A graduated rate estate (GRE) is an estate that arises as the result of the death of a person on or after December 31, 2015, and no more than 36 months after the person’s death. The estate at that time must be a testamentary trust.
The GRE designation brings with key benefits such as access to the lower marginal tax rates and simpler and more flexible donation rules. Perhaps more important in the context of private company ownership is the ability to reduce the potential for double tax on death.
When the deceased owns private company shares, a potential double tax problem exists. First, the shares are deemed disposed at fair market value (FMV) upon the death of the shareholder. Second, another tax hit could occur if the corporation is wound up by the estate and proceeds are paid as a taxable dividend to the beneficiaries of the estate. Alternatively, with proper planning, when the corporation is wound up, the estate could end up with a capital loss and pay a tax-free dividend to the beneficiaries of the estate. However, that type of tax planning is not allowed for non-GRE estates under what are known as stop-loss rules. Stop-loss rules do not apply to GREs, so proper estate planning can lead to large income tax savings, particularly for shareholders of private company shares.
If a GRE loses its status as a testamentary trust, the GRE status will be lost along with the benefits. Without proper planning, a testamentary trust can be tainted by actions such as another person contributing to the estate which could happen if a beneficiary borrows money from and then re-contributes to the trust or the trust borrows money from related persons to pay the deceased’s debts.
Executors are urged to tread carefully so as to not lose the GRE status.