Monday, January 18, 2016

The Way We Were (Almost)

On January 15, 2016, the federal government released proposals that will fix some of the problems created by its earlier 2015 legislation on the taxation of trusts.

The earlier 2015 legislation changed the taxation rules for alter-ego trusts, joint spousal trusts and testamentary spousal trusts (collectively, “Life Interest Trusts”).  In these Life Interest Trusts, the trust assets are held solely for the benefit of the initial beneficiary or beneficiaries (the person who established the trust in the case of an alter-ego trust and the surviving spouse in the case of a joint spousal trust or a testamentary spousal trust).  On the death of the last of those initial beneficiaries, the assets in the Life Interest Trust are subject to a deemed disposition.  This results in the taxation of any previously-untaxed increase in asset value.  Prior to 2015, that deemed disposition occurred inside the Life Interest Trust so that the trust assets could be used to pay any resulting tax.

The 2015 legislation would have changed this starting in 2016.  Instead of the deemed disposition occurring inside the Life Interest Trust, the deemed disposition would have occurred outside of the Life Interest Trust and would have become a liability of the personal estate of the deceased individual (as if the individual had personally owned the assets in the trust).  This rule would have created a host of problems, especially if the will and the Life Interest Trust had different beneficiaries – as can happen in blended family situations.

The 2016 fix reverses that aspect of the 2015 legislation and returns us back to way things used to be.  As a result, any tax triggered by the deemed disposition of trust assets will be paid by the Life Interest Trust rather than by the personal estate.  Big sigh of relief.

For those who may have altered their estate plans based on the 2015 legislation, there is an elective procedure under which the trustees of the Life Interest Trust and the executors of the estate can jointly choose to have the deemed disposition tax paid by the personal estate.  In order to do so, however, the specified individual must die before 2017.  So this elective rule merely provides time for someone who altered an estate plan in an attempt to comply with the 2015 legislation to once again alter the estate plan based on the fix to the 2015 legislation.

The death of the initial beneficiary will still trigger a deemed taxation year-end for the Life Interest Trust – so we are not fully back to the way we were – but at least the tax liability will be in the proper place.

The 2016 proposals also fix a problem that could have arisen in respect of charitable donations made by a Life Interest Trust.  That fix will be the subject of a future blog.

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The above article provides general commentary of an educational nature. It does not constitute advice for any specific person or any specific set of circumstances. Because circumstances vary, readers should consult professional advisers in order to obtain advice that is applicable to their specific circumstances.