3 fixes for clients’ trust woes

In my last column, we explored some of the key estate-planning problems arising from rule changes introduced by the previous government. In January, the Department of Finance released draft legislation that would fix three key problems and introduce other beneficial changes.

Fix #1: Tax liability on the death of the life interest beneficiary under spousal, joint partner and alter-ego trusts remain with the trust.

As enacted, subsection 104(3.4) of the Tax Act deems there to be a year-end at the end of the year of death of the life interest beneficiary. It also deems that the life interest trust’s income for the year (including amounts deemed realized as of the result of death) to have become payable to the life interest beneficiary in the same year, resulting in the income being included in the life interest beneficiary’s final return. The problems with this were numerous.

Thankfully, the draft legislation released will essentially undo the enacted legislation and put things back to where they were prior to the changes. This will allow for proper post-mortem loss carry back planning relating to these trusts.

When thinking about insurance to fund the ultimate tax liabilities, it’s important to consider recent CRA comments regarding the ownership and premium payment relating to insurance held by such trusts. CRA has said that if the trustee either has the duty or the ability to pay premiums under a policy held by the trust under which it is the beneficiary, this taints the trust so that the rollover of capital property into the trust is not permitted.

Fix #2: Charitable donations by the life interest trust can offset income deemed to arise on death of the life interest beneficiary.

The draft legislation also permits a life interest trust to allocate, within 90 days after the calendar year of death, the eligible donation amount made by the trust to the trust’s return for the year of death. This will allow the charitable credit to be used in the year where there may be a large income inclusion resulting from the deemed disposition on the death of the life interest beneficiary.

Fix #3: Estates that have gone beyond the 36-month period of the GRE can enjoy the tax benefits of charitable gifts.

Finance recognized that an estate may have trouble making charitable gifts within the 36-month period of a GRE. That may happen if a charity is a residual beneficiary of an estate and there is litigation regarding the estate or if the gift of a specified sum to charity must come from the sale of an illiquid asset, such as private company shares or even liquid assets that are at their lowest values with no recovery in sight in the near term.

The draft legislation will permit an estate that would otherwise meet the requirements to be a GRE, but that has exceeded the 36-month period, to carry back charitable tax credits to the deceased’s terminal and prior-year return so long as the gift is made within 60 months (5 years) of death.

In addition, the nil inclusion rate (in respect of the deemed disposition on death) applicable for gifts of publicly listed securities and ecological gifts, and no capital gain on cultural gifts, are tax benefits to the deceased that will also be able to be enjoyed in these circumstances.

This additional flexibility is a welcome relief. There will be some lingering concern where significant estate litigation is in progress but the lengthened time period will help to alleviate this to some degree. It still may be a good strategy to provide charitable gifts using insurance where a charity is designated as beneficiary directly.

In general, life insurance claims are paid promptly upon receipt of all claims documents—normally well within any 36- or 60-month period. Like gifts made by an estate, gifts by direct designation can be carried back to the terminal and year-prior return of the deceased.

Florence Marino

Insurance

Florence Marino is Assistant Vice-President, Tax, Retirement and Estate Planning Services, Retail Markets, at Manulife.