Taxation of Canadian Estates: Changes Are Coming

In the 2013 federal budget the federal government announced its intention to amend the tax provisions with respect to testamentary trusts (i.e., trusts created as a result of death). These were followed by specific proposals in the 2014 budget. On December 17, 2014, Bill C-43 received Royal Assent and brought into force many new income tax provisions.

One of the most widely discussed changes is that graduated tax rates will generally no longer be available to testamentary trusts. Beginning in 2016, income earned and retained by a testamentary trust will be subject to tax at the top flat tax rate, with the exception of a graduated rate estate and a qualified disability trust (QDT).

The graduated rate estate (GRE) is a completely new type of trust that comes into effect for income tax purposes beginning January 1, 2016. In general terms, a GRE is an estate that arises as a consequence of a death and can exist for up to 36 months following death provided the trust remains a testamentary trust. A GRE will be subject to the “old” graduated tax rate treatment. In simple terms, an estate will be treated as a GRE for up to 36 months immediately following the testator’s death and during that time it will be eligible to utilize graduated tax rates. If the estate exists beyond the 36 month point following the deceased’s death, the estate will no longer be a GRE and becomes subject to the top flat tax rate regime.
The estate representative can select any year end for the GRE; however, if the trust continues to exist beyond the 36 month point, the trust year end will convert to a December 31 year end from that year forward.

An estate typically remains open for the time needed by the estate representative to complete the work required to administer the estate, including activities such as identifying the assets, locating beneficiaries, and completing the estate distributions. The federal government suggests 36 months is a reasonable period for an estate to be treated favourably through GRE status because the majority of estates are typically wound up within this window of time.


Let’s look at an example that highlights the year end for a new estate under the new regime.
Ted passes away on September 30, 2016 with a fairly complex estate which will likely remain open for an extended period of time. Ted’s estate taxation year begins at the moment of death and will be treated as a GRE for up to 36 months from his date of death.

First tax return April 30, 2017 (Selected by Ted’s estate representative)
Second tax return April 30, 2018 (12 months)
Third tax return April 30, 2019 (12 months)
Fourth tax return September 30, 2019 (36 months following Ted’s death) – GRE period ends.
Fifth tax return December 31, 2019 – Top flat tax rate
Sixth tax return December 31, 2020 (12 months)

Any testamentary trust arising because of a death, other than a GRE or QDT, will now be immediately taxed at the top flat tax rate. For example, if Ted decides to establish a testamentary trust for each of his three children and their respective children, the three testamentary trusts will be taxed at the top flat tax rate if Ted dies after December 31, 2015. Using trusts to achieve specific testamentary wishes such as passing assets on to successive generations remains a valid estate planning tool, but the income tax consequences have changed somewhat dramatically.

A second significant change to the taxation of trusts was not addressed in the government’s 2013 announcement or the 2014 budget but appeared in the final legislation. A spousal trust, alter ego trust and joint partner trust are all subject to a deemed disposition of their capital assets upon the death of the income beneficiary (second death in the case of a joint partner trust). This deemed disposition triggers the realization of any accrued capital gain in the assets held by the trust and is currently reported as income to the trust. For deaths after 2015, these capital gains will be taxed in the deceased beneficiary’s terminal tax return and not the trust.

While the change seems simple because all it does is shift the income tax liability from the trust to the deceased, the implications may be significant, particularly in situations that cannot be changed.


Consider Mark and Mary, a married couple. This was a second marriage for each and both have children from a first marriage. At the time of Mark’s death several years ago, Mark left the preferred shares of a family business to a spousal trust, with Mary as the beneficiary of the income earned in the trust. Mark’s children were named the “capital” beneficiaries who would ultimately receive the shares at the time of Mary’s passing. The business purchased a last-to-die life insurance policy on the lives of Mark and Mary. The intention was to use insurance proceeds to redeem a portion of the preferred shares held by the spousal trust in order for it to meet its cash flow needs relative to the income tax liability arising in the trust upon Mary’s death. Mark and Mary’s plan was designed with the current income tax rules in mind; insurance was going to provide the liquidity to fund the income tax liability.

Under the new regime, the tax liability resulting from the deemed disposition of the trust’s assets will now arise in Mary’s estate. This means that Mark’s children, as capital beneficiaries of the trust, will inherit the remaining preferred shares from the spousal trust, plus the cash that the trust will receive from the redemption of shares from the business. Mary’s estate will bear the income tax liability arising from the trust’s deemed disposition of the shares, and only the residue of her estate will be available for distribution to her own beneficiaries. This is not what Mark and Mary would have intended based upon their planning objectives and the tax rules in effect when they undertook their estate planning.

Mark and Mary’s situation involves a testamentary spousal trust; however, a similar situation arises with an inter vivos spousal trust as well as alter ego and joint partner trusts. In each of these scenarios, the tax liability is shifted from the trust to the deceased. Unless the deceased’s estate has the same beneficiaries as the trust, an unanticipated inequity will arise. To the extent the deceased spouse’s estate does not have sufficient funds to pay the resulting tax liability, the trust is jointly and severally liable.

Beyond the shift of the income tax liability, planning will also be significantly impacted because post mortem plans that depended on netting capital losses against capital gains will all need to be revised. The capital gain triggered by the deemed disposition will be reported by the deceased, but the capital loss created by a redemption will be realized in the trust.
Planners and clients will want to review the impact of these changes. Some clients will need to revise plans, and others may need to develop additional plans to deal with those situations that cannot be changed.

(Reprinted from Comment, edition 290, with permission of the Institute of Advanced Financial Education, Queens Quay West, Toronto, Ontario)

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Is Quiet Disclosure the Best Solution?

The IRS estimates that there are millions of U.S. taxpayers with unreported offshore accounts. Americans with accounts in Switzerland. Dual nationals with accounts in their home country. American expats living and banking in Israel. Although every situation is different there is a common thread – millions of taxpayers are not reporting their foreign bank accounts.

Although American taxpayers have been required to report foreign accounts for decades, compliance has been spotty at best. Beginning in 2008, the IRS began a campaign to pursue taxpayers with unreported offshore accounts and the banks and bankers that helped them hide their assets. Now the IRS has begun criminally charging individual taxpayers with unreported accounts.

There is no one size fits all solution for unreported accounts. The IRS would have everyone use their amnesty program (Offshore Voluntary Disclosure Program) although that solution is often not the best.

One of the most common ways of coming into compliance is what the IRS calls a “quiet disclosure.” For many, however, that is an invitation to disaster. To understand why quiet disclosures may not be the best fit, some explanations are necessary.

The IRS wants everyone to come into compliance through its Offshore Voluntary Disclosure Program. If you have possible criminal exposure or have significant unreported offshore income, the OVDP program may best for you.

It is worth mentioning that despite the IRS’ very effective publicity machine, less than 200 people have been indicted for unfiled FBAR forms and many are bankers, lawyers and accountants who helped taxpayers hide their money. In other words, the risk of criminal prosecution is low.  (The willful failure to file an FBAR is a felony punishable by  five years in prison.) Some of the most compelling reasons to come into compliance are the huge civil penalties for an unreported offshore account.

If you are considered a “low risk” individual by the IRS, the agency’s Streamlined Filing Compliance Procedures may be a better fit. The penalties are much lower, however there is no guaranteed “get-out-of-jail-free” card and once you enter the Streamlined program there is no going back to traditional amnesty if things don’t work out.

Another method is to “opt out” of amnesty. By opting out, there are no guarantees although it is possible to receive no penalties.  Opt out candidates must demonstrate why the traditional penalties should be abated.

Although all these options may be better choices for many taxpayers, the two most common choices are doing nothing and making a quiet disclosure. With the IRS’s FATCA law (Foreign Account Tax Compliance Act) now in full effect, the chances of getting caught are huge as are the corresponding civil penalties. Doing nothing remains the worst possible option.

That leaves us with “quiet disclosures” or simply mailing in missing FBAR forms to an IRS service center and amending old returns. Thousands of taxpayers do this each year and most without any legal or accounting help. They hope that by simply sending in the missing returns they won’t get caught or penalized.

Prior to October 2014, the IRS strongly discouraged these so called quiet disclosures. Now they are authorized if taxpayer doesn’t need to use the OVDP or Streamlined programs. Although an offshore tax professional can best advise you, common examples could include an offshore account owned by parents but which list the children as signatories. The kids could qualify for a quiet disclosure if they do not receive income from the account and also have no ownership interest in it.

Another possible example is a taxpayer who properly reported and paid all taxes on the income from his or her offshore account but failed to file an FBAR.To avoid future problems and audits, the IRS says that a letter of explanation should accompany the missing FBAR forms.

So what are the risks of making a quiet disclosure? The risks are few if you truly have no interest in the account or have paid all taxes on income from the account. Unfortunately, most people who decide to go the quiet disclosure route don’t consult with a tax professional and many aren’t eligible for the no penalty treatment. For those folks that don’t qualify, the risks are plenty.

The biggest risks are the onerous FBAR penalties. Congress has said that the willful failure to file an FBAR carries a civil penalty up to the greater of $100,000 or 50% of the historical high balance of the account. Penalties can be imposed for multiple years. Although these are the maximum penalties, the maximum penalties have become the norm.

Of course, there is some risk of criminal prosecution as well. If you have already gone the quiet disclosure route and are targeted for audit, it is still possible to make an argument for abatement of the harsh penalties but amnesty is off the table.

The best thing to do? Consult with a qualified FBAR lawyer of offshore tax professional before taking action. Understand your risks and obligations first. If a quiet disclosure is best for you, make sure you have a letter of explanation. Whatever choice you make, don’t ignore the problem. The surest way to huge penalties and a prison cell is doing nothing.

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Unfiled FBAR Conviction Against St Louis Man–Report of Foreign Bank and Financial Accounts

The United States Department of Justice secured a conviction against a St. Louis man accused of not reporting foreign bank accounts in Switzerland and Singapore. Raju Mukhi, age 67, was indicted last year on charges of willful failure to file an FBAR and filing false tax returns. Offshore accounts with an aggregate value of more than $10,000 must be reported annually on one’s tax return and on a separate Report of Foreign Bank and Financial Accounts or FBAR.

After pleading guilty in October 2014 to single counts of filing a false return and failure to file an FBAR, a federal judge sentenced Mukhi last week to three years probation. He remains subject to hundreds of thousands of dollars in civil penalties to the IRS.

According to the indictment, Mukhi opened an account at Swiss bank Clariden Leu. The account was originally opened in the name Sukhmani Partners II. Later he changed the name on the account to Safekeep. The government said notwithstanding the names on the accounts, Mukhi was the beneficial owner. They also say that he simultaneously opened another offshore account in nominee name at Goldman Sachs Bank – Singapore.

When completing his returns, he checked the “No” box to the question “Do you have interest or signature authority over an account in a foreign country?” Making a false statement on a tax return can be a felony as is the willful failure to file an FBAR form. Mukhi is lucky that he wasn’t also charged with tax evasion as the government often considers nominee accounts – accounts opened in another name – to be an affirmative act of tax evasion.

In announcing the convictions, the IRS issued a statement saying, ”Hiding income and assets offshore is not tax planning, it’s tax fraud. We are continuing our work to crack down on offshore tax evasion.”

We don’t know how Mukhi was caught since much of the court record has been sealed. We do know, however, that the government said Mukhi never disclosed his accounts to his tax preparer and signed returns indicating he had no offshore accounts.

The sealing orders from the court coupled with the probation sentence may signal that Mukhi is cooperating with the Justice Department and IRS. The government has been rumored to be investigating Clariden Leu bank in Switzerland.

Having an offshore account in Switzerland or Singapore isn’t illegal. Not telling the government, however, may be a felony. In addition, failure to file FBAR forms can carry civil penalties up to the greater of $100,000 or 50% of the historical high balance of the account.

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