Tag: Spouse

Spousal trusts and blended families – A different mix in 2016

It can be challenging managing finances between spouses in second marriages.  

Add two sets of children to the mix — and often some mutual children — and things can get very complicated.  And it doesn’t necessarily get any easier as those children become adults, or even if they are already adults when the new relationship develops.  It’s a delicate balance.

Beyond the day-to-day issues, attention will eventually turn to what happens when one of the spouses dies.  While there are common interests between them as spouses, their parental desire to provide for their respective children adds a layer of complexity to the estate planning exercise.

How spousal trusts work

The spousal trust has been used for decades as a tool to address these concerns.  Let’s assume the spouses are Jay and Pat.  

Jay’s Will may make some immediate bequests, then a trust is set forth with Pat as lifetime income beneficiary.  Pat may or may not be allowed to encroach on the capital to some extent, with Jay’s children being the ultimate capital beneficiaries on Pat’s death. 

As an alternative, Jay could settle a joint-partner trust created during lifetime.  In that case such an inter vivos trust would be a top bracket taxpayer, though income distributions would be taxed to Pat.

Either route would result in a spousal trust into which capital assets could be transferred at their cost base.  This defers tax recognition of gains to that point, and allows for continuing deferral on future gains.  Some gains could be triggered and taxed to Pat if there is an encroachment, but otherwise the gains will be deferred until Pat’s death.

Tax changes after 2015

A couple of wrenches were thrown into the machinery of this planning with changes to the rules for trust taxation passing into law in 2014.  Let’s assume Jay dies, with the trust provisions having been established in Jay’s Will.

First, Jay would have contemplated that Pat’s income could be optimized by coordinating with the testamentary trust’s graduated tax brackets.  But after 2015 (unless Pat is disabled at Jay’s death), such a testamentary trust will be subject top bracket taxation.  Thus there will be less spendable income than the plan intended, possibly insufficient to sustain Pat based on Jay’s expectations when the Will was executed.  

The second key change relates to the capital gains related tax on the deemed disposition of trust assets on Pat’s death.  Under prevailing rules the trust is responsible for that tax, following which it distributes the net remainder to Jay’s children as capital beneficiaries.

Under the new rules for deaths occurring after 2015, the capital gain is deemed to be Pat’s. Pat’s estate is responsible to pay the tax, though if it is insolvent then the trust has the contingent liability.  Subject to that proviso, Jay’s children will likely receive the trust capital, while Pat’s children bear the brunt of the taxes in the form of a depleted estate.  

Even if an agreement is struck to have the trust pay the taxes, this will likely be considered a contribution to Pat’s estate that immediately disqualifies it from use of graduated tax rates (which otherwise would be available for three years under the new rules).

Any reprieve ahead?

These issues were acknowledged by the Canada Revenue Agency at this year’s annual conference of the Society of Trusts and Estates Practitioners.  Not surprisingly, the loss of graduated brackets for testamentary spousal trusts did not seem to be a concern.  

On the other hand, the mismatch problem on death of the spouse-beneficiary appears to have been unintended.  It remains to be seen whether the government takes any action to address this.

Regardless, spouses in the planning stages may wish to reconsider, redraft or possibly completely unwind their plans — hopefully both spouses still have testamentary capacity.  It’s likely not so easy for trusts that have already come into existence, potentially requiring a court application to vary trust terms.

[NOTE: Late in 2015, the federal Department of Finance issued a comfort letter acknowledging the issues discussed in this article, opening a dialogue with tax professionals intended to address the concerns.

No spousal rollover where beneficiaries assign rather than disclaim RRSP

At issue

When a person dies, RRSP holdings are generally brought into income in the deceased’s terminal tax year.  However, where there is a beneficiary designation to a spouse (or certain dependents), a tax-deferred refund of premiums enables a rollover to the recipient’s RRSP.

Alternatively, the RRSP may be paid into the estate if there is no valid designation in place, or if the estate itself is named as beneficiary.  Either way, it is possible to make a joint election with the estate to effect a similar rollover, assuming the spouse or other qualified beneficiary has sufficient entitlement in the estate.

IT-500R Registered Retirement Savings Plans – Death of an Annuitant (Archived) 

This interpretation bulletin (now archived) includes CRA’s past guidance on dealing with RRSP rollovers.  (Such bulletins are administrative only, and specifically are not binding legal authorities.)

It includes reference to RRSP joint elections between an estate and a spouse, and the potential to use them when other beneficiaries have disclaimed their interests in an estate.  This requires that the spouse’s estate entitlement is at least the value of the RRSP, and is not available if the spouse is only entitled to a portion of the RRSP or if under an intestacy the spouse only receives specific assets other than the RRSP.

There is no discussion of the effect of a named beneficiary of an RRSP disclaiming such interest.

Estate of the late John Arthur Murphy v. Her Majesty the Queen, 2015 TCC 8 

John Arthur Murphy died in Nova Scotia in 2009.  Despite owning a home, farm property, forest properties, rental properties, cottages and livestock, he had no Will – His estate was an intestacy.

Mr. Murphy’s heirs were his spouse Barbara DeMarsh and three adult children from a previous marriage (“the Murphys”).  There were ebbs and flows in the dispute that followed, including claims under matrimonial and intestacy law.  Eventually a Consent Order was filed with the court in May 2011, providing (among other matters) that the Murphys take all necessary steps to “release, convey and transfer to and in favor of [Ms. DeMarsh] any and all interests that they may have in” an RRSP worth $237,026, on which they had been the named beneficiaries.

The particular RRSP had been reported in Mr. Murphy’s terminal tax return, filed in April 2010.  To give effect to the agreement and enable a rollover to an RRSP with Ms. DeMarsh as annuitant, the estate requested a T1 adjustment in August 2011.

The CRA denied the request, leading to the present appeal in which the estate argued that the Consent Order had the effect of indefeasibly vesting the subject RRSP in Ms. DeMarsh retroactive to the time of Mr. Murphy’s death.

The judge disagreed.  A disclaimer is a refusal to accept a gift, after which the disclaiming party has no right to direct who is to receive the gift.  In this case, the Murphys did not disclaim their interest in the subject RRSP, but rather they settled the litigation by transferring their interest in the RRSP to Ms. DeMarsh.  In the judge’s view, the settlement “is not a disclaimer but an assignment.”

The RRSP proceeds remained as income to the estate, with no refund of premium allowed to roll over to an RRSP for Ms. DeMarsh.

Practice points

  1. Mr. Murphy’s lack of a Will (and the resulting intestacy) contributed to uncertainty and delay generally, and arguably factored into the substance of the outcome.
  2. The settlement dealt with assets and issues well beyond the subject RRSP, including contingencies like the potential that the T1 adjustment might be denied.  While the judgment rested at least in part on the text of the settlement, the chosen words may have been necessary to preserve the broader agreement.
  3. Though not discussed in the case, generally RRSP rollovers must occur by December 31 of the year following death.  Had the estate been successful on the core issue, it may still have faced a hurdle on this administrative requirement.

Whether a surviving spouse can claim donations of deceased spouse

At issue

Most tax credits are limited in value to the lowest bracket tax rate.  The charitable tax credit is generally more lucrative, as it is claimed based on two tiers.  Federally, the lowest bracket rate applies on the first $200 of annual donations, with any excess entitled to a credit at the top bracket rate.  (Provincial credits operate similarly, though not all are exactly at the top bracket rate.)

For spouses, there is a further benefit available via administrative practice of the Canada Revenue Agency.  CRA recognizes that donations are generally made based on the family unit, despite that one name may appear on a donation receipt.  Accordingly, the agency allows donations to be claimed on the return of either spouse or common law partner.  This simplifies reporting and efficiency of credit use, at the very least helping elevate past the $200 threshold.

Until recently, spouses could also depend on a related CRA administrative practice on the death of a spouse, but after 2015 it is no more.

2010-0372621E5 Donation by will claimed by spouse

The CRA was asked whether an individual can claim a tax credit for a charitable donation made by his/her deceased spouse’s will in the year in which the spouse died.

The response cited the CRA’s general administrative position on donations on behalf of a family unit.  It went on to highlight ITA s.118.1(5) (as it was at that time), which deems charitable gifts made by an individual in his or her Will to have been made by the individual in the year of death and not by the estate.  This is despite that the executor/estate really carries out the donation, and that it may not actually occur until a later year altogether.

The writer then stated that the deceased’s executor and the surviving spouse (which could very well be the same person) are entitled to claim the tax credit in the most beneficial manner available.  Thus, supported by the deemed timing of the donation, a spouse would be entitled to claim the donation on his/her own return for the year in which the spouse died.

Bill C-43, Royal Assent (2014-12-16)

This Bill enacted provisions of the February 11, 2014 federal budget.

The definition of “total charitable gifts” in s.118.1(1) was replaced, including explicit acknowledgement for either the individual or his/her spouse or common law partner to claim donations.  This somewhat codifies the past CRA administrative practice with respect to the family unit, except that this treatment does not apply to donations made by a trust.

In that latter respect, new provisions were also enacted to deal with donations made by Will.  Such donations would no longer be deemed to occur in the year of death.  Rather, the donation could be claimed in the year it is actually made, with the executor (on behalf of the estate, which is a trust) having discretion to claim the donation in any earlier estate year, in the terminal year or the year prior to death.

2014-0555511E5 E – Spousal sharing of charitable gifts

On November 7, 2014 (while Bill C-43 was still making its way through Parliament), a taxpayer inquired whether the CRA would continue to apply its administrative position from letter 2010-0372621E5.

The CRA response was issued January 27, 2015, citing the amended definitions and deeming provisions outlined above.  Given these amendments, the CRA’s administrative practice as stated in the 2010 letter will no longer apply for deaths occurring after 2015.

Practice points

  1. For modest donations (relative to prevailing income), it is likely that the full value of the credit will be able to be claimed through the carryback to the deceased’s terminal year or the year prior to death.  Where the donor has little income, the inability of a surviving spouse to report the donation may mean that some of the credit value may be unusable.
  2. The Bill C-43 amendments also encompass donations made by beneficiary designation under life insurance and through registered plans.
  3. Those who have strategically planned their charitable giving may wish to consult with their philanthropic and tax advisors whether reconsideration and revision may be warranted.  For some, it may swing the balance toward lifetime gifting, rather than being exposed to potential uncertainty in the estate.