The Basics of Estate Taxation in Canada
In addition to the emotional consequences of losing a loved one, estate administration can be a difficult undertaking, even for those familiar with the affairs of the deceased. The deceased may have passed away with a will (testate) or without a will (intestate). Either way, the personal representative of the estate has rigid obligations with respect to the tax filings of the deceased. These obligations must be discharged in order to avoid tax consequences stemming from prematurely distributing the estate, exemplifying the maxim that the only certainties in life are death and taxes.
Is there an Estate Tax in Canada?
In Canada, unlike other jurisdictions, any inheritances stemming from the estate of the deceased are not subject to estate tax. Officially, the only taxes payable by the estate of the deceased are based on the income earned by the deceased. However, it is not conclusive to say that the only taxes payable by the estate of the deceased are derived from the income of the deceased in the year prior to and the year of passing.
For example, if the testator held property in the United States at his or her time of death, the property may be subject to taxation under American estate tax. The same could be true of any other jurisdiction in which the deceased held property, as property laws vary country to country, and even province to province.
What is the Proper Filing Procedure for One’s Estate?
The personal representative of the testator must ensure that income tax returns have been properly filed for the year preceding death and that any income earned between January 1st and the date of passing of the deceased in the same calendar year is accounted for in the last return filed on behalf of the deceased. This final return is dubbed a “terminal return” in Canadian tax law.
The day after the passing of the testator results in the creation of a “new person” in the eyes of Canada Revenue Agency: the estate. Unlike the filings of the year preceding death and the terminal return, the personal representative of the deceased would not file a T1 tax return for the filings of the estate. Instead, the estate is considered to be a trust for the purposes of taxation and consequently, the administrator of the estate must file a T3 trust return. Furthermore, income is deemed to have accrued on a daily basis for the estate, as opposed to on an annual basis for living taxpayers. This subtle variance in accrual periods has the effect of accelerating the taxation of the income of the estate.
What are the Consequences for Failure to File?
For personal representatives, planning circumspect compliance with the taxation rules surrounding the administration of estates can be an onerous task. There are various filing deadlines for the respective returns, specific documentation that must be included in the filing, and distinct accrual periods to consider. Personal representatives can also be held personally liable for failing to adequately discharge their obligations with respect to the income tax filings of the estate.
Canada Revenue Agency (CRA) is also statutorily permitted to pursue beneficiaries to recompense any amounts they assess to be owing where disbursements of the estates are deemed to have been made prior to satisfying requisite filing criteria.
How can a Personal Representative Protect Himself or Herself from Liability?
Prior to distributing any of the estate property to potential beneficiaries, it would be prudent for a personal representative to determine whether it is necessary to obtain a “clearance certificate”. If a personal representative is required to have a clearance certificate, any disbursement of an estate asset without having first obtained a clearance certificate could put the personal representative at risk of personal liability. Click here to learn more about the requirements and application of clearance certificates.
It is harder than one might think for a personal representative to ensure compliance with each of the CRA’s filing requirements. The obvious answer is to meet every filing deadline, to accurately compile all returns correctly (including any “deemed realizations” pertinent to the estate asset pool), and to retain all requisite documentation. Practically speaking, it is very difficult to ensure compliance with respect to CRA filing requirements and the personal representative and beneficiaries may collectively choose a different path.
There are alternatives available depending on the circumstances of the personal representatives and beneficiaries of the estate. For example, beneficiaries may wish to agree to indemnify the personal representative of an estate from tax liability in order to receive assets from the estate prior to the personal representative receiving a clearance certificate. Similarly, where the personal representative is the sole beneficiary of the estate, the personal representative would be liable regardless of having obtained a clearance certificate. The appropriate method of mitigating tax liability depends on the circumstances of the estate.
When to Seek Help?
Many personal representatives seek guidance with respect to estate administration to insulate themselves from personal liability, especially when they are unfamiliar with the affairs of the testator and/or the income tax rules surrounding estate administration. It is also commonplace for testators to seek tax planning advice as tax planning can be an effective means of reducing estate tax liability and passing more of what they have earned onto their loved ones. Depending on the size of the estate, proper tax planning can reduce or delay the amount of taxes payable by the beneficiaries of the estate to better provide for the loved ones of the testator in the short term and long term.
If you are considering planning out your affairs to make sure your Estate runs as smoothly as possible, contact us today!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.