Effective on January 1, 2016, there will be significant changes to the manner in which trusts created under a will are subject to income tax. As there are no grandparenting provisions these changes will also affect current wills, trusts and estates.
Two substantial changes to trust and estate taxation are:
- The introduction of Graduated Rate Estates ("GREs"); and
- The shift of the tax burden for Spousal/Common-Law Partner trusts, Joint Spousal/Common-Law Partner Trusts, and Alter-Ego Trusts ("Spousal Trusts").
GREs and Graduated Rates
Currently, any trust that arises as a consequence of death ("Testamentary Trust") is taxed at graduated rates indefinitely. This has led to potential savings of over $10,000 per year per Testamentary Trust. While Testamentary Trusts have been used extensively for estate planning, starting in 2016 only qualified disability trusts and GREs will be taxed at graduated rates. All other trusts, including Testamentary Trusts, will have all of their income taxed at the top marginal rate (currently 39% in Alberta).
Unlike Testamentary Trusts, there may only be one GRE per deceased, lasting for 36 months after the deceased's death. A GRE must also designate itself as a GRE in order to take advantage of the benefits available to them. GREs are also the only trusts which may carryback losses and transfer donation receipts to a deceased's previous tax years.
Shift of Tax Burden for Spousal Trusts
Spousal Trusts have a deemed disposition of their assets at the death of the surviving spouse. Currently, the trust bears the tax burden for the income of that deemed disposition.
To the alarm of tax practitioners, starting in 2016, in the year the surviving spouse dies, the Deceased must include all the taxable income, including the income from the deemed disposition of the Spousal Trust, in the Deceased's final tax return. This occurs even if neither the Deceased nor the Deceased's estate will ever receive that income. As a result, while the trust may have the income, the Deceased's estate will bear the tax burden associated with that income. This potential mismatch between the tax burden and the income will be especially problematic if the beneficiaries of the Deceased's estate and the remainder of the trust are not the same, as is often the case.
The Spousal Trust is jointly and severally liable for the additional tax payable by the Deceased as a result of the inclusion of the Spousal Trust's income. The government has indicated that the Canada Revenue Agency will first look to the Spousal Trust for the owed taxes, although it may not be obligated to do so. This does not change the fact that the ultimate burden rests with the Deceased, and it raises the possibility that the Spousal Trust may have a civil claim against the Deceased for those same taxes.
In conclusion, as a result of these changes:
- Estate plans using Testamentary Trusts will not have the tax advantages they previously had, potentially leading to substantially worse tax outcomes than those of a plan designed taking the new legislation into account.
- For estate plans that include Spousal Trusts, it would be substantially preferable to avoid the potential tangle caused by this shift of the tax burden from the Spousal Trust to the Deceased by drafting wills/trust deeds to take into account this new legislation.
- Anyone with an estate plan which creates a Testamentary or Spousal Trust should seriously consider having their estate plan reviewed.
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.