December 23, 2015
Much talk about the upcoming changes to the taxation of trusts and estates has surrounded the introduction of the concept of Graduated Rate Estates. Effective January 1, 2016, the Income Tax Act will recognize 3 types of testamentary trusts: a Graduated Rate Estate (“GRE”), a Qualified Disability Trust (“QDT”) and all other testamentary trusts (“OTT”).
Currently, testamentary trusts are taxed in the same way as individuals – at graduated tax rates. Following the implementation of the new tax changes, OTTs will be taxed at the highest marginal tax rates. QDTs – trusts where the beneficiary qualifies for a disability tax credit, and GREs, will continue to be eligible for the graduated rates of tax.
A GRE may only enjoy the benefits of graduated tax rates for up to 36 months. Certain criteria must be present for an estate to qualify as a GRE – and benefit from the graduated rates available to GREs. The estate must designate itself as a GRE in its first tax return; the deceased individual’s SIN must be provided; there must be no other existing GRE for the deceased individual; and no more than 36 months may have passed since the death of the individual.
Notwithstanding the 36 month maximum period for a GRE, under the new tax rules, it is possible in some circumstances to maximize the benefits of the GRE graduated tax rates by stretching this 36 month period into four taxation years rather than three. The tax law permits a GRE to have an off calendar year end. By selecting a taxation year end between the date of death and its first anniversary, the estate may be able to benefit from a longer period of graduated rates. This could be especially useful where the GRE holds shares of a private corporation paying dividends over this period.
As only one estate may be designated as a GRE for a deceased individual, consideration must be given to the impact of that designation where an individual has multiple wills, or multiple testamentary trusts. For example, if a GRE transfers assets to a trust established under the will of the deceased individual, that trust is considered to be an OTT. If a capital loss is realized on the sale of a property in the first taxation year following the date of death, the loss may now only be carried back to the terminal return from a GRE. Consequently, if an OTT incurs the loss but does not have any capital gains to offset the loss, the loss may never be used.
The new rules surrounding GREs allow greater flexibility in using the charitable donation tax credit. Where a charitable donation is made by a GRE, the donation tax credit can be divided between the deceased and their GRE. In such case, the donation may be applied to the taxation year of the GRE in which the donation was made, a prior taxation year of the GRE, or the final two taxation years of the individual. Charitable donations made by will or a GRE are deemed to have been made when actually transferred to the charity (not at the date of death) and, according, if the estate is not a GRE at the time the donation is made, the ability to apply the donation to prior years will be lost and the tax benefit arising from the donation may be reduced.
Anyone looking to maximize the benefits of GREs should speak to a practitioner knowledgeable about such changes.