New Estate Tax Rules Impact Trusts, Trust Beneficiaries and Estate Trustees
In December 2014, the federal government passed legislation that has important implications to those who have an estate plan that includes the creation of trusts, trust beneficiaries and/or estate trustees.
When a Canadian individual taxpayer dies, a testamentary trust is created for tax purposes. Traditionally, income earned by the estate prior to the distribution of the estate assets is taxed within the trust. The ability to benefit from graduated tax rates have been the primary motivating factor behind using testamentary trusts. Like individual taxpayers, testamentary trusts have access to the same graduated rates and other benefits spanning the life of the trust. Starting January 1, 2016, certain trusts will be taxed at the top marginal rate rather than the lower graduated tax rates. The top marginal rate in Ontario is approximately 46%. These changes will affect trusts significantly, both past and future. There will be no grandfathering. What this means is, that existing trusts and new testamentary trusts will be deemed to have a year‐end on December 31, 2015, and from then on, they will also be subject to tax at the highest marginal tax rate. There are two exceptions to these changes:
1. Graduated Rate Estates: Once a testamentary trust has been designated a Graduated Rate Estate (GRE), it will be taxed at graduated personal tax rates for the first 36 months after the date of death of the individual. A GRE will also be able to maintain an off calendar year end for the first 36 months.
To qualify as a GRE: Subsection 248(1) of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), as amended and in force as of December 31, 2015, (the “Act”) defines a graduated rate estate (“GRE”) as an estate that arose on and as a consequence of an individual’s death if:
- no more than 36 months has passed since the date of death;
- the estate is at that time a testamentary trust;
- the individual’s Social Insurance Number (or if the individual had not, before the death, been assigned a Social Insurance Number, such other information as is acceptable to the Minister) is provided in the estate’s return of income under Part I for the taxation year that includes that time and for each of its earlier taxation years that ended after 2015,
- the estate designates itself as the graduated rate estate of the individual in its return of income under Part I for its first taxation year that ends after 2015, ; and
- no other estate designates itself as the graduated rate estate of the individual in a return of income under Part I for a taxation year that ends after 2015
2. Qualified Disability Trusts: A Qualified Disability Trust (QDT) will be taxed at graduated personal tax rates provided the trust has been created for the benefit of a disabled beneficiary and the beneficiary qualifies for the federal disability tax credit. What is important to note here, is that only one discretionary trust per disabled person will qualify for marginal tax rates. If there are more than one trusts set up for the benefit of one disabled person, the trustees of all the trusts must collectively determine which trust will elect to be considered a Qualified Disability Trust (QDT).
If the Estate Trustee takes longer than 36 months to distribute the estate, the estate will lose its access to the graduated personal tax rates. When the 36 months ends, the estate will pay income tax on any amounts taxed in the estate at the top marginal tax rates. The year-end for the estate must be December 31.
In terms of the income tax treatment of trust income deemed “payable” and “not payable,” trustees will no longer be able to elect to include in the trust’s taxable income amounts that were paid or made payable to a beneficiary. Any amounts paid or made payable from a trust must now be included on the beneficiary’s tax return, except when the trust has a balance of capital or non-capital losses carrying forward. In this instance, a trustee can elect to retain an amount equal to the losses in the trust’s taxable income (to ensure any losses incurred by a trust can be used to offset taxable income).
Another significant consequence to these legislative changes is that capital gains arising in “spousal” trust (or “alter-ego” trusts and “joint-partner” trusts) on the death of the beneficiary individual after 2015 will be deemed to be payable, and therefore taxable, to that individual as opposed to the trust itself. This may be particularly important in situations such as second marriages or in blended families where the beneficiaries of the deceased individual’s estate are not the same as the ultimate beneficiaries of the trust.
The advantages to having multiple wills have now become even more pronounced. The idea behind multiple wills is that the primary will would be intended for “probate” and therefore subject to the Estate Administration Tax and the secondary will would deal with assets that could be transferred without the need to apply for a Certificate of Appointment of Estate Trustee With a Will (“probate”) and therefore without the need to pay the Estate Administration Tax on the value of those assets. Typical assets that may be dealt without probate include but not necessarily limited to: shares in privately held corporations, assets held in trust for the testator by private corporations and amounts owing to the testator from private corporations, beneficial interests of the testator in a trust, unsecured loans owing to the testator and certain real property interests.
The income tax treatment of multiple wills is something to keep in mind. As long as the executors or estate trustees of each will are the same, it is the CRA’s view that for tax purposes, there is one trust. Thus, during the first 36 months of the estate administration, any income not distributed, will be taxed in the trust at the marginal rates as a GRE. However, if either the primary or secondary will call for a trust longer than 36 months, any income that is not paid out to a beneficiary will be taxed at the highest marginal rate, whether it becomes an asset in the primary or secondary estate.
|Mike D’Aloisio||Kristina Kang|