New complications for trust planning

Estate planning has become much more complicated now that the Department of Finance has passed legislation to implement some 2014 federal budget measures.

Now, all trusts, except Graduated Rate Estates (GREs) and Qualified Disability Trusts, are subject to the top tax rate on income retained in the trust. These rules take effect for the 2016 taxation year and onward, and there is no grandfathering.

Tax practitioners expected these changes based on the budget’s language, but the final legislation added several unexpected provisions, resulting in potential snags. Let’s look at how the provisions affect GREs.

Read: The importance of post-mortem planning

What’s a GRE?

An estate can be a GRE if it’s a testamentary trust in the first 36 months after death. (If the trust still exists 36 months after the testator’s death, it no longer qualifies as a GRE and will generally be taxed at the highest marginal tax rate.) Once an estate designates itself a GRE, none of that person’s other estates can make the same designation. The first taxation year in which the designation can be made is the one that ends after 2015. Each year, the GRE-designated estate will need to include a reference to the deceased’s social insurance number (SIN) in its return. If no SIN is available, the estate will have to file other information; the finance minister hasn’t yet said what that might be.

An existing trust can qualify as a GRE starting in its first year-end after 2015, provided it hasn’t existed for more than three years since the person’s death.

Read: Alternatives to testamentary trusts

A GRE’s benefits include:

• access to graduated tax rates;
• the availability of an off-calendar year-end to give more time for tax planning, especially in the first year after death; and
• the ability to pay tax in a lump sum at year end, as opposed to paying installments throughout the year.

Estates that stop being GREs are deemed to have a year-end immediately prior to the date they cease to qualify. So, if an estate stops being a GRE on April 1, 2019, it’s deemed to have a year-end on March 31, 2019. The estate’s next year-end is December 31, 2019. Existing estates that don’t qualify as GREs, but have a year-end other than December 31, will have a deemed year-end of December 31, 2015, creating two year-ends in 2015. So, the estate will have to file two returns in 2015.

When does someone have multiple estates?

Historically, primary and secondary wills have been used for probate planning in Ontario and B.C. In such cases, one usually deals with assets subject to probate (e.g., real estate, non-registered portfolio investments) and the other with business assets, which are not subject to probate (e.g., shares and loans of private corporations).

Read: Is that trust resident, or non-resident?

Regardless of whether the executors and beneficiaries of both wills are the same, up until now, the assets under both wills have generally been considered as only one estate, and would give rise to only one GRE. It’s not clear whether two wills with different executors (as required in B.C.) or different beneficiaries are considered two different estates. The new legislation’s wording appears to open that door, which means only one of the two potential estates could be designated as a GRE.

Reasons the GRE designation is important

Only a GRE can qualify for the benefits we’ve mentioned.

More importantly, only the GRE can qualify for certain estate planning tools.

• If the client owns private company shares that have increased in value, only the GRE can use the section 164(6) loss carry-back provision, and, consequently, the 50% solution outlined in Section 112(3.2) to mitigate double taxation that can arise on death (for more on how these manoeuvres work, see Advisor.ca/trustrules). If the private company shares aren’t in the GRE, they could be subject to double tax.
• A client must donate securities with capital gains through the GRE to access the nil capital gains income inclusion and the new flexible donation credit rules for deaths after 2015. If the donated securities are in the non-GRE, capital gains tax on those donated securities will be payable by the estate.

In cases where both scenarios are in play, clients used to put any securities subject to probate in a separate will from the private company shares (which aren’t subject to probate).

But, if they’re considered separate estates, it’s important to plan which will be designated as the GRE. If someone does not designate a GRE, none of his estates will be designated since the legislation doesn’t appear to offer an automatic designation.

Losing more than graduated rates

A non-graduated-rate testamentary estate cannot:

• claim the $40,000 exemption from Alternative Minimum Tax;
• allocate investment tax credits to beneficiaries;
• qualify for the exemption from Part XII.2 tax (applies to distributions of designated income to non-resident persons);
• distribute trust property to beneficiaries on a tax-deferred basis;
• flow through the character of certain pension income to a beneficiary (e.g., so the beneficiary can qualify for a pension tax credit); or
• flow through to a beneficiary the first $10,000 of a death benefit received by the estate, which is excluded from tax.

by Stella Gasparro, CPA, CA, a tax and assurance partner at MNP LLP