Do you have a trust for your husband, wife, or common-law partner in your will? If so, you need to have it reviewed before the end of 2015. As I explained in an earlier blog, the 2014 Federal budget brought in new rules affecting the taxation of these trusts. The results are particularly unpleasant for couples who have used this method of planning to deal with the estate planning complexities of a second relationship.
Let’s take an example. Steven and Laura were in a second marriage. Each of them had adult children from a previous relationship, and each of them brought assets to the marriage. As part of their planning, they made mirror wills with standard spouse trusts, allowing for rollover of capital gains on the first death.
Steven died in 2011. His estate was made up largely of a portfolio of investments, half of the family residence, and a family cottage. The portfolio grew well over the years, and has a capital gain of about $100,000 gain. The cottage has also increased in value, by about $300,000 since 1978.
Steven’s will directed his executors to keep his investment portfolio and pay the income to Laura, and to maintain the family home and the cottage for Laura to use, but said that when Laura died, all of the assets should pass to his children after payment of debts and taxes.
Until the changes in the 2014 budget become effective January 1, 2016, Steven’s will has worked beautifully.
Laura has about $150,000 of her own, mostly in investments. She gets some income on her own investments, pension and CPP, and relies on Steven’s estate to top up her income. She also continues to enjoy visiting the cottage.
Now, however, after the end of this year, the income on Steven’s investments can no longer be taxed at Laura’s lower tax rate. Instead this trust income will be taxed at the top marginal tax rate (which, in Ontario, is almost 50%), unless it is actually paid out to Laura.
Worse, when Laura dies, there will be a taxable capital gain on the portfolio and the cottage. The new provisions will deem the gain to be taxable in Laura’s hands. The $100,000 gain on Steven’s investments and the $300,000 gain on the cottage will generate about $100,000 in tax to be paid, not by Steve’s estate, and his children who actually inherit the assets, but by Laura’s estate. The deemed tax will effectively wipe out 2/3 of Laura’s estate.
Somehow, Steven’s executors and Laura’s executors are going to have to figure out how to get the tax paid from Steven’s estate.
What happens if Steven’s executors are willing to pay, but just don’t know what to pay or when? When Laura dies, the two families may work together, but many families in this event are distant if not outright hostile.
What happens if Steven’s family just refuses to contribute to the tax? Canada Revenue Agency may eventually come after them, but only after Laura’s estate is cleaned out.
Fortunately, it is not too late for most couples in this position. If Steven and Laura were both alive, they could revise their wills to work around the new laws. Even if Steven has died, if his will contains an encroachment provision, Laura may be able to re-arrange his estate to achieve the desired result and be fair to everybody.
A similar problem arises with all estates and trusts that have a life beneficiary – alter ego trusts, joint spousal and common-law partner trusts – as well. Anyone with a trust, especially one that benefits a second spouse, should consult their accountants and lawyers as soon as possible, certainly before the end of the year!