Beware of tainting GRE status

Clients commonly name their loved ones, such as spouses or children, as estate executors, given that family members tend to be most trusted to carry out last wishes and administer the estate accordingly. However, family members who are named as executors should be cautioned about paying for expenses on the estate’s behalf, as this could taint the estate’s graduated rate estate (GRE) status.

GREs have become an important estate planning tool for many Canadians, and they provide many post-mortem tax benefits. The primary benefit is that the estate is subject to graduated tax rates, whereas most other trusts are taxed at the highest marginal tax rate for every dollar earned. Additional benefits include flexibility in claiming donation tax credits, the ability to choose a non-calendar year-end, and flexibility for post-mortem tax planning for private corporations.

To access these benefits, the estate must meet several conditions, one of them being that the estate must be a testamentary trust as defined under subsection 108(1) of the Income Tax Act (ITA). Per paragraph (b) of the definition of a testamentary trust, an estate will lose its testamentary trust status if property is contributed to the trust “otherwise than by an individual on or after the individual’s death and as a consequence thereof.” Paragraph (d) of the definition prohibits the estate from incurring a debt or any other obligation owed to, or guaranteed by, a beneficiary or any other person or partnership with whom the beneficiary of the trust does not deal at arm’s length (“specified party”), with a few exceptions.

These two limitations can result in estates losing their testamentary trust status, and, consequently, their GRE status. So, what are some common ways this can happen?

Most executors who are also beneficiaries of the estate (e.g., surviving spouse, children or grandchildren) may find it easier and simpler to pay for estate expenses, such as funeral expenses, maintenance costs for the deceased’s home, accounting fees and so on, out of their own pockets. They may be indifferent to how the expenses are paid, as either they bear the costs personally and immediately or the estate bears the cost, reducing their inheritance.

In other cases, estates may have illiquid assets, such as a family cottage, that the deceased would like to pass on to the children. However, because there are no other liquid assets in the estate, the beneficiaries may have to pay the taxes resulting on death to keep the property within the family.

As noted in the limitations, contributions to the estate can be made only by an individual on or after their death and as a consequence thereof. “Contribution” is not a defined term in the ITA, and as such we rely on the precedent set by Greenberg Estate vs. R, which refers to “contribution” as meaning a voluntary payment made to the estate for no consideration, and that increases the estate’s capital. When executors who are also beneficiaries believe that expenses paid by them personally would be no different than the estate bearing the cost and subsequently reducing their inheritance, that belief could ultimately result in the testamentary trust being tainted.^* A contribution can be made even if no direct payment is made to the estate. Payment of expenses on the estate’s behalf are considered gifts to the estate, as they relieve the estate of a liability, thereby increasing the estate’s capital. 

What happens if an individual decides to pay for an expense on behalf of the estate and treats the payment as a loan? As noted above, loans to the estate by a specified party can also taint testamentary trust status. However, the ITA provides exceptions when the loan was made within the first 12 months of the individual’s death and was repaid by the estate within 12 months after the payment was made.

Often, when a specified party loans money to the estate, the individuals do not seek repayment from the estate until the estate is ready to make distributions. However, given the time frame provided in the legislation, specified parties should be mindful of the timing of estate expenses, and reimbursement from the estate should be sought no later than 12 months after the loan is made.

Also, if any payment made on behalf of the estate is considered a loan, it is important that the loan be documented. In Greenberg Estate vs. R, the appellant attempted to argue that the payment was a loan; however, absent an agreement with specific terms of repayment, the court denied this argument.

Many estate expenses may be due or paid for well in advance of the completion of the estate settlement. Caution should be taken for any payments on behalf of the estate, as they could taint the estate’s GRE status prior to accessing tax planning opportunities. If any expenses are paid on behalf of the estate within the first 12 months of the deceased’s death, care should be taken to document the payment as a loan, and repayment should be sought immediately. While the ITA permits repayment no later than 12 months after the payment is made, immediate repayment will ensure the “deadline” is not missed.  

It’s important for financial, accounting and legal advisors to stay in touch with estate clients to keep careful watch of when and how expenses are paid to ensure that GRE status is preserved.

* CRA document 9613135

Catherine Hung

Tax & Estate

Catherine Hung is vice-president, Tax, Retirement and Estate Planning with CI Global Asset Management.