Currently testamentary trusts and grandfathered inter vivos trusts benefit from graduated rates of taxation, but commencing January 1, 2016, these trusts will be subject to the top marginal tax rates. In the 2013 Federal Budget, the Federal Government announced that these changes were being introduced as a response to certain perceived abuses, including the use of multiple testamentary trusts and tax motivated delays in completing estate administration.
Draft legislation respecting these changes was released on February 11, 2014, updated on August 29, 2014 and subsequently the legislation received royal assent on December 16, 2014. The result is that all trusts, other than graduated rate estates and qualified disability trusts, will be subject to the highest marginal rates of taxation. This article will address the concept of a graduated rate estate and some of the benefits that GREs will receive.
Subsection 248(1) of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.), as amended, (the “Act”) defines a graduated rate estate (“GRE”) as an estate that arose on and as a consequence of an individual’s death if:
- no more than 36 months has passed since the date of death;
- the estate is considered a testamentary trust for tax purposes;
- the individual’s Social Insurance Number is provided in the estate’s return of income for the taxation year in question and all prior taxation years;
- the estate designates itself as the GRE of the individual in its first taxation year that ends after 2015; and
- no other estate designates itself as the GRE of the individual for a taxation year ending after 2015.
GREs maintain their status as such for up to 36 months, and during this time, some of the benefits conferred upon GREs are as follows:
1. Graduated Income Tax Rates
Graduated tax rates currently enjoyed by testamentary trusts will only apply to GREs and qualified disability trusts effective January 1, 2016. Income earned and retained in the estate will be taxed at graduated rates.
2. Loss Carry-backs and Avoidance of the Stop-loss Rules - subsections 164(6) and 112(3.2) of the Act
Effective January 1, 2016, the loss carry-back provisions of subsections 164(6) and 112(3.2) of the Act are restricted to a GRE. It will be important for any post-mortem double tax planning involving private corporation shares that an estate designated as a GRE holds the shares.
3. Capital Gains Inclusions
Only a GRE will be able to report a nil capital gain on the gift of shares on death (for deaths after 2015).
4. Charitable Donations
Effective January 1, 2016, the rules regarding charitable giving in a will are changed. The charitable donation will be considered to be made at the time when the property is actually transferred to the qualified donee (e.g. registered charity) by the estate. The donation value for tax receipting purposes is the fair market value of the donated property at the date of transfer (instead of on the date of death). Subsection 118.1(1) of the Act will provide flexibility to allocate the donation between the deceased and an estate that qualifies as a GRE. A gift made by a GRE can be used by:
- the deceased in their terminal return for their last taxation year;
- the deceased for their taxation year preceding the taxation year of death;
- the GRE for the year in which the donation is made;
- the GRE for its prior taxation years (which would be the 2 prior taxation years, assuming the maximum 36 month allowable period is available); or
- the GRE for the 5 subsequent taxation years.
Estates that are not a GRE will be able to claim a charitable donation tax credit in the same manner as other trusts.
5. Calendar Year End
Only GREs will be able to have non-calendar year-ends. For existing testamentary trusts not qualifying as a GRE that have non-calendar year ends and will be in existence as of December 31, 2015, a deemed year end will occur at that time and for all following years the calendar year end will apply.
While the genesis of these changes was top rate taxation for testamentary trusts, depending upon the deceased’s circumstances, qualifying an estate as a GRE may be most important for tax results other than top rate taxation, such as charitable giving and post-mortem tax planning.
The elimination of graduated tax rates for testamentary trusts and the introduction of the GRE and qualified disability trusts will require practitioners to rethink and adjust traditional post-mortem planning. It will be crucial for estates to align themselves to qualify as GREs to take advantage of benefits such as graduated tax rates, flexibility regarding the use of donation credits and ability to effectively implement post-mortem planning strategies.