There was some good news last week on the tax front. This was the introduction on January 15 of some much-needed new draft legislation to correct serious mistakes made when the previous government sought to tighten up tax rules on trusts, and poor drafting caused unintended tax consequences.
The biggest revisions come in the area of “Life Interest Trusts”, or “LITs”. This is any trust that you can transfer property into on a tax deferred basis, then is subject to tax on the death of the life beneficiary. They are commonly used as an estate planning tool to provide a surviving spouse with income while preserving capital for the ultimate beneficiaries.
I am not going to try and explain the problems with the previous legislation or the solutions. My purpose today is more to alert accountants and lawyers, as well as people who have any type of testamentary trust (created by a Will after a person died), that things have changed. This is very complicated stuff and new to most practitioners, so get good advice.
The previous legislation was part of an initiative announced in 2013 and passed into law in 2014, taking effect January 1, 2016. In addition to the intended effect of eliminating the favourable graduated tax treatment of testamentary trusts, the changes also had some incredibly negative and unintended effects on LITs.
In the context of a blended family situation where one spouse was leaving assets in a spousal trust for the surviving spouse, the original legislation could effectively force the children of the surviving spouse to pay the taxes on the assets left to the children of the deceased spouse once the surviving spouse passed away. If they weren’t talking before…
The new legislation gives relief here. It also acknowledges that, since the bad law was in place for two years and many people made complicated plans to avoid the unintended consequences, it also allows for families to mutually agree to stay under the previous law and finish their plans.
It has been a very bad situation, but kudos to the Department of Finance for moving so quickly after the election to make these changes happen, and respond to the pleas from the tax community.
The new draft legislation also fixed some negative effects which resulted in a mismatch between the location of the donation credit and the tax liability on death for LITs, though a wrinkle here is that a Will or other enabling document must give Trustees some discretion on giving, in order to take advantage of the credit in the trust.
Section 118.1 of the Income Tax Act was also tweaked to give more flexibility on charitable gifts by the new Graduated Rate Estates, whose complicated rules also took effect January 1. Now, the value of a donation will be based on the date of the actual gift, not the date of death. This will be helpful for some estates.
New for 2016 is a long list of requirements for an estate to qualify as a “Graduated Rate Estate” for the 36 months after death that is being allowed. During this time, income earned by the estate will be taxed at graduated rates, rather than the top rate, providing all the rules are followed.
This tax treatment also allows for a zero capital gains inclusion rate on shares or certain other appreciated properties that are donated to charities.
To qualify as a GRE, among other things, the estate must designate itself as the GRE, and it must also qualify as a testamentary trust. It can lose this status if it receives deposits from any source other than the deceased person. If using multiple Wills, only one estate return must still be filed, encompassing both estates, as there can be only one estate for tax purposes.
Careful tax filing may allow for four tax returns to be filed over the 36 months after death, which can be good planning.
All of this is a sea change for estate planning, and all people with large estates are advised to review their plans. In August, 2013, I wrote a full review on the continued use of testamentary trusts in 2016 and beyond, now that the automatic tax benefits of such trusts have been eliminated. This is available on the Winnipeg Free Press website.
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Dollars and Sense is meant as an introduction to this topic and should not in any way be construed as a replacement for personalized professional advice.
Please consult legal, tax, insurance and investment experts for advice on your unique situation.
David Christianson, BA, CFP, R.F.P., TEP, is a financial planner and advisor with Christianson Wealth Advisors, a Vice President with National Bank Financial Wealth Management, and author of the book Managing the Bull, A No-Nonsense Guide to Personal Finance.