Canada: Graduated Rate Estates – Testamentary Planning

Last Updated: December 5 2016

What is a Testamentary Trust or Estate?

A testamentary trust is a trust that arose as a consequence of the death of an individual and the trust assets came from that individual. Basically, when an individual dies, their assets are deemed to be disposed of for Canadian income tax purposes and then reacquired by the estate. The estate then must pay off the debts and taxes owed by the individual, and the remaining assets are distributed according to the individual’s will. An individual can create more than one testamentary trust on death, but as of January 1, 2016, each deceased individual can only have one graduated rate estate. Due to the major changes in estate rules, if you have a will from 2015 or earlier, it is possible that the rule changes could have significant impact on your will, both financial and otherwise. To carry out tax planning to make sure that your will accurately reflects your desires and that your estate is passed on with as little tax as possible, see one of our top Toronto Estate and Tax Lawyers for advice.

What is a Graduated Rate Estate and what are the Tax Benefits?

A graduated rate estate benefits from a special tax status and pays income taxes on its income at a graduated rate. Normally, the entire income of a trust is taxed at the top marginal tax rate; however, a graduated rate estate is taxed like an individual in that it pays income tax on its income based on graduated income tax brackets, resulting in a lower average tax rate than regular trusts. This means, compared to a regular trust, a graduated rate estate can save over $20,000 per year in income tax. However, the estate only benefits from this graduated rate for 36months after it is created. Luckily, one of the other benefits of the graduated rate estate is that it has a flexible year end – it can be set to any time of the year, so a graduated rate estate can actually benefit from four tax years of graduated rates if the year end is properly tax planned by our expert Toronto Estate and Tax Lawyers.

Furthermore, taxes for graduated rate estates do not have to be paid in monthly or quarterly instalments; instead, graduated rate estates can pay the entire year’s income taxes all at the end of the year. This deferral allows you to free up money to use for other purposes throughout the year that would otherwise have been paid on income tax instalments. Graduated rate estates are also now the only type of testamentary trust that can utilize capital loss carrybacks, which allows the graduated rate estate to carry capital losses back to the deceased’s terminal year under s.164(6) of the Canadian income tax act. This is an important income tax planning tool. Additionally, graduated rate estates enjoy various administrative benefits, such as being entitled to refunds beyond the normal assessment period and an extended notice of objection deadline. With careful tax planning, graduated rate estates can mean that more of what you leave behind for your beneficiaries reaches their hands instead of being paid to CRA. Our experienced and dedicated Toronto Estate and Tax Lawyers can help you make a will and set everything up so as to ensure that everything is done in as tax efficient a manner as possible.

What are the Requirements for a Graduated Rate Estate?

In order for an estate to qualify as a graduated rate estate, it must be a testamentary trust resident in Canada, it must designate itself as such in the T3 return of its first taxation year, and there must be no other graduated rate estate for that testator. If the estate fails to designate itself as the individual’s graduated rate estate in its first taxation year, then it can no longer become a graduated rate estate and will not benefit from the beneficial tax rates. Furthermore, the estate must not distribute assets to other trusts, nor can it be tainted by outside funds – that is, funds not originating from the death of the individual. It is easy to get caught up in a moment of grief and forget to make sure your estate meets all the requirements to be a graduated rate estate. Call one of our Toronto Tax and Estate Lawyers today and make sure it’s done right.

The information is thought to be current to date of posting. Income tax law changes frequently and content may no longer reflect the current state of the law. This document is not intended to create an attorney-client relationship. You should not act or rely on any information in this document without first seeking legal advice. This material is intended for general information purposes only and does not constitute legal advice. If you have any specific questions on any legal matter, you should consult a professional legal services provider.

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