, CPA, CA, TEP, KPMG, Halifax, LL.B., TEP, McInnes Cooper, Halifax Halifax 2
Introduction Changes are Coming! 1. Taxation of testamentary trusts flat top-rate taxation (loss of graduated rates) Exceptions GREs and QDTs 2. Taxation of life-interest trusts shifting burden CRA s position 3. Loss carry-back planning 4. Charitable giving on death 3 Introduction Changes are Coming! 1. How will these changes affect estate planning? 2. How can we draft in order to deal with these changes? 3. How do we deal with existing situations and structures 4
Testamentary trusts current rules Income generated in trust can be paid to beneficiary, but taxed at graduated rates in trust 104(13.1) and (13.2) designations AMT $40,000 deduction Late assessment allowed to reduce tax No tax instalments required Non-calendar tax year allowed 5 Taxation of testamentary trusts new rules as of January 1, 2016: No more graduated rates! Taxed in trust at top rate - or allocate out Can only elect to tax in trust (if paid out) if taxable income equals nil Loss of income splitting with trust itself All special relief that applied to testamentary trusts now only apply to GRE No grandfathering will apply to existing trusts! 6
Tax planning that is disappearing: Testamentary spousal trust: Example: $1,000,000 investment portfolio produces $50,000 income Outright to high-rate spouse: $50,000 x 50% (NS 2015) $25,000 tax In testamentary trust instead: $29,590 x 23.79% $7,039.46 tax $15,111 x 29.95% $4,525.74 tax $5,299 x 36.95% $1,957.98 tax $50,000 income $13,523.18 total tax Annual tax saving: $11,476.82 Trust for spouse Spouse 7 Two exceptions to top-rate taxation of testamentary trusts 1. Graduated rate estates (GRE) 2. Qualified disability trusts (QDT) 8
Graduated Rate Estate s.248(1) GRE = estate (individual has only 1 estate) Testamentary trust created by will not an estate, so cannot be a GRE no 3 year window for testamentary trusts 9 Conditions for an estate to qualify as a GRE No more than 36 months have passed since death Estate is a testamentary trust Deceased s SIN is provided in the estate tax return Estate designates itself as the GRE in its first tax return No other estate designates itself as the GRE of the deceased Graduated Rate Estate No grandfathering of existing trusts / estates Transition after end of GRE status deemed year end Maximizing benefit 4 taxation years 10
GRE status the benefits: Graduated tax rates on income earned and retained in estate No tax instalment requirements Off-calendar year-end permitted Access to new flexible donation credit rules for donations made in Will or by estate (for deaths after 2015) Nil capital gains inclusion for donation of shares on death (for deaths after 2015) Availability of 164(6) and 112(3.2) loss carryback planning 11 Issues that can arise with GREs Since a GRE must be a testamentary trust, a loan to the trust by a non-arm s length party can cause loss of GRE status CRA has no discretion to extend 36 month time period (even in situations where an estate can t distribute assets in 36 months i.e., estate litigation, waiting for clearance certificate) Executor must designate estate as GRE in first return (although no deadline is specified) 12
Non-calendar Year End s. 249(4.1) Effective January 1, 2016 Only GREs may have a non-calendar year end Deemed year end on loss of GRE status End of 36 month period Other triggering event Existing non-gres and testamentary trusts will have a deemed year end as of December 31, 2015 Note two tax filings for 2015 Are clients aware of changes and new filing deadline? 13 Non-calendar Year End s. 249(4.1) No proration of tax benefits for short taxation year November 1 to December 31, 2015 Plan to maximize income for this period Redeem private company shares? Realize accrued capital gains? 14
Graduated Rate Estate Drafting language to allow for 36 months estate administration Other considerations? 15 Exception #2: Qualified Disability Trusts (QDT) More limited than GRE exception Trusts for the benefit of disabled individuals who are eligible for the federal Disability Tax Credit Beyond scope of presentation details in paper 16
Testamentary Trusts in the Future drafting considerations and stick-handling No more income splitting with trust Income sprinkling / splitting with other beneficiaries / minors Non-tax reasons for trusts Credit protection Matrimonial claim protection Spend-thrift beneficiaries Disabled beneficiaries Can wind up testamentary trusts that no longer have any advantages if possible! Increased usage of Alter Ego and Joint Partner Trusts 17 Tax planning with testamentary trusts: still possible! Family testamentary trust income splitting with low-rate beneficiaries $1,000,000 in trust for Daughter and her 3 children investments produce $50,000 income each child requires $16,667 (1/3) per year for tuition, rent, various expenses and children have no other income Trust Tax each child pays (NS 2015): $8,481 x 0% = $0 tax $2,846 x 8.79% = $250.16 tax $5,340 x 23.79% = $1,270.39 tax $16,667 income = $1,520.55 tax Total tax of all 3 children on the $50,000: $4,561.65 tax Compare tax to Daughter on $50,000 with no trust $50,000 x 50% = $25,000 tax Annual tax saving: $20,438.35 Child Child Child daughter Pay children s expenses out of trust income 18
19 Taxation of Life Interest Trusts current rules LIT trusts which get a rollover on a transfer of property to the trust, then deemed disposition on death of surviving life tenant (spouse/common law trusts, AET, JPT) Tax payable in the trust in year of death before assets distributed This allowed for effective cross-border planning between low tax rate jurisdiction AB and high tax rate jurisdiction NS (and all other jurisdictions with rates higher than AB!) 20
Shifting Burden of Taxation - LITs New rules are a complete 180! Ss. 104(13.4) - Tax burden is shifted from life interest trust (which holds assets) to estate of life interest beneficiary This separates the tax liability from the ownership of the property that created the tax obligation! 21 Shifting tax burden blended families Husband Wife rollover spouse trust for wife tax husband s children wife s children 22
Life Interest Trusts s.160 Subsection 160(2) and new ss. 160(1.4) - the LI beneficiary LIT are jointly and severally, or solidarily, liable for taxes owing Finance has indicated that it is intended that 160(1.4) will be applied as though the LIT is liable for the tax in the first instance... BUT, this isn t what the legislation says! How will CRA administer? 23 Life Interest Trusts s.160 - issues If deceased LI beneficiary has tax attributes (losses, charity tax credit carry-forwards, etc.), must they be used to decrease the tax liability flowing from the LIT? Can they be saved for use by the deceased s Estate/beneficiaries in future years? What if the assets of the LIT are not liquid, or the LIT has other creditors and is not solvent? If LIT pays tax voluntarily, is GRE of LI Beneficiary tainted under ss. 108(1) definition of testamentary trust (contribution to trust/gre) If LI Trustee pays tax under a ss. 160(1.4) assessment, will Trustees of LIT have a fiduciary duty to sue LI Estate to recover tax? 24
Taxation of Life Interest Trusts drafting and stick-handling Can draft to deal with the issue going forward: Trust can pay the tax owed by estate... Lose GRE status? may be ok Trust can pay bens of estate directly to make up for funds lost to tax (after estate pays the tax owing) but how to draft? Direct allocation of capital to LIB (as per terms of LIT), with payment deferred until death of LIB (creates receivable owing by LIT to LIB) If person deceased/incompetent, fewer options Solutions/fixes to structures that have crystalized Example of all beneficiaries agreeing to encroach on trust Variation of Trust? 25 Loss Carry-back Planning s.104 (13.4) Assume spousal trust owns investment company On death of life interest spouse beneficiary: Capital gain deemed on death deemed payable to spouse Spousal trust redeems shares (consider application of ss. 112(3.3)) Spousal trust elects to carry back capital loss to tax year in which spouse died; however all capital gains had been deemed payable to spouse 26
Loss Carry-back Planning s.104 (13.4) Can spousal trust make a late designation under ss. 104(13.2) to reduce deemed capital gain previously payable to spouse so that it is taxed in the spousal trust? Under legislation no However, CRA has provided administrative concession that late filed ss. 104(13.2) designation is permitted to provide for loss carry back Will administrative concession continue with addition of 104(13.4)? 27 Technical Issues and Increased Compliance s.104(13.4) Increased compliance for loss carry-back planning: File terminal T1 return reporting deemed capital gain on trust assets File T3 trust tax return excluding deemed capital gain After loss is realized - file amended T3 trust return including ss. 104(13.2) designation, offsetting gain with loss carry back File amended T1 return removing gain due to loss carry-back If tax paid by trust to reduce interest until loss carry back can be claimed, who will get the refund? 28
Charitable Giving on Death New rule for gifts on death announced in 2014 Budget: Ss. 118.1(4.1) & (5): Gifts by individuals in Will, designated gifts, or gifts made by estate, will be deemed made by the estate at time property actually transferred to charity/donee Value of gift = value at time of donation Estate can carry-forward unused credit for 5 years 29 Charitable Giving on Death GRE rules Ss. 118.1(5.1): If estate is a GRE at time of donation, credit can be claimed in: Year of death or immediately preceding year GRE for year of donation or prior year of the GRE 5 year carry-forward is available in (unlikely) event estate continues after GRE status ceases Therefore, if gift made in last year of GRE status, could in theory have up to 10 years to use credit Donation can be used to offset 100% of income in year of death and prior year, but not in GRE 75% limitation applies to Estate 30
IMPORTANT: Charitable Giving on Death Gift must be made by GRE Litigation or other complexities may prevent donation from being made within 36 months of death Must ensure GRE does not inadvertently lose its status e.g. loss of testamentary trust status by loan or transfer to Estate by someone other than deceased Could happen if Estate s taxes are paid by an Life Interest Trust 31 Charitable Giving on Death If not a GRE: Mismatch of donation credit and tax liability on death Tax advantage of donation may be lost if estate does not have enough income to claim credits 0% inclusion rate for donated securities does not apply Query why tax status of a deceased s estate should have any impact on the donation credits arising on a gift on death? 32
Charitable Giving on Death The donated property must be property acquired by estate on a consequence of death (i.e. property owned by deceased) or property substituted therefor Example Deceased owned shares of private corp on death, no liquid assets in estate Corporation pays dividend to estate to make donation Cash not an asset held at death donation not claimable in final return Solution: redeem shares cash on redemption is substituted property 33 Charitable Giving on Death Timing and valuation issues: Donation occurs at time of actual transfer of property to charity by Estate No longer deemed to be made at date of death Value of donation-in-kind is at time donation is made If property increases in value, Estate will realize a capital gain Estate can use part of donation credit to offset tax on this gain If property decreases in value, Estate will realize a capital loss Can carry loss back to final T1 under 164(6) BUT only if donation is made in first taxation year of Estate 34
Charitable Giving on Death Cash flow issues If final tax return is due before donations are made by Estate: Pay tax on final tax return, with no benefit of donation credit If marketable securities are to be donated, pay tax on deemed capital gains on final return Once donation is made by estate, file an adjustment to final T1 to claim 0% capital gains rate and to use donation credit against other income Compare to current rules: donation could be claimed on final T1 even if not actually made until later This will impact cash flow of estate and may delay distributions to other beneficiaries 35 Example #1: Charitable Giving on Death Mary has a RRIF worth $200,000 at the date of her death, with a charity as designated beneficiary Mary also has an alter ego trust (AET) to which her other assets have been transferred. Her children are the beneficiaries of the AET Under Old Rules: Taxes on RRIF fully sheltered by donation tax credit. Children receive remaining assets in AET after tax triggered on Mary s death paid by the AET 36
Charitable Giving on Death Example # 1 (con t) Under New Rules: Capital Gain on assets in AET on death is deemed paid to Mary s estate (not borne by AET) Mary s estate has no assets so AET will have to fund the tax liability Will Estate lose GRE status and thus prevent the donation credit on final return? Wait for S 160(2) assessment which puts tax liability in Trust? If Estate pays tax after 1 st taxation year then Estate is still a GRE at time donation was made Because there was a direct beneficiary designation, donation was likely made in 1 st taxation year 37 Charitable Giving on Death Example #2: Mary has a investments worth $200,000 at the date of her death, to be transferred to a charity under her will Mary has a RRIF worth $200,000 with children named as beneficiary Mary has an alter ego trust (AET) to which her other assets have been transferred. Her children are the beneficiaries of the AET Under Old Rules: NIL capital gains on securities left to charity Taxes on RRIF sheltered by donation tax credit; children receive full value of RRIF by way of beneficiary designation Children receive remaining assets in AET after tax triggered on Mary s death paid by the AET 38
Charitable Giving on Death Example # 2 (cont ) Under New Rules: Capital Gain on AET trust assets on death is deemed paid to Mary s estate (not borne by AET) Would Estate have to use $200,000 intended for charity to pay tax? Charity would get nothing No donation tax credit Capital gains tax will be paid on securities intended for donation in kind CRA would not have to use 160(1.4) because there are assets in Estate to pay tax 39 Charitable Giving on Death Example # 2 (cont ) Under New Rules: If AET beneficiaries agree that AET will transfer assets to Mary s estate to fund the tax liability, her estate may lose its GRE status Donation credit cannot be claimed in year of death 0% capital gains inclusion rate on donated securities will not apply May be OK if donation occurs in 1 st taxation year and transfer from AET to fund tax occurs after 1 st taxation year (as in Example #1) What if it takes longer to determine how to handle the donation and payment of tax, and donation of securities does not occur until second year of Estate By that time Estate may no longer be a GRE if AET voluntarily paid Estate tax Timing of donations and payment of tax will be important considerations 40
Charitable Giving Life Interest Trusts Before 2016: Donation made in same calendar year as death of life interest beneficiary can be used to offset deemed gains on death Trustees must have discretion over making donations to allow trust to claim credit As of January 1, 2016: Deemed year end on death of life interest beneficiary Donation will be made by Trust in subsequent taxation year No ability to carry-back donation to prior year (not a GRE) Mismatch of deemed gain and donation credit 41 Charitable Giving Life Interest Trusts What can be done? Move donations from Trust to Will Donation credit can be used to offset income inclusion from deemed gains in Life Interest Trust Will need to have assets in GRE to make donation Capital encroachment to move assets to spouse Estate may be subject to probate Wind up Life Interest Trust if no on-going benefit, and if terms allow for wind-up 42
Charitable Giving Life Interest Trusts What can be done? Use RRSP/RRIF or life insurance designations to make donations Match income on RRSP/RRIF final return with donation credit Direct beneficiary designation keeps registered assets out of Estate 43 Charitable Giving Life Interest Trusts What can be done? If Trust owns private company shares, redeem shares to make donation Donation credit can be used to offset deemed dividend Capital loss on redemption can by carried back against deemed gains realized on death of Life Interest beneficiary Compliance issues regarding late filing 104(13.2) designation discussed previously 44