Why is this estate litigation blog dealing with tax?
I was a speaker at the 17th Annual Estates and Trusts Summit and one of the other presenters was Barry Corbin. He gave a passionate presentation about changes under the Estate Administration Tax Act.1 He considered these changes so flawed and counterproductive that he beseeched us all to use every means at our disposal to encourage people of influence to address these changes. In his zeal and passion, Barry reminded me of the legendary warning of Paul Revere that the “British are coming.”2 So, Barry – this blog is for you.
My expertise is not tax. But the changes are so important to solicitors who do estate planning and administration, as well as to people of means, that I felt it important to help raise awareness about what is going on. So to prepare this blog, I reached out to my colleagues who have expertise in this area. The ensuing research revealed additional changes in estates and tax laws that will have a significant impact on both practitioners and persons of means. So while there are a number of people who assisted us in the preparation of this blog, I want to especially thank Leigh Taylor3 whose expertise and assistance was of fundamental importance. In preparing this blog we have relied heavily on Karen Slezak’s blog4 and on Barry Corbin’s and Jordan Atin’s articles on this issue.5
This article provides an overview of two major developments: (1) the introduction of estate inventory disclosure in Ontario; and (2) some new rules for the taxation of testamentary and inter vivos trusts.
New regulation under the Estate Administration Tax Act, 1998 (EAT)
Mr. Corbin has been quoted as saying that the changes to the EAT are: “dumb and dangerous.” He also advised the Ontario government that: “… they should abandon this before it makes a mess.” In my view, he is right.
In terms of policy, at the Estates and Trusts Seminar, Mr. Corbin made the following key points:
- The government’s goal was to increase revenues by increasing the probate fees. At first glance that makes sense. If the government increases probate fees, they should make more money. But, a closer examination shows it will accomplish the opposite.
- Mr. Corbin analyzed the history of probate fees to demonstrate how wrong-headed the government was in its approach. The Rae government tripled probate fees in 1992 from $5 to $15 per $1,000 of estate value. Prior to the increase in taxes, the government collected an additional 10% per year in probate fees. With the hike in probate fees, the money collected went down instead of up. As Mr. Corbin pointed out, the government incentivized Ontarians to find ways around having to pay probate fees. For example, there is a “trillion-dollar transfer” of wealth from parents to children going on right now by means of jointly held property. Since the property passes by way of survivorship, there are no probate fees. As well, people of means started to use more than one will as a way to transfer assets. The secondary will does need probate and therefore no probate fees are paid on those assets.
- Prior to the passing of the EAT, it was standard practice for the executor to make an interim distribution prior to obtaining a clearance certificate from the CRA. Now, after the passage of the amendments to the EAT, there are significant changes to the powers and duties of the various parties involved. The Minister of Revenue can now assess or reassess an estate for the probate fees payable under the EAT at any time within four years after the day on which the tax became payable. There is no mechanism for obtaining an EAT clearance certificate. In fact, the Minister can assess or reassess an estate for its tax payable under the EAT at any time whatsoever if the person failed to comply with his or her disclosure obligations or made a misrepresentation. Mr. Corbin offered the view that executors will need closure well before four years. Says Mr. Corbin: “It’s a long time. Unlike the Income Tax Act, where there is an obligation to assess with all due dispatch, there’s no obligation to issue a certificate at all or even tell them if they are clear.”
Here is a non-exhaustive list of issues for estate practitioners to take note of:
- the return is deemed to be given to the Minister of Finance on the date that it is received (not sent),6 so keep in mind the 90-day deadline referred to above;
- a failure to file the return can lead to fines and possible imprisonment;7 and
- assets governed by a will that is not submitted for probate do not have to be disclosed on the return and assets that are beneficially owned by the deceased, even though legal title resides in another person, must be included in the return.8 More about that later.
There are a number of substantive issues for accountants and lawyers who are helping their clients prepare applications for a certificate of appointment with a will. While it is beyond the scope of this paper to address all those issues,9 there are some concerns that I wish to point out here. In the Pecore case,10 the Supreme Court of Canada explained that certain assets held jointly with a right of survivorship between an elderly parent and adult child are presumed to be held in trust for the estate. Ordinarily, jointly held assets are not included as “estate assets” in a probate application because the surviving joint tenant inherits the asset by right of survivorship. Now, given the presumption that these jointly held assets are really estate assets, and having in mind the changes discussed, the accountant and lawyer helping their client must pose a question. Should the joint asset presumed to be held in trust for the estate be included as an estate asset for the purposes of the application for a certificate of appointment? On the one hand, the Ministry may rely on the presumption; on the other hand, it is a rebuttable presumption and there may be proof that the testator genuinely intended for the asset to pass by right of survivorship. If so, the presumption would be rebutted and the asset should not be included as part of the estate assets. In his paper, Jordan Atin points out that: “Assets that are beneficially owned by the deceased, even though legal title resides in another person, must be included in the EI return. The question arises as to how the Ministry will look at a joint asset that is presumed to be held in trust for the estate. Does it have to be included in the estate assets for the purposes of probate?” If the answer is yes, will those executors and professionals who fail to do so find themselves being sanctioned by the Ministry?11
Any professional helping an executor in preparing the quantum of assets for an application for a certificate of appointment might find himself or herself personally liable for not including assets properly required to be included. I refer the reader to the specific wording of subsection 5.1(2). It seems to be broad enough to impose personal liability on anyone assisting the estate trustee. The section states:
“Every person is guilty of an offence who, in giving information required under section 4.1 (the disclosure obligations), makes or assists in making a statement that, at the time and in light of the circumstances under which it was made, is false or misleading in respect of any fact, or that omits to state any fact the omission of which makes the statement false or misleading.”
The addition of those four words “or assists in making” raises the question whether an accountant’s advice leading to a false statement by the client constitutes “assists in making” and puts the accountant at risk.
New rules for testamentary trusts12
People of means often use trusts for their estate planning. Sometimes if there are minors, a trust is set up for them until they are old enough to handle money. Sometimes a spousal trust is set up because the settlor married a second time and wants to protect his or her new spouses as well as the children from the first marriage. The spousal trust allows the surviving spouse to enjoy the income of the trust while he or she is alive and for the children of the deceased to get the capital after the surviving spouse dies. There are also tax advantages to these trusts including:
- lower marginal rates;
- maximizing tax deferral; and
- income splitting.
Much of this will change on January 1, 2016. The most significant proposed changes will see the tax rate applicable to income earned in testamentary trusts increase from the individual graduated rate to the top marginal rate. In other words, under the current regime, the same graduated tax rates that apply to individuals also apply to income earned in testamentary trusts. So what does this mean in terms of dollars and cents? For the first $135,000 of income earned by the testamentary trust, the higher tax rate will cost almost an additional $20,000 per year. For wealthy families, estate planners sometime advised having multiple testamentary trusts. Since there is no grandfathering, what was a good idea prior to January, 2016, now becomes a bad idea. For the spousal trust, the new legislation now taxes the accrual of capital gain in the deceased beneficiary’s terminal return instead of the trust. Translation – the children of the first marriage, as beneficiaries under their parent’s will, now pay the tax.13
So what happened to the graduated tax rates for testamentary trusts? They are now only in place for the first 36 months after death14 and after that point, the estate will have a deemed year-end of December 31 and be subject to the highest marginal rate on every dollar earned.15 Moreover, these trusts and estates will not only be paying more taxes, but they will have to remit quarterly installments and cannot claim the $40,000 basic exemption when calculating alternative minimum tax.16 Existing testamentary trusts after December 31 2015 will immediately come into these new tax changes. Accordingly, the resulting tax consequences for wealthier families who have created multiple testamentary trusts in their wills will be significant.
What is more, the tax regime changes will reduce or eliminate a number of very simple tax planning opportunities, including:
Testamentary spousal trusts. Planning using a testamentary spousal trust for tax purposes only will be significantly reduced, with a punitive tax effect to a family on the death of the first spouse; and
Bequests to adult children. The income splitting opportunities created when a parent leaves a bequest to an adult child in a testamentary trust may also be eliminated. 17
What do these tax changes mean for the client and for solicitors?
For the client
People of means should return to their lawyers and verify whether the changes impact on their previous estate plans. If the testator has died, it’s important for the executors to remember that they too should return to their lawyers for advice because the changes are not grandfathered. For example, notwithstanding that the tax planning was valid when the will might have been signed the testamentary trusts will still be taxed at the highest rates. Executors who are administering estates with testamentary trusts, which are not grandfathered, have to educate themselves on the lost tax advantages and seek legal counsel as to how to address these issue. It may pay to explore the possibility to vary the testamentary trust or possibly collapse the trust.
For the solicitor
There is no doubt that many lawyers drafted wills and crafted estate plans that are now flawed because of the changes in the tax law. No one can fault the lawyer about the estate planning that took place prior to the changes, but the question is what should the lawyer do now? Clearly, best practices might indicate that it is prudent for lawyers to contact those clients whose estate planning has been impacted upon by the tax changes. But, given the changes in the tax law, what duty of care, if any, does that lawyer have to warn his or her clients that it is time to come in to do a new will? Would a failure to give that warning fall below the standard of care expected of that lawyer and give rise to a negligence claim?18 Or, alternatively, is it too much to expect a lawyer to call all of all those former clients and warn them of the change? Time will tell.
- Estate Administration Tax Act, 1998, S.O. 1998, c. 34,Sched. I also refer the reader to Ontario Regulation 310/14 found at http://bit.ly/estate_tax_act ↵
- According to Wikipedia, Paul Revere never uttered this phrase. His mission depended on secrecy. See http://en.wikipedia.org/wiki/Paul_Revere ↵
- Leigh Somerville Taylor Professional Corporation is tax litigation counsel to the firm. Leigh has extensive experience and success in tax litigation before both the federal and provincial courts. ↵
- Karen Slezak is a partner with Crowe Soberman’s Tax Group and leads the firm’s Estates & Trusts Group. Karen is also the co-chair of the firm’s Women for Women Group. Karen wrote a piece meant for tax professionals, which appeared in our own blog: “New tax changes to Canadian trust rules means it’s time to revisit your estate planning” ↵
- I refer the reader to Jordan M. Atin’s paper, “Estate Administration Tax Act, 1998, The New Regulation.” This paper is part of Jordan’s initiative called IWEE – Institute for Wills & Estate Education. Jordan’s paper is an excellent introduction to the changes and provides a guideline for solicitors who have to deal with the legislation. ↵
- Regulation, at section 2 ↵
- Atin, at p. 2 ↵
- Atin, p. 3. ↵
- The Primer for Accountants on Amended EAT can be found at https://www.wagnersidlofsky.com/power-attorney-primer/ ↵
- Pecore v. Pecore, (2007) 1 S.C.R. 795. The Supreme Court of Canada defined a resulting trust as follows:
“A resulting trust arises when title to property is in one party’s name, but that party, because he or she is a fiduciary or gave no value for the property, is under an obligation to return it to the original title owner. While the trustee almost always has the legal title, in exceptional circumstances it is also possible that the trustee has equitable title.”
Pecore is the seminal case dealing with the presumption of a resulting trust that arises when children hold joint accounts with their elderly parents. The presumption is that, upon the parent’s demise, the money does not pass by right of survivorship to the child; rather, it is held in a resulting trust for the estate. See more at: http://bit.ly/resulting-trust ↵
- As part of the research for this blog, I discussed the issues raised herein with Barry Corbin. He feels that the issue of joint accounts between a parent and an adult child are susceptible to a significantly more nuanced analysis. According to Mr. Corbin, the issue is properly examined by the estate trustee’s first asking the adult child — and we can leave aside the difficult issue when they are one and the same person — what his or her position is. If the adult child says that the parent did not intend a gift, the matter is no longer in doubt. Otherwise, the estate trustee has to evaluate the prospect — and costs — of a successful lawsuit to ‘recover’ the asset for the estate. It is in the assessment of the prospect of such a recovery that the presumption of resulting trust may play a role. Ultimately, it is a valuation exercise, not unlike the valuation of a loan receivable as an estate asset. The actual outcome of the litigation should have no impact upon the declared value that was initially included for EAT purposes. Barry’s points are well taken. It remains to be seen what the position of the Ministry will be. ↵
- Please note that a review of all of the changes to Canadian tax and trust rules are beyond the scope of this article, which focuses on the higher tax rates for testamentary and inter vivos trusts. Other changes include, but are not limited to, loosening of the rules applying to charitable donations, changes to the deemed disposition rules for special types of trusts, restrictions on the election to tax income in a trust, and qualified disability trusts. Please see Karen Slezak, “New tax changes to Canadian trust rules mean it’s time to revisit your estate planning” for a comprehensive review which can be found at http://www.estatelawcanada.ca/new-tax-changes-to-canadian-trust-rules-means-its-time-to-revisit-your-estate-planning/ ↵
- Please see KMPG’s article entitled, “New Tax Regime May Upset your Estate Planning”: http://bit.ly/new-tax-regime
- In other words, the changes do not apply to a “graduated rate estate,” i.e., an estate that is a testamentary trust, for the first 36 months after the date of death. Section 248(1) of the Income Tax Act provides a new definition of “graduated rate estate.” This is defined as an estate that arose as a consequence of the individual’s death if: (1) that time is no more than 36 months after death; (2) the estate is at that time a testamentary trust; (3) the individual’s social insurance number is provided in the estate’s return; (4) the estate designates itself as a graduated rate in its first return of income for its fiscal taxation year that ends after 2015; and (5) no other estate designates itself as a graduated rate estate in a return of income for a taxation year that ends after 2015 ↵
- Slezak, at p. 1. ↵
- “Tax Insights from High Net Worth/Private Company Services,” Issue 2014-34, September 18, 2014, at p. 1. ↵
- Catherine D.A. Watson, “Legal Update: Punitive Impact of Proposed Changes to Taxation of Testamentary Trusts,” McInnes Cooper on-line publication, June 13, 2013. Ms. Watson notes that other tax planning opportunities will be eliminated, including:
Minor Beneficiaries. Tax on income earned in a trust benefitting a minor will increase, and the money for the minor will decrease, even though a parent’s only choice is to use a trust. Disabled Beneficiaries. Similarly, tax on income earned in a trust benefitting a disabled person will increase, and the money available to the disabled person will decrease, limiting the planning necessary to safeguard a disabled person’s entitlement to government benefits and programming and from undue influence. ↵
- There is an excellent article on solicitors’ negligence written by David Lobl. I refer the reader to “Recent Developments in Estate Solicitor’s Negligence” that appeared in the 15th Annual Estates and Trusts Summit – Day One. ↵