This blog post was written by Melissa Plunkett, Director, Scotiatrust

Over my almost twenty-five-year career in the trust industry, I have seen a lot of clients who have settled trusts for protection – protection of assets and protection of the beneficiary.  Over the course of this past year, with all the Alternative minimum tax (AMT) changes, proposed changes, proposed changes that did not go through, and more changes, I’ve waited to see what the result would be for 2024 and what AMT would do to these trusts.  Of all the trusts I’ve seen, one really stands out in my memory – the trust that Betty* settled for her son.

Betty’s is a sad story.  She passed away unexpectedly in 2014, but in 2008 her parents were killed in a car accident.  As their only child, she received a settlement of $ 750,000.  Betty was a single mother to a 17-year-old son who had been diagnosed with a degenerative condition that would eventually see him dependent upon others for his care.  Betty’s sole objective for the settlement was to ensure it would be available to support her son when the time came.  It was 2008; we talked to Betty about waiting and settling a testamentary trust rather than an inter-vivos trust, but Betty needed the comfort of knowing the trust was in place, and no one could take that money away.

The trust was settled in late 2009, with discretionary access to income and capital until her son reached the age of 21, at which time the income became payable.  The capital is to accumulate and is only assessable when needed for the beneficiary’s medical care.

This trust has issued a T3 tax slip to Betty’s son for the past several years, but given his health has remained stable, the capital has been accumulated and taxed in the trust.

Will this trust be subject to AMT?  Is this the type of trust the government was targeting when they changed the AMT rules?

As trustee, we did what I think most did in June 2024, we crystalized the accrued capital gains in the trust, triggering about $80,000 in gross capital gains.  The trust earned its income from its portfolio, which was all paid to the beneficiary and will be reported on a T3 tax slip to be taxed in his hands.  The trust had about $12,000 in other capital gains throughout the year.  This leaves the trust with a taxable capital gain of $46,000 and, in Ontario, total income taxes payable of almost $30,000.  That’s a 65% effective tax rate for 2024 and an 11% increase in the effective tax rate between 2023 and 2024.  Of this amount, almost $5,100 is AMT.  Yes, we can carryforward the AMT for seven years and apply it in a future year when the regular tax is greater than the AMT, but that’s unlikely to happen in this trust.

So, what happened?  How did this trust find itself with a 65% effective tax rate?

Certain types of income, like capital gains and Canadian dividends are given preferential treatment under regular income tax rules.  For this reason, the net was widened for AMT; the AMT tax rate increased to 20.5% from 15%, and under the new AMT rules, capital gains realized and taxed in the trust will see 100% of the capital gain included in income for AMT purposes (as opposed to the 80% inclusion rate previously).  Furthermore, for this trust, because we don’t have discretion to allocate the capital gains to the beneficiary and we expect to retain the capital gains and accumulate for years to come (as long as the beneficiary’s health remains stable), there may be little chance of any recovery of the AMT paid. To add insult to injury, this beneficiary has a modest income, and receives all the income earned in the trust, but he has no other sources of income, meaning his personal exemption from AMT will go to waste every year.

While I understand the new AMT rules are designed to ensure high income earners and trusts pay a minimum amount of tax, I would argue Betty and her son were not the intended target taxpayers for these changes and sadly, I think there are a lot of Bettys and sons out there.  These are people who have or will, I think, be victims of the widened AMT net, inevitably leading to many trust clients asking to reevaluate the benefit of trusts at all.  It will be incumbent on our industry to remind clients that trusts of this nature continue to provide the protection and safeguard the nest egg for the reasons initially intended, even if it costs more tax every year to do so.

** names changed to protect the privacy of our client.