Canada Revenue Agency (CRA) does not, as a rule, send out condolence cards. Instead, they sit back and wait for the executor or administrator (both known as a personal representative), to wrap up the deceased's taxes. There is no excusing the dead for their unpaid taxes. Someone has to step in, prepare the tax returns and pay CRA.

The first is the date of death return, a tax return which sets out income in the calendar year of death, from January 1 to the date of death, which the law sometimes refers to as the terminal year or "year of death".

The personal representative needs to check to see if there are any outstanding returns from previous years. Not all taxpayers, particularly seniors, are up-to-date with their tax returns. Armed with a probate or administration order from the Court, CRA will be pleased to report on any outstanding tax returns due from the deceased, as well as take the considerable interest owing on any amounts due. To minimize exposure to personal liability, from CRA and towards beneficiaries who would expect the personal representative to diligently ascertain the deceased's tax status, act promptly in this regard.

In Death of a Taxpayer, the authors note that:

"For income tax purposes, the death of a taxpayer not only terminates the deceased's final taxation year, but also marks the opening of the first taxation year of the estate."

tax tombstoneGenerally, give that the administration of an estate can take some time, known as the executor's year, the deceased continues as a financial being for a bit, almost as a ghost, the formal legal term of which is a testamentary trust. While that ghost exists, CRA is right behind it asking for taxes on any income. This, they demand by requiring the preparation of tax returns for periods of time post-death where income accrued. This goes on for as long as it takes to wind up the estate.

One issue is the legal fiction of a phantom or deemed disposition to set up a capital gain, explained this way in The Executor's Handbook:

"The Income Tax Act deems a taxpayer to have disposed (sold) of his or her assets immediately before death, at fair market value. As a result, if the property has increased in value since it was acquired (by the deceased), this increase may be subject to tax in the terminal year."

Indeed, CRA takes the testamentary trust as if it were a separate individual tax payer, albeit with a unique tax return form. Each year, a trust return is required and taxes paid on any taxable income.

Testamentary trusts often arise as of death as the will reveals, for example, that the executor must hold in trust any gift or benefit accruing to a minor subject to distribution to that child when he/she reaches the age of majority.

When the executor has finished his/her job and assets have been distributed and debts paid, it is time to exorcise the ghost and file a final return, also known as a terminal return.

Tax lawyers or accountant may advise to elect to file other returns as well in an effort to avoid taxation. The final return covers income in the terminal year.

When all the tax steps have been completed, you do not have to hold your breath and keep yourself personally exposed to liability towards CRA forever. CRA does have a mechanism to shut down your liability once and for all. In their 2007 publication, Preparing Tax Returns for Deceased Persons, CRA couches in friendly language a very ominous liability:

"As the legal representative, you may want to get a clearance certificate before you distribute any property under your control. A clearance certificate certifies that all amounts for which the deceased is liable to us have been paid, or that we have accepted security for the payment. If you do not get a certificate, you can be liable for any amount the deceased owes. A certificate covers all tax years to the date of death. It is not a clearance for any amounts a trust owes. If there is a trust, a separate clearance certificate is needed for the trust."

Pursuant to the Income Tax Act, §159, a personal representative has every interest in securing a clearance certificate before distributing property that he or she controls in their capacity as the legal representative. If the estate property is distributed without a certificate, your personal liability for the estate's unpaid taxes, plus interest, may be claimed by CRA. The question often is: if I make a distribution to others, will there be enough property remaining to pay any CRA tax liability?

In any event, such a certificate may clear the personal representative from personal liability but does not clear the estate, which remains liable in the event of a future claim from CRA.

This article is just general legal information designed to introduce this esoteric and complex area of the law to the individual stuck with acting as another's personal representative, and just skims the surface of tax issues, what with some provinces still managing distinct tax administrations. Numerous scenarios and options have not been canvassed, any one of which might save the estate considerable tax liability. There are so many side-roads in the taxation of an estate - some to the benefit of the estate and other to CRA - that any executor is strongly encouraged to seek and obtain legal and accounting advice. Some hardy folk like to defy logic and "do it yourself" but I wouldn't attempt it unless (1) you like paying taxes or (2) you just happen to be one of those rare doubly-qualified birds, the C.A./lawyer variety.

A lawyer will generally advise the personal representative to ensure that written advice is given to the beneficiaries as to their individual responsibilities to pay taxes on any portion of the estate they receive.

Consulting with the deceased's accountant, if known, may have a significant benefit for the personal representative. For one, the accountant can usually produce previous year tax information., Secondly, the accountant may be aware, if not an advisor, of tax avoidance strategies measures implemented by the deceased prior to death precisely to minimize the taxation upon the estate.

A chartered accountant may also be able to assist in transferring the tax liability from the estate to the beneficiary in a lower tax bracket, depending on the relative facts of each.

Often an estate will have an outside-of-Canada beneficiary which creates its own host of issues such an obligation on the personal representative to act as tax collector for CRA by withholding taxes due by the non-resident beneficiary, a role and obligation certain to make the executor popular at future family gatherings.

Finally, CRA is notoriously slow in processing estate returns as they seem to go to the bottom of their pile and are dealt with after the tax returns of living Canadians are processed. Staff at CRA are generally helpful in answering questions so don't be shy of calling them and always keep detailed written notes of your conversations with them including the CRA officer's name and the date and time of the consultation.

REFERENCES:

  • Frostiak, L. and Poyser, J., Practitioner's Guide to Trusts, Estates and Trust Returns (Toronto: Thomson-Carswell, 2005).
  • Greenan, J., The Executor's Handbook, 2nd Edition (Toronto: CCH Canadian Ltd., 2003).
  • Greenan, J., and others, Canadian Estate Administration Guide (Toronto: CCH Canadian Limited, 2007)
  • Hanson, I. and Bussey, C., Death of a Taxpayer, 8th Edition (Toronto: CCH Canadian Ltd., 2005).
  • Canada Revenue Agency, Preparing Tax Returns For Deceased Persons, T4001, published at cra-arc.gc.ca/E/pub/tg/t4011/README.html
  • Income Tax Act, Revised Statutes of Canada, 1985, Chapter 1 (5th Supplement), published at http://www.canlii.org/ca/sta/i-3.3/