I want to first acknowledge that any errors in this blog article are my sole responsibility, but I tip my hat to Ms. Estelle Wieler CPA, CA, CEA (Certified Executor Advisor) of Calvin G Vickery CPA Professional Corporation for her guidance.
One of the most important duties of an executor is ensuring that the final tax return of the deceased is filed, often referred to as a terminal return.
That tax return covers the deceased’s final year from January 1 to the date of death, which is why it is sometimes called a “stub year”.
In most Estates, this responsibility also includes filing tax returns for the Estate. The Estate is a taxable entity, just like a corporation or person. If it earns income, it must file a tax return.
Our firm’s practice is to strongly recommend to all of our Estate clients that they seek the services of a qualified accountant. This task is beyond the capabilities of all but the most learned of our clients and certainly that of simple tax preparation services and bookkeepers.
The rules and forms of an Estate tax return are quite different from a personal tax return.
It is important that we separate the different types of taxes. There is the provincial estate tax, which is generally calculated at 1.5% of the value of an estate that is being probated.
Then there are the final income taxes that are triggered by the death of a person and in the absence of a spousal rollover will trigger a deemed disposition upon death. In English, it is as if the deceased had sold everything the day before they died and the profit or tax sheltering that they had organized in their lifetime is exposed to the waiting hand of the taxman/woman.
There is another tax and that is upon any income earned by an Estate. An Estate before distribution can earn interest income. If it holds real estate, that real estate may appreciate and possibly attracts even more income and the responding income tax.
Under the present tax laws, an estate is able to enjoy graduated tax rates for the first three years of its existence. Graduated rates are the same income tax rates that we as private individuals get to enjoy. As we climb the income ladder, the government takes an even greater share of income tax. Estates for the first year three years of its “life” enjoys the same benefits. However, beyond the three year limit, any estate income is taxed at the highest marginal rate presently approximately 53%.
One possible strategy is to attribute the estate’s income to the actual beneficiaries and have them declare the estate’s income to take advantage of their lower tax rate rather than the estate’s exposure. CRA does seem to find it acceptable administratively to allow the estate’s accountant to choose the best option between whether to tax income inside the estate or allocate it to the beneficiaries as long as certain basic rules are followed (which are too complicated to expand on here). When it is allocated to the beneficiary, the estate’s accountant must indicate that this is being done on the estate tax return and a tax income slip is issued to the beneficiary. However, this strategy is rarely taken for a number of reasons. Firstly, the first 36 months of an estate, the estate also has the graduated rates that we have indicated. So, unless a beneficiary has so little income that he or she has not used their personal tax credits, it is generally better to tax the income within the estate itself. There are even additional negative consequences of having the income declared by the beneficiaries. This flow-through income may very well affect the beneficiaries dependent claim. Further, all of the low income support that one potentially could receive such as the Ontario Trillium Benefit, GST Credit etc. or perhaps even disability support, such as under the ODSP maybe negatively be affected. Clearly, this is a very complicated question, and an accountant’s guidance is required. In conclusion generally, unless the estate has continued to drag on beyond its 36 months graduated tax rate period, one almost always taxes an estate income within itself and it is not generally allocated down to the beneficiaries during that time.
All of this is driven by CRA‘s administration rules which are generally observed for the smaller sized estate. For estates that are of significant value, one must tread carefully. As more senior CRA agents are generally involved, they administer the rules far more strictly.
One should also note that an estate does not enjoy a capital gains exemption for a principal residence, except in very limited circumstances that do not apply to most estates. The home that you have owned and lived in may have dramatically appreciated, but it is deemed to be tax free for you because of that capital gains principal residence exemption. The estate has no such shield from the open hands of the taxman.
Conclusion, this is complicated stuff and as lawyers, it is our job to simply alert you in broad strokes to those concerns and to emphasize to you the importance of having the input of a qualified accountant.