In the coming years, you or someone close to you might act as the executor of the estate of a friend or relative. In order to fulfill the duties of an executor and act in the best interests of the beneficiaries of the estate, it is important to understand the estate’s income tax filing obligations.
Income tax returns
Depending on the complexity of the estate and the provisions of the will, one or more estate income tax returns may be required in addition to the deceased’s terminal income tax return. There may also be outstanding income tax returns from prior years that must be filed.
The terminal income tax return
The first return that the executor is responsible to file is the terminal tax return. This return reports the deceased’s income from January 1 of the year of death to the date of death. In addition to reporting the deceased’s income, other special tax situations arise when a taxpayer dies.
Deemed disposition
Upon death, taxpayers are deemed to dispose of all their capital assets at fair market value at the date of death. Sometimes, establishing a value for a deceased’s assets is straightforward, as with portfolio investments like mutual funds or public company shares. But valuing real property and shares in private corporations can be more difficult. In such cases, it may be appropriate to engage the services of a professional valuator, such as a real estate appraiser or a Chartered Business Valuator.
RRSPs and RRIFs
Upon a taxpayer’s death, any registered accounts owned are deemed to be deregistered, and the value of any assets held within those accounts is included in income for that year. If the death was unexpected or the withdrawals from those accounts were poorly planned, the taxes owing on deregistration could be significant.
Spousal rollover
Where the will indicates that the deceased’s assets are to be transferred to the deceased’s spouse, there is some relief from taxes. Any deemed disposition that would otherwise have been included in income may be deferred for the spouse’s lifetime.
Where the spouse inherits the deceased’s registered accounts and those assets are transferred to the spouse’s registered accounts, the amounts that would otherwise be included in income are also deferred until the spouse withdraws from the registered account or dies.
Due date
The terminal tax return is due six months after death or April 30, whichever date is later. For self-employed individuals and their spouses, the due date is June 15.
The first estate income tax return
A taxpayer’s financial activities don’t stop upon death. Investments continue to earn income, rental properties keep earning rent, and other assets (hopefully) appreciate in value. The estate income tax returns capture the income these assets generate, including any gains that the estate realizes from the deceased’s date of death until the assets are liquidated.
RRSPs, RRIFs and TFSAs
Income earned in registered accounts or TFSAs is taxable to the estate, provided the accounts have not been transferred to the deceased’s spouse or another beneficiary. If the assets have been transferred to a beneficiary, the estate will be liable for taxes on any income or change in value up to the date of the transfer and the beneficiary will be responsible for taxes arising thereafter.
Capital losses
To the extent that the estate realizes more capital losses than capital gains in the first tax year following death, the executor may request that these capital losses be carried back to the deceased’s terminal income tax return. If there are not sufficient gains reported on the terminal income tax return, half of these capital losses may be applied to reduce other income reported on the terminal income tax return.
Year end and due date
The executor chooses the estate’s year end, which may be any date within a year of the date of death, though December 31 or the anniversary of the date of death are typical. Based on proposed amendments, following the first 36 months, the estate will be required to adopt a calendar year end. Estate income tax returns and any taxes owing are due 90 days after the estate’s year end.
Subsequent estate income tax returns
Estate returns that follow the first estate return will report the net income earned by the estate’s assets. Subject to proposed amendments mentioned above, each estate return up to the final return will cover a period of one year and will have the same year end as the first estate return. Returns are due within 90 days of the estate’s year end, along with any tax balance owing.
The final estate return
Once the estate assets have been transferred to beneficiaries or liquidated and transferred to a non-interest-bearing account, the estate is ready to be wound up. Any date that falls within one year of the previous estate return or terminal income tax return’s year end may be used as the final estate return’s year end. Since the assets are no longer earning interest, it is likely that there will be no further income to be reported.
Income tax rates
Based on the proposed amendments, for the first 36 months after death, the estate is taxed using the same graduated income tax rates used to calculate taxes owing by individuals. Subsequently, the top marginal income tax rate will apply.
U.S. estate taxes
If the deceased owned U.S. situs property, such as real property or U.S. investments held inside or outside of a registered account, U.S. estate taxes may apply. Depending on the situation, the Canada-U.S. Tax Treaty may also apply.
Non-resident beneficiaries
Where an estate has beneficiaries that are not resident in Canada, additional filings may be required to report the distribution. There may also be withholding tax requirements.
Clearance
Before making any distributions from the estate, the executor may request a clearance certificate from the Canada Revenue Agency (CRA) confirming there are no taxes owing by the estate, as of the date indicated on the application.
The executor is responsible to ensure that all liabilities are paid. This includes the liability for income taxes. If an executor distributes all the funds from an estate and a subsequent income tax liability occurs, the executor could be personally liable for those taxes.
If you find yourself acting as an executor of an estate, contact your Collins Barrow advisor to discuss these and other estate tax considerations.