Testamentary Trusts and Graduated Rate Estates

By virtue of legislation enacted by the previous federal government, as of January 1st, 2016 most testamentary trusts, including those already in existence on that date, are subject to the highest marginal rate of tax. Up until this year testamentary trusts had been taxed at graduated rates (in other words like individuals).

As of January 1, 2016 only an estate can qualify as a GRE-(which means graduated rate estate). Generally speaking an estate only exists while the Estate Trustee administers the assets before distribution or the establishment of trusts.

No separate testamentary trust (including a spousal trust) nor an insurance testamentary trust can qualify as a GRE. If an estate takes more than 36 months to administer, the estate ceases to be a GRE and loses the benefit of graduated rates and must report for tax with a December 31 year-end.

If, for instance, to avoid the levy of Estate Administration Tax, a taxpayer has created a secondary will to govern their private company shares and personal belongings, it will almost invariably be the case that the same executor should be appointed for each of the primary and secondary wills so that a joint income tax return can be filed as only one estate, for tax purposes, will qualify as a GRE.

Qualified disability trusts are excepted. These are discretionary or popularly Henson trusts for disabled beneficiaries. However if more than one such trust exists only one will qualify for GRE type treatment, and then only if the proper joint election has been filed by the Trustees of the trust and the disabled beneficiary. Any second or other disability trust will be taxed at the highest marginal rates. As a result an estate plan should be crafted so that the assets which fall to the disabled beneficiary in accordance with a discretionary trust accumulate and are all contained in one trust.

• Only GRE’s are exempt from the requirement to pay installments.
• Only GRE’s can allocate investment tax credits to beneficiaries.
• Only GREs can have a non-calendar year-end.
• Only GREs provide relief for loss carryback postmortem planning to avoid double taxation when the deceased’s assets include private company shares.

As a result of all of these changes existing wills should be reviewed and recommendations made by lawyers preparing wills will no longer include the making of testamentary trusts unless they are important, from the client’s point of view, for the benefit of a particular beneficiary or class of beneficiaries or if the beneficiary is disabled.

As for the loss of a Graduated Rates with regard to minors, as long as a trust for a child contained in a Will qualifies as an "age 40 trust" (a trust made in accordance with the provisions of subsection 104 (18) of the Income Tax Act) by vesting the income earned in the trust prior to age 21 in the minor and making no condition on the beneficiary's right to payment except that the beneficiary must live to an age not exceeding 40 years, such a trust can continue to exist as a discretionary trust after the child becomes 21 and can also provide for a gift over to other beneficiaries if the child does not survive to the specified age (under 40).

With regard to charities, a bequest made in a Will for a GRE estate is deemed to be made by the testator in the year of death and the credit can be used to offset income in the deceased's year of death or the year prior or can be used to offset income in any of the three years during which the estate is a GRE.

In a non-GRE estate, however, the donation credit can only be used by the estate in the year that the donation is actually distributed or in any of the five subsequent years. Because the most significant tax event occurs, usually, on the death of the taxpayer it's important that language be placed in a Will with regard to a charitable bequest confirming that the trustees must make the gift within 36 months after the date of death or at least while the estate is a GRE estate notwithstanding any other provision to the contrary.

Another significant change is the change to the taxation of spousal trusts, alter ego trusts, joint spousal trust, joint common law partner trusts. Starting in 2016 all of these types of trusts will have a deemed a year-end at the end of the day of the death of the last surviving life interest beneficiary. Tax payable on the deemed disposition of the assets in the trust will primarily be the obligation of the beneficiary. Although there is a new rule that the life interest trust will be jointly and severally liable with the beneficiary for tax liability the beneficiary is primarily liable. What does this mean?

If, for instance, a trust is created in a will by a husband for his wife by his second marriage to provide income and discretionary amounts of capital to the wife but upon her death to pay the assets which remain to his children who are not her children, and if the wife has an estate of her own, and her will provides gifts to her children and not his then by the present law her estate will be primarily liable for the tax which results from the deemed disposition of his assets which happens on her death. This is a potentially dreadful result.

There is no perfect solution to this problem. Fortunately it appears that there is draft legislation from the Department of Finance as of January 15, 2016 to modify those rules so that the income arising in certain trusts on the death of the trust's primary beneficiary is taxed in the trusts and not in the hands of the beneficiary.

The foregoing should not be considered to be legal advice and should not be relied upon as such. Please consult a lawyer to get advice and an opinion on your unique circumstances.