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The Deceased's Estate Will Be Required To Pay The Tax Instead of The Trust

Subject: New Rules for Certain Trusts – Part I Number: 14-22 Date: 12/22/2014

We encourage you to speak with your tax advisor regarding the significant impact of these new rules

New tax rules that received Royal Assent on December 17, 2014 will significantly impact past, present and future estate planning.  This week we will address one change and next week, another, just to ring in the holidays on a cheerful note!

The new rules will significantly change the taxation of alter ego trusts, joint partner trusts and testamentary spousal / common law partner trusts, after 2015 (even if they were created prior to 2016).   We last discussed alter ego trusts in Tax Tip 10-29 and previously discussed the tax implications upon death of the spouse or the last to die spouse in Tax Tip 10-16. 

The current rules deem these trusts to have disposed of their assets on the date of the death of:

i)    The sole beneficiary for an alter ego trust;

ii)   The last to die spouse or common law partner for a joint partner trust; and

iii)  The spouse beneficiary for a testamentary spousal trust;

Currently, each of these types of trusts report the deemed disposition and include such income or loss  at the end of the affected taxation year.  The new rules will deem the affected trust(s) to have a new taxation year end at the end of the day of death. 

In addition, the affected trust will be deemed to have paid out the income (including the deemed dispositions referred to above) to the deceased individual.  Accordingly, instead of being taxed in the trust, the income from the deemed disposition and other items will be included in the deceased’s final income tax return instead of the trust’s. 

What does this mean?  Most notably, it means the deceased’s estate will be required to pay the tax instead of the trust (although the trust will be jointly and severally liable for the payment of the tax).

These changes are significant and traditional estate planning will now have to be reconsidered.  For example:

1.       If the beneficiaries of the affected trust(s) are different than the beneficiaries of the estate of the deceased, inequities could arise.  Will the executors be able to reconcile the two without breaching their fiduciary duties?

2.       If the province of residency of the deceased individual is different than the affected trust such disparity could increase the overall tax liability that was previously planned for.  Will these changes require revision to a Taxpayer’s current planning and insurance strategies?

3.       In some cases, the affected trusts may own private corporation shares.  Traditional planning involving such cases would ensure that the deemed disposition, upon death, of the trust’s assets would not result in double taxation when the corporation ultimately distributed funds to its shareholder, the trust.  Will such traditional planning still work?  This answer can only be determined on a case by case basis.

The Joint Committee on Taxation (of the Chartered Professional Accountants of Canada and the Canadian Bar Association) as well as STEP Canada raised these issues with the Department of Finance when the new rules were first proposed.  At the Canadian Tax Foundation’s recent Annual Conference, the Department of Finance acknowledged the concerns but stated that no changes will be forthcoming.   With the granting of Royal Assent to the unadjusted rules, this statement has been confirmed.

Stay tuned.  There’s more to come next week.

TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.