Tax changes that will become effective January 1, 2016, may have a harsh and surprising effect on your will and estate planning. To explain these new changes, I have a guest poster, Howard Kazdan, a tax expert with BDO Canada LLP.
Below, Howard highlights some of the more significant changes in the legislation.
Recent Changes in Legislation Make Reviewing Your Will A Must
By Howard Kazdan
The interaction of life’s two certainties – death and taxes – is about to get more complicated effective January 1, 2016, due to legislative changes to the taxation of trusts and estates that have been enacted. You may wish to review your will after considering the information discussed in today's post.
Change in tax rates for estates and testamentary trusts, except for Graduated Rate Estates ("GRE")
Currently, estates and testamentary trusts (i.e. trusts that are created by will upon death) are subject to tax at graduated tax rates. Under these old rules, you could set-up multiple trusts (generally for each child to control their inheritances) to be taxed at the lower graduated income tax rates.
Effective January 1, 2016 only a GRE will be eligible for graduated tax rates. The lower tax rates may only be available during the first thirty-six months of the estate if that period is required to settle the estate. All of the income in other estates and testamentary trusts will be taxed at the highest personal tax rate. Under the new rules, if you had set-up say 3 separate trusts for each of your children, all of them will be subject to the highest tax rate, as they will not be considered GRE’s (however, there may be non-tax reason for still creating multiple trusts, such as to protect against spendthrift children, protect assets for family law purposes and asset protection).
The administration of these new rules may also become challenging where you have multiple wills (some provinces allow for two wills, one for personal assets and one for assets that are not required to be probated) and have different executors, since all of the wills may make up one estate. If one component of the estate no longer qualifies as a GRE, the entire estate may no longer qualify, and therefore all income will be taxed at the highest marginal tax rate.
Finally, the availability of tax elections for income to be taxed in a trust at graduated rates, even if such income was paid or payable to a beneficiary will now be extremely limited.
To qualify as a GRE certain conditions must be met, which include:
- The estate must arise as a consequence of death
- The determination time is within the first thirty-six months of the estate
- The executor must designate the estate as a GRE
- No other estate can be designated as a GRE
Other benefits that will only be available to a GRE also include:
- ability to maintain an off-calendar year end
- ability to avoid capital gains on taxation of donated securities
- no requirement to make tax installments
- ability to carry losses back to terminal return
- more flexibility for claiming tax credits in respect of donations made by will/bequests
Due to the significant benefits of qualifying as a GRE, it will be necessary to plan accordingly.
Change in taxation of Life Interest Trusts
These trusts are often used to provide an income stream to a surviving spouse during their lifetime with the residual assets being distributed to other beneficiaries after that individual dies.
For example, spousal trusts are common in a blended family where husband and wife were previously married and each has children from a previous marriage. The husband may have established a spousal trust in his will whereby his wife was to receive income during her lifetime, but his children from previous marriage will receive the capital of the trust after she dies, and her children from a previous marriage are the beneficiaries of her estate after she dies.
Currently, when the wife dies, there will be a deemed disposition of the assets of the trust at fair market value and any income arising from the deemed disposition will be taxed in the trust.
The new rules will shift the reporting of income arising in the final year before death of the wife, including income on the deemed disposition of the assets, to her final income tax return. Since the beneficiaries of her estate and the spousal trust are different, this will lead to inequitable results (estate beneficiaries will owe tax, but the trust beneficiaries will own the assets). If the Canada Revenue Agency is unable to collect this tax from the estate, then it will have the ability to demand payment of the tax from the trust beneficiaries.
Planning for Disabled Persons
The new rules provide for a Qualified Disability Trust (“QDT”) which can be established for a beneficiary that qualifies for the disability tax credit. A QDT will allow for the taxation of income at marginal tax rates during that beneficiary’s lifetime, provided all of the required conditions are met.
As the conditions are very complicated and potentially require elections, it is imperative to review any wills that have provisions for a disabled person in context of the new rules with your lawyer and accountant.
Charitable Bequests On Death
Currently, on death, donations in the will are included in the final tax return of the individual or in the prior year, not in the estate return. Under the new rules, the donation will be deemed to be made from the estate which may result in additional flexibility in claiming the donation tax credit if the estate qualifies as a GRE.
The new rules are very complex and it would be prudent for your accountant and/or lawyer to review your will and any current estates, testamentary trusts or other life interest trusts that you may be connected with as a trustee, executor or beneficiary because planning strategies previously anticipated may no longer be effective. Where it is possible to amend such documents, it may be advisable to do so. Where it is no longer possible to amend such documents then additional planning may be required to determine next steps.
Here is a link to an excellent BDO tax memo which you may also wish to read if you want more detail.
Howard Kazdan is a Senior Tax Manager with BDO Canada LLP. He can be reached at 905-946-5459 or by email at firstname.lastname@example.org
This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.