Tax Factor 2015-04

April 16, 2015

The 2015-04 issue of the Tax Factor is available for download. In this issue, we cover:

Upcoming changes to the taxation of trusts benefiting disabled individuals
Canada Revenue Agency’s My Account for individuals
CRA online mail — is it for you?
U.S. tax rules for snowbirds, U.S. rental property investors and U.S. citizens


Upcoming changes to the taxation of trusts benefiting disabled individuals

Changes are coming into effect in January 2016 that impact the taxation of trusts. In our 2015-02 Tax Factor article titled “New legislation passed that will impact the taxation of trusts”, we discussed several of the new changes, including the elimination of graduated rate taxation for testamentary trusts. In this follow-up article, we will look at another change included in the new legislation which will benefit disabled individuals. This change is the introduction of the “qualified disability trust”, or QDT.

To begin our discussion, we will first review certain rules concerning the taxation of testamentary trusts. Then we will take a look at how the QDT fits into these rules, as well as some key issues to consider.

Graduated rate taxation for testamentary trusts

As you may recall from our discussion in the 2015-02 Tax Factor article cited above, testamentary trusts are currently subject to more favourable tax rules than those applicable to other types of trusts, including ordinary inter-vivos trusts (like family trusts). Specifically, testamentary trusts have access to graduated tax rates not available to inter-vivos trusts. As a result, a beneficiary of a testamentary trust may be able to enjoy some tax minimization as a benefit of being permitted to utilize two sets of graduated rates. Unfortunately, this advantage will no longer be available beginning in January 2016, when testamentary trusts will start to be subject to the same flat income tax rate currently applicable to other trusts. This flat rate is set at the top federal rate of 29% plus provincial tax at the top marginal rate. Bear in mind, however, that an estate will generally still have access to graduated rates during the 36-month administration period following the date of death of the individual.

Upon the initial release of the proposed changes to the taxation of trusts back in June 2013, it became clear that the elimination of graduated rate taxation in respect of all testamentary trusts (and the resulting increased tax burden on the beneficiaries of such trusts) would have a more adverse effect on those beneficiaries with disabilities. As a result of feedback received on the proposals, the government recognized that penalizing this more vulnerable group of beneficiaries would be unjust. Consequently, when the draft legislation was introduced, it contained additional provisions to allow certain testamentary trusts that have disabled beneficiaries to continue to have access to graduated rates. These provisions were subsequently introduced into law when the legislation was passed in December 2014.

The new QDT

In order to facilitate the ability of trusts with disabled beneficiaries to retain income within the trust to be taxed at graduated rates, the government introduced QDTs — a new category of testamentary trusts. A QDT is a testamentary trust that is resident in Canada and has one or more beneficiaries who qualify for the disability tax credit. These beneficiaries are referred to as “electing beneficiaries”, and in order to qualify as a QDT, the trust and the electing beneficiary must jointly elect that the trust be a QDT. It is important to note that, while a QDT may have more than one electing beneficiary and may also have non-electing beneficiaries, each electing beneficiary may only elect in respect of one QDT.

Furthermore, specific measures were put into place that would penalize a QDT in the event that certain conditions are violated. In particular, QDT status will be lost if:

  • the QDT ceases to be resident in Canada,
  • none of the beneficiaries of the trust at the end of the current year was an electing beneficiary of the trust in a preceding year, or
  • the QDT pays any of the trust’s capital to a non-electing beneficiary.

Where QDT status is lost, the trust will become subject to a recovery tax. The purpose of the recovery tax is to essentially require the trust to repay the tax savings on the income taxed at graduated rates that was or will be distributed to a non-electing beneficiary and not included in that beneficiary’s income for the current or prior year. While the computation of the recovery tax is complex, it appears likely that it will apply on the death of the last remaining electing beneficiary. This outcome will require advance tax planning to minimize any punitive impact.

Concerns arising from the rules governing QDTs

Conceptually, the introduction of QDTs as a means of preserving access to graduated rates for trusts with disabled beneficiaries appears to be a good thing. However, there are concerns with the rules governing QDTs and their impact on the very beneficiaries they are meant to protect. Consider the requirement that an electing beneficiary may only benefit from one QDT. It is not uncommon for multiple family members (such as parents, grandparents or other supporting family members) to set up testamentary trusts in their wills to ensure the ongoing support and financial security of their disabled relative. As a consequence of limiting each electing beneficiary to only one QDT, if a disabled person becomes entitled to benefit from more than one testamentary trust, only one of them can be a QDT. This means that any income that is taxed within any of the other “non-QDT” trusts will be subject to tax at the highest applicable marginal tax rates, thus restricting the ability to minimize tax on income from all of the sources intended for that beneficiary’s ongoing support.

Furthermore, consider the example of an insurance trust. It is not unusual for an individual with a disabled family member (such as a parent or grandparent of a disabled child) to take out an insurance policy for the benefit of that person, to be paid out after the death of the policy’s subscriber. Often an insurance trust will be created for the disabled individual by the subscriber of the policy so the trust is the beneficiary of the insurance proceeds. Although an insurance trust will qualify as a QDT, assuming all of the conditions are met, this may mean that an issue will arise if the person is also a beneficiary of the deceased’s estate. Since, as the electing beneficiary, the individual may elect in respect of only one of these two trusts to be a QDT, the other trust will be subject to the highest marginal tax rates. A possible solution to this problem may be to include the insurance policy in the estate of the subscriber; however, the impact on probate will need to be considered if applicable.

One final point to consider is that qualifying as an electing beneficiary is not necessarily a given. Since the requirements are that the individual qualify for the disability tax credit, the conditions that must be met in terms of the severity of the impairment are quite stringent. This is a concern in cases where a person may be considered to have special needs but fails to meet the eligibility criteria for the disability tax credit. It was suggested during the consultation period that the conditions to qualify an individual as an electing beneficiary be relaxed to meet similar and less arduous requirements that are set out in respect of other income tax rules affecting persons with mental and physical impairments. However, this suggestion was not taken into consideration in the final QDT legislation. Determining whether an individual qualifies for the disability tax credit can be complicated. If you have questions about the benefits available for individuals with special needs, speak to your BDO advisor.

Plan ahead

In summary, the introduction of the QDT as a means of preserving access to graduated rate taxation for those beneficiaries who qualify for the disability tax credit can be seen as a beneficial change in light of the more general elimination of graduated rate taxation for other testamentary trusts. However, there are still issues to consider and potential pitfalls to be aware of once these rules come into effect.

If someone that you love qualifies for the disability tax credit, and you are planning to provide for that person after your death, speak to your BDO advisor without delay. As
previously mentioned, the new rules governing the changes to the taxation of trusts will begin to apply after the end of this year. It is important to start planning now in order to ensure that you maximize any tax saving strategies available to protect the assets you wish to designate for the ongoing support of your loved one.

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Canada Revenue Agency’s My Account for individuals

There is little doubt that computers and the internet have made it easier for us to look after our personal finances. Online services offered by banks, other financial institutions and investment companies have made it almost effortless for us to manage our financial affairs online. The Canada Revenue Agency’s (CRA’s) service portal My Account is no exception to this, as it is intended to allow individuals to access their own personal income tax and benefit information and manage their own personal tax affairs online.

What can I do on My Account?

My Account allows you to, among other things, track your personal income tax refund, view or change your return, check your benefit and credit payments and your RRSP limit, set up direct deposit and receive online mail (which is discussed in this issue of the Tax Factor in the article “CRA online mail — is it for you?”). You should note that it is possible for you to view personal tax information and documents, such as your notice of assessment, on My Account before you would have received the official documents from the CRA through the mail. This is because the CRA intends to post the most up-to-date personal tax information immediately on My Account, before you would receive that same information through the mail system as a paper notice goes through several manual processes before you receive it in the mail. For a detailed description of the services provided on My Account, see http://www.cra-arc.gc.ca/esrvc-srvce/tx/ndvdls/myccnt/bt-eng.html.

How do I register for My Account?

To register for My Account, you will need to have your social insurance number, date of birth, current postal code and personal income tax returns for the current and prior year on hand. You can access My Account in one of two ways — either by logging on with a CRA user ID and password or through a “Sign-In Partner”. A Sign-In Partner is a financial institution that has registered as such with the CRA and with whom you already have an online financial relationship. For example, if you do online banking, that bank may be registered to be a Sign-In Partner. Keep in mind that if you select the Sign-In Partner option, you will have the choice of selecting a user ID and password that you already use, such as for online banking. (The advantage of this, of course, is that it will mean that there will be one less user ID and password for you to remember).

As noted, when registering for access to My Account you must provide some personal information online. Following that, the CRA will mail, to the most recent address that they have on file for you, a personal security code which will allow you to log in to My Account. While most of the services provided by My Account require the security code, a few do not. As a result, while you wait to receive your personal security code in the mail you will be able to access some of the services offered by My Account.

Summary

The CRA promises that My Account is not only convenient and easy to use but that it is also fast. The CRA boasts that “information is up-to-the-minute and transactions are
processed immediately”.

If you have any questions about My Account, contact your BDO advisor.

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CRA online mail — is it for you?

In February 2015, the Canada Revenue Agency (CRA) introduced a new service for individual taxpayers called “online mail”. When you register for this service, any notices and future correspondence eligible for online mail will no longer be mailed to you. Instead, you will receive an email notification that there is mail to view on My Account, the CRA’s secure online information portal for individuals. My Account is discussed in this issue of the Tax Factor in the article “Canada Revenue Agency’s My Account for individuals”. At first glance, online mail may sound appealing, especially if you already conduct many of your day-to-day transactions, such as banking and paying bills, online. However, there are other considerations associated with this service that we’d like to bring to your attention.

How it works

First, let’s explore how this service works, starting with the sign-up process. It is possible to sign-up for this new service in one of the following ways:

  • If you paper file your personal tax return, you can sign-up by providing your email address in the new email field on page 1 of your T1 individual Income Tax and Benefit Return;
  • If you use NETFILE (i.e. you file online directly to the CRA using consumer T1 software), you can provide your email address with your tax return data in the software. It will then be transmitted to the CRA;
  • If you use an approved efiler, such as BDO, to EFILE your return, you can provide your email to the efiler. The efiler will include your email address on the T183 EFILE authorization form and it will be transmitted to the CRA with your tax return;
  • You can sign-up directly by using My Account, or
  • You can sign-up by calling a CRA enquiries agent.

Once your sign-up request is processed, you will receive a registration email notification from the CRA to the email address you provided, confirming your registration for online mail. In addition to completing this sign-up process, you must also make sure that you register for My Account (if you haven’t already done so), as CRA online mail works in conjunction with My Account. If you register for online mail, let’s review what will happen when your 2014 tax return is assessed:

  1. You will receive an email notification from the CRA to the email address you provided to them.
  2. This notification will be your prompt to sign-in to My Account on the CRA’s website so that you can download your 2014 notice of assessment.
  3. You can then print the notice of assessment if you’d like a hardcopy of the document.

Currently, only notices of assessment and notices of reassessment issued after
February 9, 2015 are available through My Account. Any notices and correspondence delivered online on My Account will be presumed to have been sent on the date of that email notification.

Keep in mind that it will be possible to cancel your participation in online mail. You will be able to cancel through My Account by selecting “Manage online mail service” or, alternatively you will be able to do so by calling the CRA’s Individual Income Tax and Trust Enquiries telephone line.

Coordination with My Account

As discussed above, signing up for online mail is a two-step process, except for those taxpayers who have already signed up to use My Account. There is a concern that some taxpayers may sign-up for the CRA online mail service without also signing up for My Account. This could lead to delays in receiving correspondence from the CRA, or could result in the CRA online mail service not being functional. Therefore, it will be important to ensure you are properly registered for both to avoid these issues.

Authorized representative

If you use a tax return preparer, you may have authorized them to make enquires about your tax return status, to obtain certain details of your personal tax data, and in some cases, to request changes to your tax return on your behalf. Because of these authorizations, you may expect that your authorized representative would also receive the email notification that a document, such as your assessment notice, was ready to be downloaded from My Account.

However, this capability is not currently available in the CRA online mail service system. This disparity in levels of information sharing raises the concern that tax advisors will not be notified of changes in your tax account on a timely basis. This could delay the process of following up on any discrepancies in your tax assessment or making changes to your tax return. This means that if you sign-up for online mail and have an authorized representative, you will need to notify your authorized representative when you receive email notification of new items on My Account. It is important to do this on a timely basis because, as mentioned above, the date of the email notification will be considered the date of record for the correspondence sent from the CRA.

Spam and email fraud

As discussed above, once you have successfully signed up for the CRA online mail service, you will receive an email notification when an item is available on My Account. With the volume of email most individuals receive daily, there is a possibility that the notification email from CRA will be overlooked, mistaken for spam or a fraudulent email, or automatically assigned to a junk mail folder. Therefore, it will be important to keep in mind that you will receive email notifications from the CRA if you register for online mail. However, similar to the secure system employed by Canadian banks, sensitive or confidential information will not be sent to you by email from the CRA, nor will the CRA request such information from you through email.

Differences in notices of assessment

Some early users of online mail have reported that they cannot view a detailed notice of assessment when they log in to My Account. It is important to understand that there are two levels of access to My Account. In order to view your detailed notice of assessment, you must have entered the CRA security code that was sent by paper mail when you registered for My Account. You only need to do this once to authorize the detailed level of access in My Account.

Summary

It is expected that the CRA online mail service will continue to evolve, and that a number of these initial concerns will be addressed over time.

If you are interested in subscribing for online mail, please consider discussing this new service with your BDO advisor.

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U.S. tax rules for snowbirds, U.S. rental property investors and U.S. citizens

Do you spend an extended period of time in the U.S. each year? Do you own property there? If either apply, it is important to consider the U.S. tax consequences. And even if in recent years you have reviewed the relevant U.S. tax issues that affect Canadians, it may be time to review these matters again.

You may be liable for U.S. estate tax if you own certain property in the U.S. It is beneficial to note that the exemption limit for this tax has been indexed since 2011. This means that for 2015, there is an exemption limit of $5,430,000 ($ U.S.) for U.S. citizens and for residents of Canada under the Canada-U.S. tax treaty. For further details, please refer to our Tax Bulletin titled  U.S. Estate Tax Issues for Canadians.

Canadians who spend a considerable amount of time in the U.S. — often referred to as snowbirds — usually need to make a U.S. tax filing in order to stay onside with the U.S. tax rules. Our Tax Bulletin, U.S. Tax Issues for Canadians, explains the need for snowbirds to track their annual presence in the U.S. and when reporting is required. This bulletin also reviews the requirements for U.S. tax reporting if you own U.S. real property and rent it out.

If you are a U.S. citizen living in Canada, you are most likely aware of the importance of filing your U.S. income tax return, particularly due to media coverage of the relevant rules in the past few years. However, being a U.S. citizen living in Canada can create some challenges for income tax compliance, especially if you have investments in an RRSP, RRIF or TFSA, or if you have contributed to an RESP for your children or grandchildren. You can find out more about these topics in our Tax Bulletin titled Tax Consequences for U.S. Citizens and Other U.S. Persons Living in Canada.

If you have questions on these or other U.S. tax matters, contact your BDO advisor.

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The information in this publication is current as of April 1, 2015.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.