Not long ago, estate lawyers would regularly draft wills with multiple trusts. They were called “testamentary trusts”, and would often remain in existence for a long time, with the idea of multiplying the beneficiary’s marginal rates. It was clever, it could result in tens of thousands in tax savings per year for beneficiaries of clients with lawyers in the know… and it was, eventually, stripped away from us by the government.
How a Tax Lawyer Can Help You Understand the Role and Benefits of a GRE
With their new legislation, back in 2015, they also introduced the concept of the “graduated rate estate”, or GRE. Regardless of how many trusts arise out of an estate, now there can be only one GRE per deceased taxpayer. That one GRE gets the marginal rates, and a number of other benefits available to testamentary trusts with GRE status.
The purpose of this note is to highlight some of those benefits, and also discusses how you can lose it. A tax lawyer can help you navigate these complex rules and ensure your estate planning strategy remains effective.
Benefit #1: Marginal Tax Rates for GREs
What Are Marginal Rates?
In case you weren’t following before, marginal rates are explained below.
We don’t pay the same rate of tax on every dollar. Instead, there are graduated rates that increase the more income you earn. The first $10,000 or so, for example, is tax-free (bottom bracket); every dollar over $252,752 (top bracket) is taxed at 53.5% (with a number of different brackets in between).
Why GRE Status Matters for Tax Rates
Estates in Canada do not get marginal tax rates by right. They must be GREs. And even then, they only have it in their first three years of existence. It’s a nice benefit that can save your beneficiaries tens of thousands in tax.
Benefit #2: Loss Carrybacks and Double Tax Solutions
There’s a double tax problem that arises where estates hold shares of a corporation. When the testator dies, she is considered to have sold and reacquired her assets (including the shares of her corporation) at fair market value. Her estate pays a capital gain and the cost in her shares rises to fair market value.
Avoiding Double Tax: Pipeline Plans and Loss Carrybacks
But what happens when the estate or beneficiaries wish to withdraw funds from the corporation? In that case, they have to pay tax again!
Clever tax lawyers found two ways around this: pipeline plans and a loss carryback. The way it works is either shares of the corporation are redeemed or the corporation winds up. This results in a loss to the estate, which can be carried back to the terminal return to wipe out the capital gain, but only if the estate is a GRE. If the estate is a GRE, the gain can be converted into a dividend, and there’s no double tax.
Benefit #3: Donation Flexibility for GREs
GREs have added flexibility when it comes to donations. If a gift is made by will, by the estate or by a qualifying beneficiary designation under a RRSP, RRIF, TFSA or life insurance policy, then the donation is deemed to have been made by the GRE.
Donation Allocation Options
That donation can then be allocated in a number of ways, including:
- Back to the deceased’s tax return in her year of death
- To the deceased in the year before her year of death
- To the GRE in its first year
- To the GRE in its second year
- To the GRE in its third year
How to Lose GRE Status (And How to Avoid It)
The pitfall I discuss here is common.
Say the estate has a bill and only illiquid assets. The executor (who often gets a significant portion of the estate anyway) swoops in and pays the bill. No problem, right?
Wrong.
What Qualifies as a Contribution?
One requirement for GRE status is that no property may be “contributed” to the estate “otherwise than by an individual on or after the individual’s death and as a consequence thereof”.
So what is a contribution? The definition from the leading case is a “voluntary payment into the estate, made for no consideration, and for the purpose of increasing the capital of the estate.” Unless you don’t care about marginal rates, loss carrybacks and donation flexibility, do not pay estate bills outright.
Can You Use Loans Instead?
This can be fine, under certain circumstances:
- The loan can’t just be to the estate; it must be in respect of an expense of the estate that the individual has paid on the estate’s behalf.
- The estate has to pay the individual back within 12 months of making the payment.
- Either the loan must be at arm’s length (i.e. commercial) terms or the loan must have been made within the first 12 months of the GRE’s existence (with certain exceptions that I won’t address here).
It’s an easy trap to fall into. The benefits of GRE status can be significant, so be on guard!
Next steps
If you have any further questions about GREs (or estate questions in general), you can feel free to book in with our experienced tax lawyers in Vancouver today, or you can contact us directly at 604-230-1068.
