Estate and testamentary trust planning

I deal directly with the executors and lawyers to ensure information is collected and CRA filings are completed on a timely basis.

Need to know….

In most situations, there is a fair market value deemed disposition of capital property held by the decedent at the time of death unless the particular property passes to one’s spouse. Similar rules are in effect for RRSP and Registered Retirement Income Funds. Procedures are available in the first year of estate to transfer capital losses realized by the estate to the terminal tax return, thereby reducing or eliminating the capital gain triggered on the terminal return. Distributing loss assets to beneficiaries will not allow the estate to take advantage of this planning procedure. There is no alternative minimum tax levied on a terminal or other optional tax returns.

Compliance planning

The filing due date for terminal tax returns is April 30th of the following year for deaths occurring between January 1 and October 31st. For deaths occurring in November and December the due date is 6 months subsequent to the date of death. The balance due date for a balance owing is the same as the due date for the return.

If the deceased operated a business the due date for the return is extended to June 15th from April 30th with the 6 month date for deaths occurring in November and December. Tax owing is due by April 30th for death occurring between January 1 and October 31st and 6 months subsequent to the date of death for deaths occurring in November and December.

Unpaid bonuses, dividends or social security benefits at the time of death, may be reported on a separate rights or things tax return. The advantage of this special return, is that this type of income is not intermingled with other income reported on the terminal return, and is taxed at graduated rates with full refundable tax credits. Residents of Canada who have an interest in an unmatured U.S. IRA (“individual retirement account”) is also considered a right or thing in accordance with various CRA technical interpretations.Rights or things returns may filed by the later of 1 year of the date of death or 90 days after receiving the notice of (re)assessment for the terminal return.

Additional planning considerations
Will planning

Individuals should have their Wills reviewed every 5 years to ensure they are consistent with present tax legislation.

Proper Will planning will aid in minimizing the tax burden created by this rules. Similarly, different ownership vehicles may avoid the 1.5% Ontario probate fees or what is called now called Ontario inheritance tax. You must consider “DUAL WILLs” to avoid probate on property that normally would not require probate such as personal property and shares of your CCPC. These assets are conveyed in a secondary Will, while other assets may requiring probate, such as bank accounts, are part of the primary Will. Many business owners have only one Will and are not aware of the benefits of the secondary Will.

Testamentary trusts

Testamentary trusts, whether spousal or non-spousal, are an easy, flexible and effective way to minimize tax on income realized on investments or other assets that were held by the decedent. The trust acts as a separate person; taxed at graduated tax rates. Estate tax returns are due for filing within 90 days after the year end. The legal representative may select a taxation year ending in the calendar year for a testamentary trust.

For 2015, $100,000 of interest income from these investments that would be taxable to the surviving spouse will attract tax of approximately $26,875 if he or she had no other income subject to tax. (Current rates would not be materially different however note the discussion on GRE below.) If this interest income was split equally by the trust and the surviving spouse, the combined tax would be approximately $19,939, for a savings of $6,936 annually plus any savings from the potential OAS clawback. The after-tax income of realized by the spousal trust may be distributed tax-free to the spouse. Property transferred to a spousal testamentary trusts is deemed to have been disposed of at the decedent’s adjusted cost base as opposed to the fair market value. This amounts becomes the basis to the trust. An election may be made to allow the disposition to occur at fair market value. This is advantageous where the decedent has capital loss carryovers or has not utilized the capital gains exemption.

The testamentary trust may also be a non-spousal trust for other family members. Theses trusts may also be utilized in the same fashion as a family trust for income splitting.

Please keep in mind that the testamentary trust can only be created by Will. If it is determined at a later date that the trust may not be as beneficial, it may be wound up with the assets distributed to resident beneficiaries, generally without tax to the trust.

Post 2015 changes affecting estates and testamentary trusts

The 2014 federal budget proposals became law at the end of 2014 that commence after 2015. The term “graduated rate estate” is defined in section 249 of the Income Tax Act (“ITA”). Generally speaking, graduated rates will apply for the first 36 months of an estate that arises as a consequence of an individual’s death. After the expiration of the 36-month time period, the top rate applicable to inter-vivos trusts will apply. For graduated rate estates in existence at the end of 2015, the higher rate will apply after the expiration of the 36-month period.

There can be only one graduated rate estate in respect of a deceased individual for an estate to be an individual’s graduated rate estate. The estate must designate itself in its T3 return for its first taxation year or if the estate existed prior to 2016, for its first taxation year after 2015.

Off-calendar fiscal year ends for such estates will also cease to exist with a deemed year end occurring when the 36-month period expires and a new year end commences that has to have a calendar year end. For graduated rate estates commencing in 2016, the 36-month period commences at the date of death and the year end may be off calendar year end for the first 36 months, then the deemed year end and calendar year end will commence. Reference may be made to Section 249.1 of the ITA. Obviously, with 2 year ends, ending in the same calendar year, tax payable will be higher.

For estates and testamentary trusts in existence as at January 1, 2016 that are not “graduated rate estates”, (“GRE”) by definition, the loss of graduated rates will apply for the 2016 filing. Also in this regard, a deemed year end at December 31, 2015 will occur. For example, if the 36 month period expired April 30, 2015, the estate will have a deemed year end at December 31,2015 resultng in two taxation years ending in 2015. Income and assets of these trusts should be reviewed to determine the tax implications of the new rules.

By definition an estate is treated as a testamentary trust. However graduated rates do not apply after 2015 to formal testamentary trusts created by WILL, including spousal and family trusts, CRA has confirmed that once property is transferred from the estate to the trust, income derived by the trust will be taxed at the top rate in accordance with the pased December 2014 legislation.

These revisions will not apply to testmentary trusts for the benefit of disabled individuals who are eligible for the federal disability tax credit.

The above rate change still allows the graduated rates in the first 36 months of the estate, although most simple or less complex estates should be wound-up within one to two years. If the estate is a graduated estate that has income, one may avoid a potential OAS clawback to the beneficiary but only for the 36 month period. It may be possible for a spousal trust that would othewise be taxed at the top rate after 2015 to distribute income to the spouse beneficiary to get him/her to a bracket that will avoid the OAS clawback. This will depend on the language in the spousal trust. If the income was required to be paid or payable to the spouse, as noted below with the amendments to subsections 104(13.1 & 13.2) have been revised. Non-tax benefits such as creditor proofing,control of assets situated in the trust and remarriage situations should also be considered in deciding to utilize a formal testamentary trust.

The December 2015 Economic Statement will increase the top federal rate from 29% to 33% commencing in 2016. This means the effective 2016 top rate in Ontario for inter-vivos trusts, non-graduated rate estates and testamentary trusts will be approximatley 53.53%. There still may be some limited ability to tax income paid or payable by the spousal trust to the spouse where the spouse is at a lower bracket, but keeping the threshold for the OAS clawback under consideration.

Other changes

After the first 36 months, estates are required to pay tax instalments pursuant to subsection 156.1. Testamentary trusts will also be required to pay tax instalments commencing in 2016. The $40,000 basic AMT exemption is also lost to non-graduated rate estates. ITCs (“investment tax credits”) will no longer be available to beneficiarires of non-graduated rate estates or to a testamentary trust by virute of the flow-through provisions. The ITCs must be utilized by the estate or by the testamentary trust in computing it’s tax iiability.

Subsection 104(13.4) has been amended for 2016 to require the unrealized gain inherent in a spousal trust that is triggered on the death of the spouse (including income of the spouse trust for that taxation year) to be taxed in the spouse’s terminal tax return as opposed to being taxed in the spousal trust. This has raised concerns in that tax would be due by the estate for tax payable arising in the terminal tax return, while assets of the spousal trust would be distributed to beneficiaries. After consultations with Finance, there was an amendment made to this section released by Finance on January 15, 2016 that adds paragraph 104(13.4)(b.1) which effectively states that the foregoing law would not apply if joint election is made by the spousal trust and the graduated rate estate (of the spouse) that is included in both the T1 and the T3 tax returns.

Effective for 2016, charitable gifts made by the estate pursuant to the Will, will no longer be deemed to be made by the deceased prior to death, but for be deemed to be made and claimed by the entity tranferring the property. This means the donation credit will not be claimed on the terminal return, a prior years’ return or by the surviving spouse. The legislation does provide for allocating the gift to the terminal return, prior return or the estate provided the gift is made by the estate when it is a graduated rate estate which means the gift must be made within 36 months.

The December 2014 legislation also curtailed the ability to tax income in the estate or the trust where the income is paid or payable to a beneficiary. This election or designation was beneficial to take advantage of graduated rates where such income would otherwise be taxable in the beneficiary’s hands at his or her maginal tax rate. Sections 104(13.1 &13.2) designations/elections will only be allowed if there are non-capital or capital losses in the estate or trust and only to the extent thereof. Legal documents with regards to the distribuiton of income and capital should be discretionary to allow for flexibility in the taxing provisions of income.

As before, alter-ego or joint partner trusts created during one’s lifetime to avoid provincial probate may still be an alternative even though income realized therein is taxed as an inter-vivos trust at the top flat rate.

Post-mortem planning

Post-mortem planning procedures are available to estates holding shares of investment companies or active business corporations. Estates may transfer the shares to a new holding corporation that may allow for the tax-free extraction of surplus from the corporation. A similar transaction may allow for the company to obtain an increase in the underlying tax cost of capital property such as land or portfolio investments, up to their fair market value at the time of death.

A more detailed analysis is required to determine the benefits of the post-mortem planning procedures.

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