By: Halldor K. Bjarnason, Access Law Group
As parents, we want the best for our children – it’s an age-old maxim, but it’s also true!
It is no more obvious than in estate planning – especially for parents with sons/daughters who have disabilities. As a lawyer who has been doing this “stuff” for three decades, I can attest that parental concerns haven’t changed. Parental worries from the 1980s and 1990s haven’t changed much, but the techniques we use to fix the problems have.
In fact, many of the techniques we used prior to 2017 for a “perfect solution”, when used today, can cause a serious financial mess.
In 2017, the income tax rules around two key planning tools that we use to help our sons/daughters: trusts and the Principal Residence Capital Gains Exemption (the “PRCGE”), changed drastically. As a result, while they’re still helpful, the way we can use them has been altered. Hence, if we rely on the estate planning strategy that we used in 2006, it may cause a financial disaster for our estates in 2020.
In a nutshell, parents want to leave inheritances for their sons/daughters, and often want to give them a home to live in. Due to capacity issues and/or provincial government disability assistance rules, we often use trusts as a means to hold the home and other assets.
To fully appreciate the affect of the changes, let’s look at the rules pre-2017 and now. I’m assuming that the reader understands what a trust is, and that trusts, like a person, are required to pay income tax on all earnings.
Before the 2017 tax reforms, the Income Tax Act provided a fair amount of flexibility for estate planning. With testamentary trusts – trusts created through a will, or otherwise coming into effect upon death – all got a preferred tax rate. While most trusts have a base tax rate of around 49%, trusts designed to come into effect upon death had a graduated tax rate (like a human). Testamentary trusts had a base tax rate of around 21.2%, and the rate gradually increased until all income over $130K was taxed at the highest rate – roughly 49%.
Put simply, testamentary trusts were a great deal from an income tax perspective!
As a result, when doing estate planning, we often used as many testamentary trusts as possible: one from mom’s will, one from dad’s will, one from grandma’s will, one for the insurance proceeds, etc . . . and they all got taxed at the lowest rate. It was a challenge to see how many we could create to maximize the tax advantages!
As well, when it came to home ownership, almost every personal trust qualified for the PRCGE. For a son or daughter with a cognitive disability, it made home ownership fairly simple. We would set up a living trust, and place the home in the trust. It stayed there for the son or daughter’s lifetime, and upon her demise, the home was sold and the trust’s proceeds went to the residual beneficiaries on a tax-free basis. As the PRCGE applied, as long as the son or daughter lived in the home, no capital gains taxes were payable. As well, if he or she needed new/different accommodation, there remained a fairly easy solution. Even though the son or daughter didn’t have the requisite mental capacity to sell the house, it didn’t matter – the trustees could do it, avoiding the need for a Committeeship.
As an estate planner, it was exciting to find new ways to help clients both accomplish their dreams for their children AND save taxes.
Then 2017 arrived. . .
The Rules Today
On January 1, 2017, there was a significant Canadian income tax reform, and unfortunately, the creators appear to have had little understanding of the realities of supporting a son or daughter with a disability.
Essentially, the new tax rules nullify or severely restrict many of our previous planning techniques.
For starters, for our purposes, the only testamentary trusts which get the preferred tax rate (a base rate of 21.2%) are those where the beneficiary has the Disability Tax Credit (“DTC”) – now called a Qualified Disability Trust (“QDT”). However, besides needing the DTC, there are a myriad of other new rules applying to the QDT. . . including one that a person with a disability can only have one QDT per year. Hence, if the parents of the disabled son/daughter are divorced, and both put trusts in their wills, only one of the trusts gets the preferred tax treatment. The other parent’s trust gets taxed at 49%! While it is true that the QDT status can be switched between the parents’ trusts each year, it can still be a tax quagmire.
If your son or daughter either has not qualified, or doesn’t qualify for the DTC, a tax efficient trust becomes a pipe dream!
At the risk of stating the obvious, under the new rules, the trust in grandma’s will and the insurance trust will all be taxed at the highest rate. The protection provided by a trust is still available, but it often comes at a higher cost.
Similarly, home ownership has now become more complicated, expensive, and in some cases, impossible. As part of the 2017 tax reform came the revocation of the PRCGE for most trusts. Hence, under the new tax regime, unless a home is owned by a QDT (or a few other types of trusts, not relevant for this discussion), capital gains taxes are payable on the increased value of the home. As well, due to the deemed disposition rule, the taxes are payable every 21 years, whether the home is sold or not!
How does this work in reality? Let’s use a post-2017 example to show the problem. . . .
Mom and Dad buy 30-year-old Cynthia a condo in Vancouver. They place it in a living trust so that Cynthia is protected from her “new friends”. The unit is selected so that Cynthia has space for a live-in caregiver/”roomie”, it is close to all the services she needs, and she can live there for the rest of her life. When Cynthia turns 51, thanks to Vancouver’s housing market, the condo has increased in value by $400K. Due to the 21-year deemed disposition rule, combined with no access to the PRCGE, the trust owes about $104K in taxes – NOW! Unless the trust has sizeable cash reserves, the trust will likely have to sell the condo to pay the tax bill. Even if the trust survives this tax hit, the same thing will happen again when Cynthia turns 72. Very likely, unless Mom and Dad can both afford the condo and have funds for the future tax bills, owning a home is no longer a reality for many folks with disabilities.
The upshot is, the new tax laws have had a serious impact on estate planning for parents with disabled sons or daughters. Most plans created prior to 2017 are no longer tax efficient.
While there are still ways to accomplish your planning goals, relying on past techniques may become very expensive. When you hear about “brilliant plans” for your son’s or daughter’s future, remember – if created before 2017, it may not be so “brilliant” anymore!
There are still many ways to accomplish your dreams – NEVER let your dreams die. However, when doing so, it’s crucial to get advice from counsel who both understands current tax law and the Employment and Assistance for Persons with Disabilities Act and its Regulation. This will both enable your beneficiary with disabilities to avoid being cut off from their government support and minimize the income tax hit to your estate.
For more information on this important topic, visit www.accesslaw.ca.
Please note that this article is provided for general information only. As specific facts affect how the law is applied to your circumstances, it is always wise to get the advice of competent legal counsel.
If you would like to learn more about planning your will if you have a loved-one with a disability, we offer an online workshop. Click here to learn more.