Major Changes To The Income Tax Act: Time To Update Your Estate Plan
Back in 2013, the Department of Finance proposed some changes to the Income Tax Act and asked for public input on those proposed changes. The proposed changes largely related to how estates and trusts created on the death of an individual would be taxed, including that trusts created on death would be taxed at the highest marginal rate instead of the marginal rates that individuals have the benefit of (you can read more about this in my previous article entitled Department Of Finance Consults On Proposed Changes To Taxation Of Trusts).
Despite the numerous well-written and well-reasoned arguments that were submitted to the Department of Finance against the blanket changes that were proposed, the Department of Finance carried on with the proposed changes, and draft legislation to implement the changes was released in the fall of 2014. But the draft legislation did not end there. It made additional, and very significant, changes to many other elements of the taxation of estates and trusts; changes that were not previously proposed and that could seriously and negatively impact existing estate plans.
The enactment of the draft legislation proceeded very quickly: Bill C-43 had its first reading in the House of Commons on October 23, 2014, passed through the remainder of its readings in the House of Commons as well as the Senate and received Royal Assent on December 16, 2014. The new laws will become effective as of January 1, 2016.
Some of the changes made by Bill C-43 include the following:
- High rate taxation: All trusts will be subject to taxation at the highest marginal rates, except for “graduated rate estates” and “qualified disability trusts.”
- Graduated rate estates: A graduated rate estate will be taxed using marginal rates for a maximum period of 36 months. An estate may designate itself as a graduated rate estate, but only if no other estate is designated and only if there are no contributions made from outside of the estate. Estates that are not graduated rate estates will have restrictions on the use of donation tax credits and certain other tax-saving strategies.
- Qualified disability trusts: A qualified disability trust will receive preferential tax treatment. To qualify, it must have been created by a Will and have as a beneficiary someone who is claiming the disability tax credit. That beneficiary will need to jointly elect with the trust for it to be a qualified disability trust, and that beneficiary cannot have made such an election with any other trust.
- Spousal trusts, alter ego trusts and joint partner trusts: There is a taxable event for these trusts on the death of the spouse beneficiary of a spousal trust, the lifetime beneficiary of the alter ego trust, and the surviving lifetime beneficiary of the joint partner trust. The resulting taxes will now be taxable in the hands of the applicable deceased beneficiary instead of in the trust, and therefore the taxes will be payable out of the assets of that deceased beneficiary instead of out of the assets of the trust.
The implications of the above can be severe in certain situations. For instance, a surviving spouse’s estate may face a large and unexpected tax bill relating to assets in a spousal trust (and which may be going to a different set of beneficiaries). A similar result can follow for alter ego and joint partner trusts. Also, an insurance trust set up for a disabled beneficiary will be subject to high-rate taxation if the insurance funds do not pass through the estate. Donation tax credits and other tax-benefits may be lost if the estate cannot be designated as a graduated rate estate.
There are certainly still some excellent planning strategies available with trusts, and some estate plans may be fine as-is. However, it is important to review your estate plan with your advisor to ensure that it will still achieve your objectives. Any necessary changes should be made before the January 1, 2016 effective date.