It’s been just over a year since the Department of Finance introduced a new income tax term, the Graduated Rate Estate (GRE). The GRE has brought with it both advantages and some planning challenges. We will look at each in turn, as well as review, what constitutes a GRE.
A Graduated Rate Estate is an estate that arises as the result of the death of a person on or after December 31, 2015, and no more than 36 months after the person’s death. The estate at that time must be a testamentary trust.
There can only be one GRE per deceased person, and it must meet the following criteria:
- the estate must designate itself as a GRE on the first year’s tax return;
- no other estate of the individual can be designated as a GRE; and
- the estate must use the deceased’s Social Insurance Number on each tax return during the 36-month period following his or her death.
Benefits of the GRE designation
The GRE designation brings with it two key benefits.
- Graduated tax rates. As the name implies, a GRE will benefit from graduated tax rates on income for the first 36 months after the individual’s death.
- Simpler testamentary donations. Charitable donations made on or after the person’s death will be deemed to be made by the estate and not the deceased. If the estate meets the GRE criteria, there is tremendous flexibility in claiming the donation tax credits. The resulting tax credit can be claimed by:
- the GRE in the year the donation is made or any of the following five years;
- carrying it back to a previous tax year of the GRE;
- the deceased on his or her final tax return; or
- the deceased on the tax return for the year prior to death.
For gifts in-kind of publicly traded securities or mutual funds on or after death, a nil capital gains inclusion rate is available; however, the exemption is only available if the estate is designated a GRE. This allows a GRE to benefit from the same tax treatment on in-kind donations that living donors enjoy.
On the other hand, testamentary donations of securities made by non-GRE estates will not benefit from the elimination of capital gains taxation, and would therefore be subject to capital gains taxed at the regular 50% inclusion rate. In addition, the donation tax credit will be restricted to the estate and will not enjoy the flexibility of allocating the donation tax credits to the estate or to the deceased’s tax return, as described above. This could pose a mismatch between the tax liability (borne by the deceased) and the donation tax credit (limited to the estate).
The two benefits can only be realized if the executor makes the appropriate designation on the estate’s first tax return. This is especially important with respect to testamentary donations. The flexibility afforded to the executor in allocating the donation tax credit between the deceased and the estate, along with the tax treatment of in-kind donations, improves the probability that the tax credit gets fully utilized.
Other benefits enjoyed by a GRE
- Non-calendar year-end: While other testamentary trusts can only have a calendar year-end, a GRE can choose to have a non-calendar year-end. While this may seem small, it could allow the GRE to enjoy its 36 months of graduated tax rates over parts of four calendar years.
- Loss carry-backs and avoidance of stop-loss rules: When the deceased owns private company shares, a potential double tax problem exists. First, the shares are deemed disposed at fair market value (FMV) upon the death of the shareholder. Second, another tax hit could occur if the corporation is wound up by the estate and proceeds are paid as a taxable dividend to the beneficiaries of the estate. Alternatively, with proper planning, when the corporation is wound up, the estate could end up with a capital loss and pay a tax-free dividend to the beneficiaries of the estate. However, that type of tax planning is not allowed for non-GRE estates under what are known as stop-loss rules. Stop-loss rules do not apply to GREs, so proper estate planning can lead to large income tax savings, particularly for shareholders of private company shares.
- Deeming losses for employee stock options: When employee stock options are exercised after the employee’s death (up to one year, as an example), the options’ value may have declined prior to exercise. This could mean the estate realizes a benefit that is less than the amount reported on the terminal tax return, which is based on the date of death. In such cases, only a GRE can deem a loss that would reduce the amount originally reported on the terminal return. In other words, only a GRE can match the deceased’s taxation on the stock options with the benefit actually realized at the time of exercise.
Planning opportunities with Graduated Rate Estates
In light of the GRE, review current estate plans for clients with the following circumstances.
- Testamentary donations: Make sure your client’s executor understands how to elect to have the estate treated as a GRE; otherwise, you’ll lose the flexibility of allocating the donation tax credit between the estate and the deceased. Having a GRE also means tax savings for in-kind gifts of publicly traded securities or mutual funds on death. That’s because the nil capital gains inclusion rate on the donation of securities is only available to GREs.
- Private company ownership: Stop-loss rules do not apply to GREs, which can mean substantial tax savings for the deceased. Review any loss-carry back strategy in conjunction with other estate planning strategies used by private corporations, such as insurance and buy/sell agreements, to ensure all desired tax benefits are realized at death.
- Multiple wills: Multiple wills are typically used by business owners in provinces where they’re permitted, like Ontario, to avoid probate on the deceased’s business assets. But, even though two wills exist, there is legally only one estate. As such, the executors of each respective will must work together to ensure all assets of the deceased qualify as a single GRE for income tax purposes. Review existing estate plans for continuity between multiple wills and select executors that will collaborate well. This may include executors that live close to each other and will cooperate to maximize the benefits of the GRE for all beneficiaries; especially if the beneficiaries are different under each will.
- Potential for tainting: If a GRE loses its status as a testamentary trust, the GRE status will be lost along with the benefits already discussed. A testamentary trust can be tainted by:
- Another person contributing to the trust. This could happen if a beneficiary borrows money from and then re-contributes to the trust. Another example could involve substituting trust property with new property that has a FMV greater than property originally contributed.
- A distribution from an inter vivos trust. If a testamentary trust is named as a beneficiary of, or receives a distribution from, an inter vivos trust (either income or capital), this could taint the status of a testamentary trust.
A GRE unlocks several advantages. Adjust a client’s current estate plan for GRE eligibility where appropriate. Also, remind executors to make the appropriate election on the first income tax return of the estate to solidify GRE status. The designation must be on time, as CRA will not accept late-filed designations. The stakes are high for executors, but professional advice goes a long way to ensuring smooth estate administration.
Curtis Davis, FMA, CIM, RRC, CFP, is senior consultant, Tax, Retirement & Estate Planning Services, Retail Markets at Manulife. Reach him at Curtis_Davis@manulife.com