Solution to Assignment Problem Nineteen - 4

Part A - Amounts And Type Of Income To Be Distributed

Relative Tax Status
In attempting to minimize the Tax Payable of the GRE and the beneficiaries, the relative tax status of these entities is
relevant.
Renfrew Holt As Mrs. Holt has substantial amounts of other income, any income paid to her by the GRE
will be taxed at the maximum federal rate of 33 percent.
Roxanne Holt As Roxanne has no other source of income during 2019, any income paid to her is likely to
be taxed at the minimum federal rate of 15 percent.
GRE As the Graduated Rate Estate (GRE) status continues to be available for 2019, any income that is
retained in the GRE will be taxed at graduated personal tax rates, starting at the lowest federal rate of 15
percent. We would note that the GRE status will end on March 2, 2020, even if the estate assets have not
been transferred to the trust that is specified in the will. When this happens, any future income that is retained
in the trust will be taxed at the maximum federal rate of 33 percent.

Dividend Income
With respect to eligible dividend income, the gross up and tax credit mechanism provides significantly reduced tax
rates for all individuals. The relevant information for the GRE and the two beneficiaries is as follows:

GRE As the trust has GRE status during 2019, it can receive up to $34,632 of eligible dividends without
paying any taxes.
Roxanne As Roxanne has a basic personal credit of $1,810 [(15%)($12,069)], the amount of tax free eligible
dividends that she can receive is increased to $58,566.
Renfrew As Renfrew already has income in excess of $275,000, any eligible dividends that she receives
will be taxed at a federal rate of 24.8 percent [(33%)(138%) - (6/11)(38%)].

Interest Income
While Renfrew would be taxed on interest income at a rate of 33 percent, both the GRE and Roxanne could receive a
substantial amount of interest that would be taxed at the minimum federal rate of 15 percent.

Conclusion
For both interest and dividends, the tax rate for Renfrew is much higher than that applicable to either Roxanne or the
GRE. Given this, if tax minimization is the objective, no pre-tax distributions should be made to Renfrew. As her
other income is likely more than sufficient to meet her needs, this decision should not cause a financial burden for her.
With respect to Roxanne and the GRE, either taxable entity could receive all of the dividends without paying any
taxes. However, because Roxanne has a basic personal credit available, she could receive, in addition to the dividends,
a larger amount of the interest while still not paying any taxes. This would suggest distributing all of the dividends to
Roxanne, along with sufficient interest to reduce her Tax Payable to nil. Any remaining interest would be left in the
GRE to be taxed at the minimum federal rate of 15 percent.
The after-tax funds in the GRE can be distributed tax free to either beneficiary.
Part B - Tax Payable

Roxanne
If Roxanne receives all of the dividends, her federal dividend tax credit would be $6,467
[(6/11)(38%)($31,200)]. When combined with her basic personal credit of $1,810, she would have total credits of
$8,277 ($6,467 + $1,810).
For her Tax Payable before credits to be equal to this amount, her Taxable Income would have to be $ 53,151. This
value is represented by X in the following calculation:

$8,277 = $7,145 + [(20.5%)(X - $47,630)]

$8,277 = $7,145 + [(20.5%)(X)] - $9,764
$10,896 = [(20.5%)(X)]
X = 53,151

Subtracting the grossed up dividends of $43,056 [(138%)($31,200)] from this required Taxable Income figure leaves
$10,095 ($53,151 - $43,056) to be distributed to Roxanne as interest.
Roxanne’s Tax Payable would be nil as shown in the following calculation:

Tax On First $47,630 $ 7,145

Tax On Next $5,521 ($53,151 - $47,630)] At 20.5% 1,132
Tax Before Credits $ 8,277
Basic Personal Credit ( 1,810)
Dividend Tax Credit [(6/11)(38%)($31,200)] ( 6,467)
Tax Payable Nil

Note that the Tax Payable is exactly nil, with no unused credits remaining.

GRE
With all of the dividends and $10,095 of the interest distributed to Roxanne, this would leave $32,905 ($43,000 -
$10,095) of the interest to be taxed in the hands of the GRE. The tax on this amount would be $4,936
[(15%)($32,905)].

Renfrew
As no before tax distribution will be made to Renfrew, her 2019 Tax Payable will be unchanged by the existence of
the GRE.