Canada: Income Tax Changes: January 1, 2016 - Only 7 Weeks Away

Parliament recently enacted significant changes, beginning in 2016, to the taxation of estates, trusts and charitable giving on death. If your estate plan includes trusts or charitable giving, or if you are an executor or a trustee, you may be affected by these changes and you should seek legal advice.

ESTATES

Income Taxed at Top Marginal Rate

At the present time, the income of an estate is subject to tax at graduated rates, that is, the rate of tax increases as the amount of the estate's income increases, until the estate's annual income exceeds $150,000. Income greater than that amount is taxed at the top marginal rate of 45.8% (in British Columbia, to be reduced in 2016 to 43.7%). Beginning in 2016, all of an estate's income will be subject to tax at the top marginal rate. Estates that are "graduated rate estates" or "GREs", however, will have their income taxed at graduated rates, but only for the first 36 months after the deceased's death.

Designation of Estate as GRE

Beginning in 2016, an estate may be designated as a GRE in its tax return for its first fiscal year. Failure to designate an estate as a GRE in that return will result in the estate not being a GRE. Currently there is no ability to make a GRE designation after that return has been filed.

Calendar Year End

Estates, other than GREs, will have a December 31 year end. Estates that were established before January 1, 2013 and now have a non-calendar year-end, will have two year ends in 2015 – their usual non-calendar year end and a second year end on December 31, 2015. Tax returns for those estates will be required to be filed within 90 days after the first year end in 2015 and by March 30, 2016 for the year end of December 31, 2015.

An estate established after December 31, 2012 that otherwise meets the definition of a GRE and which is designated as a GRE in its tax return for its first fiscal year which ends after 2015 will be able to maintain a non-calendar year end for as long as it is a GRE (generally for 36 months after the date of death). In that case, the estate will have a deemed year end at the end of the 36th month and thereafter on each December 31st.

Advantages of GRE Status

There will be a number of other advantages of GRE status that will not be available to other estates or to testamentary trusts, including:

  • a GRE will be exempt from paying tax instalments;
  • a GRE will be able to make gifts of public securities, ecological gifts or gifts of cultural property to registered charities and other qualified donees without incurring capital gains tax;
  • a GRE will be able to allocate charitable donation tax credits for donations made by it to registered charities and other qualified donees among different tax years - the year of donation, an earlier tax year of the GRE, and either of the last 2 taxation years of the deceased individual, and unused credits may be carried forward for up to five years;
  • a GRE will be eligible for a $40,000 exemption from alternative minimum tax; and
  • a GRE will be able to carry back capital losses to the deceased's terminal return including the loss created on the redemption of private company shares.

Death of Surviving Spouse or Common Law Partner

Many wills provide for the establishment of a trust for the benefit of the deceased's spouse or common law partner. Currently, if the trust is a qualifying spousal trust for the purposes of the Income Tax Act (Canada), on the death of the surviving spouse or common law partner there is a deemed disposition of assets of the trust for proceeds of disposition equal to the fair market value of those assets and the resulting tax liability is payable by the trust.

Beginning in 2016, on the death of the surviving spouse or common law partner the trust will be deemed to have a fiscal year end and the income earned during that fiscal year, including the income arising as a result of the deemed disposition of the trust's assets, will be included in the income of the surviving spouse or common law partner in the year of his or her death. However, the assets which were intended to be used to fund the tax liability arising as a result of the deemed disposition of the trust's assets will remain in the trust, not in the estate of such spouse or common law partner. This will have significant cash flow implications for the spouse or common law partner's estate, especially if the estate does not have sufficient assets to fund the tax liability. The trust and the estate will be jointly and severally liable for the tax liability arising as a result of the application of this rule. However, the payment or funding of this tax liability by the trust may affect the status of the surviving spouse or common law partner's estate as a GRE.

These new rules will also have an adverse effect where the remainder beneficiaries of the trust are different than the beneficiaries of the spouse or common law partner's estate.

TRUSTS

Many estate plans include an alter ego trust or a joint spousal or common law partner trust (a "joint partner trust"). These trusts provide a number of estate planning benefits, including increased privacy, incapacity planning, and the saving of probate fees.

As discussed above regarding spousal trusts and estates of the deceased spouse, at the present time, when the settlor of an alter ego trust dies (or the surviving spouse or common law partner of a joint partner trust dies) there is a deemed disposition of assets of the trust and the income arising from such deemed disposition is subject to tax in the trust. However, beginning in 2016, the income arising as a result of such deemed disposition will be included in the income of the deceased settlor (in the case of an alter ego trust) or in the income of the surviving spouse or common law partner (of a joint partner trust) in the year of his or her death and not in the income of the trust. Again, the assets to fund the tax liability arising as a result of the deemed disposition of the trust's assets will remain in the trust, not in the deceased's estate, and there could be significant cash flow implications for the deceased's estate. Also, although the estate and the trust will be jointly and severally liable for the tax liability arising as a result of the application of this rule, the payment or funding of the tax liability by the trust may affect the status of the deceased's estate as a GRE.

As discussed above regarding estates, the new rules will also have an adverse effect where the remainder beneficiaries of the trust are different than the beneficiaries of the settlor's (or the surviving spouse or common law partner's) estate.

As well, many alter ego trusts and joint partner trusts provide for significant donations to charity, which will be affected by these new rules as described below. As a consequence, consideration will have to be given to how philanthropic objectives are to be realized after 2015 when alter ego trusts and joint partner trusts are utilized.

TESTAMENTARY CHARITABLE GIVING

At the present time, gifts to registered charities and other qualified donees made by an individual's will can be treated as if they were made by the individual immediately before death. The charitable donation tax credits resulting from these gifts can then offset the income in the individual's year of death and the preceding taxation year.

On the other hand, charitable gifts made by the executor under a power to do so set out in the will are considered to be made by the estate. The charitable donation tax credits resulting from a gift by the estate can offset the income of the estate in the year the gift was made, with any excess being carried forward for five years, but cannot be carried back to the deceased's final tax return.

After 2015, gifts by will be deemed to have been made by the estate at the time the donated property is transferred to the registered charity or other qualified donee. Designations in favour of a registered charity or qualified donee made under an RRSP, RRIF, TFSA and life insurance policy will also be subject to these rules.

If the estate is a GRE at the time a gift is made, the rules in effect after 2015 will provide the executors with some flexibility as to how the charitable donation tax credit can be used. The executors can choose to use the charitable donation tax credit in: (i) the tax year of the GRE in which the donation is made; (ii) an earlier tax year of the GRE; (iii) either of the last two taxation years of the deceased individual; or (iv) the following five years of the GRE (or when it ceases to be a GRE, the estate). This flexibility is not available to an estate that completes a gift at a time when it is not a GRE, or to an alter ego trust or a joint partner trust. In those cases, the charitable donation credits can be used in the taxation year of the estate or trust in which the donation is made, with any unused credits being carried forward for up to five years.

Because the charitable donation tax credits will not be available under the new rules until the donation is actually made to the registered charity or qualified donee, it may be necessary to fund any taxes arising on a deceased's death and payable in the deceased's terminal return without the benefit of any charitable donation tax credits. When the donation is made by the estate, a charitable donation tax credit will be available. Whether the charitable donation tax credit can be allocated to the terminal return or not will depend on whether the estate is a GRE at the time the donation is made.

THE TIME TO ACT IS NOW

These changes will be effective on January 1, 2016. Given the significant implications that may arise from them, we recommend that you review your estate plan to determine whether it continues to be appropriate or whether any changes are required.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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