
Make Sure to Consult a Henson Trust Lawyer in Ontario
As you can see, there are a number of considerations that go into planning and electing for a Henson Trust. When you are considering disability planning options, you should consult with a Henson Trust lawyer to learn the rules of this valuable instrument. You could learn of the benefits of a Henson Trust and how it could fit your particular situation. You would also need to speak with an accountant so that you are aware of the tax laws and how they affect your trust.
Canadian taxation laws that apply to trusts are always changing. There was a recent overhaul of these laws back in 2016, although they did not necessarily affect the power of Henson trustees. Nevertheless, you should always learn about the most recent tax laws and any possible future changes. The difference between a favorable tax treatment and having to pay top marginal tax rates can be considerable.
