Reviewing the Taxation of Estates

Estate, trust and tax planners previously had favoured testamentary trusts as vehicles to pass along assets to beneficiaries or heirs.   A testamentary trust is generally a trust or estate that is created the day a person dies. Commonly, these trusts are established in a testator's will. 

Formerly, a significant benefit to testamentary trusts had been that income earned and retained in the trust received the same graduated rate of income tax as an individual tax payer. Unfortunately, that all changed January 1, 2016.  Since that date all income retained in the trust is at the highest rate of tax applicable in the province in which the trust is resident.

There are two exceptions - The Graduated Rate Estate (GRE) and a Qualified Disability Trust (QDT).

Graduated Rate Estate

Anyone who has ever acted as an executor can tell you that it can take a considerable length of time to settle the estate. How much time is reasonable?  Under the new act, the government is telling us that the appropriate amount of time for an estate to be settled is 36 months.  To support this, they point to statistics that suggest the majority of estates are wound up by then.  As a result, for the first 36 months the estate will be classed as a Graduated Rate Estate (GRE) and during this period will be subject to graduated rates of tax as it would have been under the old system.  If at the end of this period, the trust still exists, it will now be taxed at the top rate.

The important points to consider are:

• The representative for the estate can select any year end for the GRE;

• If the trust continues beyond the 36 month period following the date of death, the trust year end will automatically convert to a December 31st year end going forward;

• A Graduated Rate Estate is an estate and not a trust created under a person's Will;

• There can be only one GRE.  If there are testamentary trusts in the Will, for example, for the benefit of children, they will be taxed at the top flat rate of tax.

Even though testamentary trusts have lost their preferred tax treatment, they will still present significant estate planning benefits for situations involving spendthrifts, special needs beneficiaries and blended families among others.

Qualified Disability Trust

A QDT is a testamentary trust that will continue to enjoy graduated rates of tax. The basic conditions of a QDT are as follows:

• The beneficiary of the trust must qualify for the disability tax credit under Section 118.3 of the ITA;

• There can be only one QDT for any disabled beneficiary;

• Each year, in the income tax return, the trust will elect, jointly with the beneficiary, that the trust is a QDT;

• In situations where both a testamentary trust AND an insurance trust are in the Will for the benefit of the disabled beneficiary only one trust can be a QDT - the excluded trust will have income received and retained taxed at the highest marginal rate.
  

The rules surrounding the Qualified Disability Trust are complicated so if you are preparing your Will with a disabled dependent in mind, please make sure to obtain professional help.

Life Interest Trusts

Spousal trusts, alter ego trusts and joint partner trust are taxed when the life interest beneficiary dies.  Upon this event, (or second death in the case of a joint partner trust), the trust is deemed to have disposed of all its capital assets at fair market value.  The income from this deemed disposition is taxed in the trust. 

There was a concern back in 2015, after legislation was introduced that for deaths occurring after January 1, 2016, capital gains would have been taxed in the deceased's beneficiary terminal tax return and not in the trust. Fortunately, this problem was averted when the changes were repealed and the treatment now is the same as it was before. 

Remember that the changes to the taxation of estates and trusts took effect on January 1, 2016. There is no grandfathering available so it is advisable to review your current planning with a professional advisor experienced in this area.

If you know a friend, relative or business colleague who would benefit from this information, please free to share it with them.