1 Trust Law Update 2015 Colloquium October 22 and 23 Sudbury
2 New Tax Rules for Trusts and Estates Graduated Rate Estates ( GREs ) Life Interest Trusts ( Spousal/Joint Partner Trusts/ Alter Ego Trusts) Practice Points 2
3 Taxation of Estates & Trusts (Review) Subs. 104(2) a trust is taxed as an individual Inter vivos trust taxed at highest marginal rate Testamentary trust (including an estate) taxed at graduated rates A trust can claim a deduction from trust income for amounts paid to beneficiaries A trust can also make a subsection 104(13.1) or (13.2) designation and trusts pays the tax
4 What s New! As of January 1, 2016: Graduated tax rates are eliminated for testamentary trusts. Two exceptions Graduated rate estates Qualified disability trusts All testamentary trusts will have a calendar year end. Trusts in existence will have a deemed year end on December 31,2015. Start Planning!
5 What is a Graduated Rate Estate? A GRE is an estate (NOT a trust created under a will) Estate must meet the following conditions: no more than 36 months have passed since death estate is a testamentary trust for tax purposes estate designates itself as the GRE in its first tax return deceased s SIN provided in estate tax return no other estate is designated as the deceased s GRE Deemed year end at end of GRE status 5
6 Graduated Rate Estate Why is GRE status important? graduated tax rates on income earned & retained in estate no tax installment obligations off calendar year end permitted GRE status is also required to: access new flexible donation credit rules for donations made in Will or by the estate (for deaths after 2015) benefit from nil capital gains inclusion for donation of shares on death (for deaths after 2015) access s. 164(6) and s. 112(3.2) loss carry-back rules 6
7 Graduated Rate Estate ( at $138,586) Alberta ( 2015 rates) $12,612 x 3 years Saskatchewan $14,249 x 3 years Manitoba $14,649 x 3 years Ontario $14,189 x 3 years Loss of other benefits of GRE status may be much more significant
8 Graduated Rate Estate: Practical Issues Only one GRE If multiple Wills, can a single estate tax return be filed? Who will sign? If different executors, how is s 159 liability determined? Estate must be designated as the GRE in first estate tax return What if an error made and designation not made? Can a late designation be filed? 8
9 Qualifying Disability Trusts (QDT) Testamentary trust, resident in Canada with one or more beneficiaries who qualify for the disability tax credit Trust & qualifying beneficiary must jointly elect that trust is a QDT. (beneficiary may only elect in respect of one QDT) QDT status is lost if: QDT ceases to be resident in Canada, none of the trust beneficiaries at the end of the current year are qualifying beneficiary of the trust in a preceding year, or QDT pays any of the trust s capital to a non-electing beneficiary. If QDT status is lost, the trust is subject to a recovery tax.
10 New Trust Provisions Their Impact on Life Interest Trusts
11 New subsection 104(13.3) The Old Rule: Could designate that income distributed from a trust to a beneficiary was taxable in the trust New Rule : Subs, 104(13.3) makes a designation under 104(13.1) & (13.2) INVALID if, after the application of the designation, the trust has taxable income Result: Designations available ONLY to allow the trust to use losses and other tax attributes ISSUE: Does not allow a designation to use tax credits (donation tax credits or ITCs) in trust Applies starting Jan 1,
12 New subsection 104(13.4) Old Rule: Property that is subject to a rollover on a transfer to a spouse, common law partner, joint spouse or common law partner, alter ego or self-benefit trust ( life interest trust is deemed disposed of by the trust on the death of the trust beneficiary. The trust is liable to pay the tax. New Rule: The estate of the beneficiary is liable to pay the tax. 12
13 New subsection 104(13.4) Applies starting Jan 1, 2016 to trusts if a deemed disposition occurs on the death of the life interest beneficiary (or the death of the surviving life interest beneficiary where a joint partner trust) - life interest trusts: spousal and common-law partner trusts, joint spousal and common-law partner trusts alter ego trusts, self-benefit trusts No grandfathering applies to all life interests trusts starting in 2016 (i.e., deaths after 2015) regardless of when the trust created or whether it can be varied or amended 13
14 Shift of Tax Burden (The Details) On the death of the life interest beneficiary (or 2nd death for a joint partner trust): trust has deemed year end at end of day of death, and all income of the trust for shortened year (including any capital gains realized on the 104(4) deemed disposition) is deemed payable in year to deceased life interest beneficiary Result: Capital gains on deemed disposition (and any amounts that are trust income) are included in deceased life interest beneficiary s terminal return and the trust claims a deduction Primary tax burden shifted from Trust to estate of life interest beneficiary (may include both gains of deceased settlor and gains accrued in the life interest trust)
15 Impact on the Estate: Example Adam & Eve are married. Second marriage for both Both have children from 1st marriage but none together Adam dies. Under his will a spousal trust is established for Eve. Eve is entitled to all of the income but cannot receive any capital. On Eve s death, the trust property will go to Adam s children Eve dies after At the time of her death, the spousal trust holds assets with a value and unrealized capital gain of $1M. Eve personally owns assets with a value of $1M and no unrealized gains. Under Eve s will her estate will go to her children
16 How will s.104(13.4) impact Adam & Eve s Heirs? Before 2015 After 2015 On Eve s death deemed disposition of trust assets results in $250,000 tax liability to trust Adam s heirs receive the trust property net of the tax due or $750,000 Eve s heirs receive $1M On Eve s death, add $1M capital gain to her terminal return resulting in tax owing of $250,000. Adams heirs receive $1M in trust property. Eve s heirs receive $750,000 ( $1M minus new tax liability under 104(13.4))
17 Avoiding Liability in the Estate There is NO mechanism to avoid the application of s. 104(13.4) to trust structures currently in place A variation of the trust or a release or surrender of the trust interest by an affected beneficiary will not avoid tax liability on death Liability for a beneficiary could attach years after, for example, removal of the spouse of a spousal trust
18 The other shoe drops S. 160(1.4): Life interest beneficiary and trust are jointly and severally liable for tax due as a result of s. 104(13.4) BUT Explanatory Notes (released Oct 30, 2014) Existing subsection 160(2) of the Act empowers the Minister of National Revenue to assess the liability that arises under subsection 160(1.4) against the trust at any time, and it is intended that the Minister apply subsection 160(2), in respect of an amount owing under subsection 160(1.4), as though the trust were liable in the first instance for that amount.
19 Advising Clients under the New Provisions Does it matter? If the beneficiaries of the estate are the same as trust there may be little concern; where beneficiaries are different or their entitlements are different there will be potential problems. Existing trusts between now and 2016 in 2016 and beyond New trusts planning drafting
20 A. Existing Trusts: Between Now & 2016 Larry s mother Marion is 96. She is the beneficiary of a testamentary spousal trust set up by her deceased husband Greg that includes a rental property with significant accrued gains and a low UCC. It is a second marriage for Marion and Greg. Randy is Greg s son. Randy is the sole capital beneficiary of the spousal trust Larry is the sole capital beneficiary of Marion s estate Larry and Randy are trustees of the spousal trust and Larry is the personal representative of Marion s estate The trust income is $80,000 per year. Potential tax liability on the deemed disposition of the rental property on Marion s death exceeds $500,000.
21 Marion: A Snapshot Spousal trust Larry & Randy (trustees) Marion s estate Larry is executor Marion-income interest Randy-capital interest Larry is the beneficiary
22 Potential Options Do Nothing An immediate sale of the trust assets. A surrender of the income interest to the trust under subs 106(3) (may require a variation of the trust). An amendment to the trust document to achieve the above and/or or to clarify intention of the settlor that trust pay the tax liability. A variation of the trust to clarify intention of the settlor that trust pay the tax liability, add an encroachment clause for the benefit of the affected beneficiary. (Distribute trust assets to cover the tax liability). Wind up the trust. If the Parties are still alive and competent enter additional agreement(s) to address the tax liability. An agreement among the beneficiaries. Other? ( Advice and Direction)
23 1. Do Nothing If Marion dies in 2015 the tax liability on the deemed disposition of the rental property on her death is payable by the spousal trust. - Randy is the sole capital beneficiary, his share is reduced. If Marion dies in 2016 the tax liability will fall to Marion s estate. -Larry is the sole beneficiary. His share is reduced.
24 2. Sale of Trust Assets Tax liability from an actual disposition is borne by the spousal trust if - property is sold in property is sold in 2016-Marion lives until As the beneficiary of Marion s estate, Larry s best option is to sell the rental property. As trustee of the spousal trust can Larry make such a decision given his conflict of interest? Does Larry need advice and direction from the court? Does Larry have to advise Randy of the potential implications of a sale of the property on Randy s inheritance?
25 3. Buy out Marion (Marion Surrenders her income interest to the trust (Sub 106(3)) If a trust distributes trust property to a beneficiary in satisfaction of all or any part of the beneficiary's income interest, the trust is deemed to have disposed of the property at its FMV Marion would not be deemed to receive proceeds on the disposition of her income interest Result : Tax liability in the spousal trust May require a variation of the trust
26 4. Marion Surrenders her Income Interest (continued) Surrender would not end Marion s tax liability on the deemed disposition of the trust assets on her death under s. 104(3.4) Liability attaches and remains because her life is the life that triggers the deemed disposition. Potential Benefits -results in an actual disposition in the trust thus transferring the tax liability to the trust -provides Marion with compensation for her income interest and proceeds from the trust to pay her later tax liability
27 5. Amend the Trust Document Most modern trust deeds contain the power to vary the trust terms Why? The original drafter of the trust cannot know the future and what might be needed to provide for beneficiaries or to deal with changes in laws especially tax laws If the power to amend permits, consider adding an encroachment clause to distribute assets to the life interest beneficiary to pay the tax due or discretion to make payment to the CRA
28 6. Vary the Trust Variation will depend on the applicable provincial legislation Success is never sure even if all the current beneficiaries agree Court must consent on behalf of contingent beneficiaries Good option to avoid allegations by trust beneficiaries of a breach of fiduciary duty if the trustee compensates the estate for subsection 104(13.4) tax liability
29 7. Wind-Up the Trust Trusts assets are distributed to the beneficiaries in satisfaction of their interests in the trust This may require an amending power, consent of the beneficiaries or a variation of the trust This may be contrary to Greg s wishes
30 8. Parties establishing the Arrangement Enter into Additional Agreements If the estate plan is based on the assumption that tax liability on will be paid by the spousal trust, the parties could enter into contractual arrangements to achieve that result Example: the settlor of the spousal trust could contractually bind his or her estate to set aside sufficient funds to pay the tax liability that arises on the death of the spouse beneficiary Because the settlor (Greg) is dead this is not a possibility
31 9. Agreement Between the Beneficiaries and the Trustee To protect the trustees of the spousal trust from liability to a beneficiary, an agreement with the beneficiaries of the spousal trust could confirm the beneficiaries consent to the payment by the spousal trust of the subsection 104(13.4) taxes owed by the estate of the life interest beneficiary
32 10. Seek Advice & Direction of the Court Application made in summary form Protects trustee against future claim of failure to properly discharge their duties and indemnification Court is generally unwilling to: take on the job of exercising the fiduciary discretion of the trustee (possible exception if trustees are dead locked) or decide issues better suited to resolution through conventional litigation
33 Existing Trusts AFTER 2015: Example The spousal trust did not dispose of the rental property in Marion passes away peacefully in her sleep in January of As a result the trust is subject to a deemed disposition of the trust asset and all of the trust income for 2016 up to and including the date of Marion s death is included in Marion s terminal period return. Larry is the personal representative of Marion s estate. He is also one of two trustees of the spousal trust.
34 Tax Liability Tax liability for trust income trust in 2016 ( year of Marion s death) death clearly falls on Marion s estate under subsection 104(13.4). Tax and non tax questions -Should the trustee of the spousal trust write a check to cover the estate s new and unexpected tax liability or wait for the CRA to take action? -Will a Trustee be in breach of his/her fiduciary duty to the trust beneficiaries if he does not attempt to collect tax paid by the trust under subs. 160(1.4) from the estate or the estate beneficiaries.
35 Marion s Estate The personal representative will be concerned about fiduciary obligations to the estate beneficiaries and about potential personal liability on the distribution of estate assets. Will the estate lose its status as a testamentary trust and therefore as a graduated rate estate if the trust pays the tax? Should somebody pay the tax in timely fashion to avoid interest and potential penalties?
36 Non-Tax Issues Beneficiaries What recourse do trust beneficiaries have if the trustees choose to pay the tax balance owed by the estate without being assessed under subsection 160(1.4)? Creditors Assuming the trustee exercises discretion to pay the tax resulting from subs. 104(13.4) on behalf of the estate, what recourse if any do creditors of the trust have if the trustees choose to pay the tax balance before being assessed? Can the estate creditors challenge the payment if the payment is made directly to the CRA on behalf of the estate? If the trust has other creditors can it challenge the payment to the estate?
37 Spouse Trust : What is the prudent approach for the trustee? The trustee should not pay the estate s s. 104(13.4) tax until issued with a s. 160(1.4) assessment. Assuming the trustee has the power to pay the tax and exercises the discretion to do so, he or she should seek releases from the trust beneficiaries. Note: A distribution by the trust to the estate may not prevent joint and several liability of the trust for the amount if the estate has other creditors who may successfully claim the amount.
38 Marion s Estate: What steps, if any, should the personal representative take? Personal representative is liable to the extent of distribution of estate assets prior to issuance of a clearance certificate. Do not distribute estate assets until a clearance certificate issued for the estate, or it is clear there are sufficient assets to pay both the deceased s and the estate s tax liability. To the extent that tax owing by the estate is a result of subs 104 (13.4), presumably the trust would be pursued under subs 160(1.4) before the personal representative personally under subs. 159(3).
39 B. New Trusts: 2016 and Beyond 2016 and Beyond: Drafting under the New Regime Make the life interest spouse a (discretionary) capital beneficiary of the spousal trust with payment to estate on spouse s death. Trust terms may require trustee to pay the subsection 104(13.4) tax or provide trustee with power to pay.
40 Practice Points and Planning Thoughts Payment of the Estate s taxes resulting from s. 104(13.4) Income Inclusion By Who? To Who? When? Arrangements between the Life Interest Trust and the Estate Arrangements between the Life Interest Trust and its Beneficiaries Arrangements between the Estate and its Beneficiaries
41 Practice Points and Planning Thoughts Dealing with Conflicts of Interest Considerations when the structure may not be easily changed
42 Practice Points and Planning Thoughts Drafting in light of the New Rules Wills Trusts What about existing documents/arrangements that could be changed? Ensuring clients understand the impact of these rules on their planning Build sufficient flexibility into documents Consider impact of tax planning on the client s objectives
43 The Bright Side? Tax liability is now calculated in deceased s terminal return based on deceased s tax attributes carry-over losses, charitable and medical tax credits and other special tax provisions that apply on death may offset the included trust income or capital gains terminal year return is subject to progressive rates access to the capital gains deduction of the settlor of an alter ego or self-benefit trust