Make sure clients understand Graduated Rate Estates

Understanding the Graduated Rate Estate concept and its implications on tax and estate planning is critical to helping clients when new federal trust rules come into effect in January 2016.

Clients who have established trusts in their existing will(s) or have included gifts to registered charities as part of their estate plans may have to re-evaluate.

Under the new rules, someone’s GRE is an estate that arises on and as a consequence of his or her death. It must also be a testamentary trust, established no more than 36 months after death.

Read: Could GREs cause more complications for executors?

To ensure CRA treats the estate as a GRE, the person’s social insurance number must be on the estate’s first tax return and the estate must designate itself as a GRE in its first taxation year (no late filing allowed). It’s critical no other estate designates itself as the client’s GRE in its tax return.

Only one GRE can exist per person and it can only exist for 36 months from the date of death to allow for the estate’s administration. The GRE is only the estate itself, and doesn’t include any other testamentary trust that may have been created under a person’s will, such as a spousal trust.

Concerns to consider

The new rules take away graduated taxation rates for most other types of trusts, so they’ll instead be taxed at the top federal personal tax rate (29%), plus the top provincial or territorial tax rate. Designating a trust as a GRE avoids the top tax bracket for the first 36 months after death, allowing the trust to income split. Once 36 months are up, the top tax rate will apply if the estate still exists.

And, there are new estate rules that also come into effect January 1 to consider. Under existing rules, CRA deems a charitable gift by will or by beneficiary designation to have been made by the person, not the estate. An executor would claim the donation credits on the deceased’s final tax return, and if necessary, the return from the year prior.

Read: More flexibility for estate donations

The new provisions deem the gift by will or beneficiary designation to be made by the estate. The estate must claim the donation tax credit in the year the gift is given to charity. However, where the estate making the gift is designated as a GRE, the executor has the flexibility to claim the donation credits in either the year of death, the year prior, or in any of the three years the estate is a GRE. This only applies to GREs. All other estates are limited to claiming the donation tax credit in the estate or in any of the estate’s following five taxation years.

The GRE designation will also be critical for those who are donating publicly traded investments to charities through their estates. One of the key benefits of donating such securities is they’re exempt from capital gains tax, whether or not the donation occurs when someone dies. However, a technical amendment to the new estate donation rules says that this capital gains exemption is only available for deaths after 2015 if the estate is designated a GRE. Otherwise, if an in-kind donation of publicly traded securities or mutual funds is made to charity by the deceased’s estate, the estate or the deceased will be subject to capital gains tax.

Clients who own private corporation shares should also consider designating their estates GREs. Typically, capital loss carry back planning under subsection 164(6) of the Income Tax Act is used to minimize double tax that arises on the death of a shareholder when the shares are redeemed by the estate.

Read: Avoid double tax at death

This subsection allows an estate to carry back any realized capital losses incurred by the estate within the estate’s first taxation year to the deceased’s terminal tax year to offset capital gains incurred in the year of death. Under the new regime, the ability to take advantage of subsection 164(6) in these circumstances will only be available to estates that are designated as GREs. Any planning that involves redeeming private company shares by the estate must ensure that the estate that holds those shares is eligible for the GRE designation.

The requirement to have one estate designated as a GRE has raised great concern, particularly in jurisdictions that allow multiple wills, such as Ontario. Having multiples wills is a common strategy for shareholders of private corporations, for example. Earlier this year, the Department of Finance indicated that its expectation is that the taxpayer would only have one estate, meaning all of a person’s wills would fall under a single estate. Nonetheless, it will be critical for executors to coordinate the GRE designation when filing any estate tax returns to avoid losing GRE status.

The designation of the GRE will be a critical component for your client’s estate plans. Now may be the time to review those plans with your clients to ensure they remain effective under the 2016 regime.

Frank Di Pietro

Tax & Estate

Frank Di Pietro, CFA, CFP, is assistant vice-president of tax and estate planning at Mackenzie Investments. He can be reached at fdipietr@mackenzieinvestments.com.