Despite many concerns and questions raised by the tax community, the revisions to the testamentary trust legislation received royal assent on December 16, 2014. As indicated in the November 25, 2014, Tax Alert “Tax Changes for Testamentary Trusts,” testamentary trusts are now subject to top marginal tax rates unless they qualify as either a graduated rate estate (GRE) or a qualified disability trust (QDT).
Graduated rate estates
Where an estate has made a designation in its tax return for the first taxation year ending after 2015, that estate will qualify as a GRE and will be entitled to graduated rate taxation for a period of 36 months after the individual’s death. Since only one estate may be designated as a GRE, there may be some unintended tax consequences.
Benefit of the 164(6) loss carryback
Under the new legislation, where a capital loss is realized on the sale of property in the first taxation year of the estate following the date of death, the loss may now only be carried back to the terminal return from a GRE. This change might result in capital losses being trapped in a non-GRE. Where an individual has multiple wills, only one estate may be designated as a GRE. If a non-GRE incurs the loss but does not have any capital gains to offset the loss, the loss may never be used.
Where a taxpayer has multiple wills, the potential tax impact of the GRE designation must be considered carefully to ensure that post-mortem tax planning is not impacted.
Charitable donations, pension benefits and death benefits
New legislation regarding charitable donations on death now deems a donation to be made when the property is actually transferred to the charity rather than at the date of death. Consequently, the donation may be applied to the taxation year of the estate in which the donation was made, a prior taxation year of the estate, or the final two taxation years of the individual. However, these rules are only applicable if the estate is a GRE at the time the donation is made. If the estate is not a GRE at that time, the ability to apply the donation to prior years will be lost and, depending on the income of the non-GRE, the tax benefit arising from the donation may be nominal.
Additionally, the new legislation now limits the estate’s ability to pass through a pension benefit and/or a death benefit to a beneficiary. This may be done only where the estate qualifies as a GRE.
Taxing income and capital gains distributed to beneficiaries in the trust
Under the prior legislation, a trustee could make a designation under subsections 104(13.1) and 104(13.2) permitting the trust to choose to have distributed income taxed in the trust rather than in the hands of the beneficiaries. This was beneficial where the trust paid a lower tax rate than the beneficiaries, or where the trust had losses (as these losses could not be distributed to the beneficiaries). However, the new legislation now permits the trustee to make such a designation only where the taxable income of the trust will remain nil. Thus, unless the trust has available losses, the designation will not be permitted.
Qualified disability trusts
A QDT, as a testamentary trust, qualifies for the other exception to the top rate taxation of trusts where an annual election is filed by the trust and at least one beneficiary (electing beneficiary) who is entitled to the disability tax credit.
Although a QDT has the advantage of the graduated rate taxation, these benefits will be clawed back if the QDT ceases to have a non-electing beneficiary, ceases to be a resident in Canada, or makes a capital distribution to a non-electing beneficiary. If any of these triggering events occur in a year, the QDT will be subject to top rate tax on all prior year taxable income that was not distributed to an electing beneficiary. This could result in a significant tax liability to the QDT in the year in which the last electing beneficiary dies.
It will be prudent for taxpayers and their advisors to review estate plans in light of these changes to ensure that no unintended tax consequences result. Contact your Collins Barrow advisor for more information.
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