My recent blog posts Changes to the Taxation of Trusts and Estates – What You Need to Know and Graduated Rate Estates – Benefits and Drawbacks touched on issues with the newly enacted tax rules for trusts and estates. Bill C-43, which came into effect January 1, 2016 (the “new rules”), was widely questioned in regards to its treatment of life interest trusts and estate donations. On January 15, 2016, the Department of Finance took steps to bring clarity to these issues by releasing legislative proposals that, if enacted, would further modify the income tax treatment of certain trusts and their beneficiaries.
Spousal and Joint Partner Trusts
The new rules changed the tax liability imposed on spousal and joint partner trusts - otherwise known as life interest trusts. The testator’s estate had been traditionally responsible for the payment of tax that occurs due to the deemed disposition of assets on the death of the life interest beneficiary. The new rules shifted this liability to the income beneficiary’s estate (or the surviving income beneficiary’s estate in the case of a joint partner trust). In other words, the estate of the testator receives the assets and the estate of the life tenant receives the tax bill for those assets. As noted by many practitioners, this shift has the potential to produce an inequitable result where the beneficiaries of the estate and the trust are different and, if not addressed, this could lead to disputes.
The proposed amendments would (in most cases) remedy the above-noted issue. They would shift the tax liability only in the context of a spousal or common law partner trust that arose on and as a consequence of a death before 2017, where the trust and the legal representative of the Graduated Rate Estate (“GRE”) of the life interest beneficiary jointly elect for this. Where such an election is not jointly made, the testator’s estate will be liable for the taxes triggered on the deemed disposition of the death of the life interest beneficiary.
Charitable Donation Tax Credits (“credits”) have traditionally been available to those making charitable donations by their Will or by way of a direct beneficiary designation. These donations have, for tax purposes, been considered to have been made immediately prior to death, resulting in a credit that is based on the value of the asset at the time of death. The credits can be applied against taxes that are owed in the year of death or the year before death.
As I mentioned in my last blog, the new rules offer more flexibility to the way credits can be used. For instance, a GRE can claim the credits in the deceased’s tax return against income taxes of the deceased’s terminal tax year, or the tax year immediately prior. A GRE can also claim the credits in the estate’s tax return for the year the donation is made, a prior year, or five years following the year of the donation. The downside identified with the new rules for credits is that if an estate is not a GRE at the time the donation is made, then it cannot apply the credits in the deceased’s terminal tax year, the immediately preceding year, or any prior tax years of the estate. As GRE’s cease to exist after 36 months, this effectively imposes a 36 month time-limit for a donation to be made in order to be eligible for the flexible benefits of the credits.
The legislative proposals address this limitation. They extend the rules to apply to donations made by the GRE after it ceases to have that status because of the expiry of the 36 month period. The legislative proposals extend the gifting period to 60 months, meaning that an estate can make a donation within 60 months of the deceased’s death and receive the credit. The donation value is determined by the value of the asset in the year of the donation. This flexibility will allow estate trustees to gift when it is most advantageous to do so from a tax perspective.
In addition to the proposed tax changes noted above for spousal and joint partner trusts, the legislative proposals also mention donations made by life interest trusts. The new rules stipulate that where donations are made by a life interest trust after the death of the life interest beneficiary, the resulting credit cannot be applied to the income beneficiary’s estate to offset the taxes triggered as a result of death. Due to this restriction the credit is effectively wasted. The legislative proposals permit a life interest trust to allocate credits in respect of a donation made by the life interest trust within 90 days after the end of the calendar year in which the life interest beneficiary dies.
Although the legislative proposals are simply a draft, they are a step in the right direction for those looking for clarification on the tax rules for trusts.