Tax For Estate Planners: Tips & Traps for Graduated Rate Estates
In the “old” days, not quite before my time, tax accountants and lawyers often advised wealthy clients to create multiple “estates” for tax planning purposes. This strategy allowed their clients to multiply marginal tax rates, saving substantial amounts in taxes. Many of these “estates” were kept active indefinitely, enabling ongoing tax avoidance.
This practice continued until 2015, when legislation introduced the concept of the graduated rate estate (“GRE”), combining multiple “estates” into one, and limiting preferential tax treatment to a single estate for up to three years.
This note is about the GRE—specifically tips for the estate planner and traps than an unwary client can fall into.
Marginal rates
Originally, each “estate” would get to use its own marginal tax rates; now, only the GRE gets them, and only for a limited period of three years following the date of death.
Marginal tax rates can provide significant tax savings—up to approximately $50,000 annually by my rough estimate. Instead of applying the top marginal rate (e.g., 53.5% in BC) to all income, graduated rates allow lower rates on income within each tax bracket.
For that reason, there are some planning opportunities available. For example, if an estate has minimal income but holds shares of a company, consider issuing dividends to the estate to take advantage of the lower marginal rates. This can result in considerable tax savings if the ultimate beneficiary is already at or near the top marginal tax rate.
Other benefits
There are other benefits to GREs. For example, only GREs are able to undertake loss carry-backs (a plan put in place to eliminate double tax with regard to shares of a corporation deemed disposed on death). Additionally, GREs have much greater flexibility for allocating dividends among tax years of the estate and the deceased (I wrote about this separately here).
So, the benefits aren’t what they used to be, but they’re still there, so long as you keep GRE status. Because it’s possible to lose it—which I discuss next.
No contributions
A key condition for GRE status is that the estate must qualify as a “testamentary trust” under the Income Tax Act, which requires that no property be contributed to the estate except by an individual as a consequence of that person’s death.
So what is a contribution?
The leading case (Greenberg Estate v. R) defines it as a “voluntary payment into the estate, made for no consideration, and for the purpose of increasing the capital of the estate”.
This provision exists to catch substantial contributions from which income can be earned at the lower marginal rates. However, practically speaking, a contribution can be any size, such as the payment of a legal bill, or property tax for a residence, so long as the purpose test is met.
Instead of a outright transfers, executors and beneficiaries for illiquid estates might consider a loan. This will not be considered a contribution under certain circumstances:
· The loan must relate to an estate expense that the individual has paid on behalf of the estate
· The estate must repay the individual within 12 months of the payment
· Either the loan must have arm’s length (commercial) terms, or it must be made within the first 12 months of the GRE’s existence
And as a final comment about contributions, they could cause subsection 75(2) to apply to the estate. This is a subject for its own note, but in short, the application of this provision can cause major tax issues for any estate.
The trap
This is an easy trap to fall into, even though it’s seldom (if ever) reported. Don’t let your client be the one estate that gets audited for this issue!
If you have any questions about GREs (or tax questions related to estate planning), you can feel free to reach out to us. The author can be contacted directly at jonathan@rkwlaw.ca or 604.425.1123.