Income taxes for estate trustees

This is a note on the basics of income tax applicable for estate trustees filing on behalf of the deceased and the estate.  It does not address the Estate Administration Tax (Ontario’s probate tax).

Nothing in this note is legal or accounting advice!

Some key terms:

 

      • Income
          • Receipts (including deemed disposition fair value) minus direct ‘capital account’ costs for acquisition, improvement and disposition.

      • Tax credits
          • Items that reduce the tax payable.  Important examples include the Disability Tax Credit, …

      • Deductions
          • Reduce the taxable income.  Important common examples include RRSP contributions,

    • GRE – graduated rate estate
        • For the first 36 months income of the estate is taxed using the ‘graduated marginal tax rates’.  Thereafter, all income is taxed at the top marginal tax rate.  Thus, most estates should aim for distribution before the 3rd anniversary of death. 

 

The Terminal Return

This is the return for the final ‘year’ of life of the deceased.  The period starts January 1 and ends on the date of death.

Formally it is a T1 return which is the usual annual return filed by everyone.  What makes the terminal return different and complex is that in addition to all income received by the deceased during the year, all income arising from assets that are ‘deemed to be disposed’ on death (and that are not rolled over to the spouse of the deceased) must be calculated and declared on this return.

Accurate and complete information is essential.

 

Rights & Things Return

This is a possible but not terribly common separate return that can be filed when income was ‘due to the deceased at death but not yet paid’.

It is most useful when the deceased was the owner-managers of an incorporated business or was expecting to receive a substantial bonus or dividend.

 

T3 Estate Returns

A return is due for each year of the estate, if the estate earned income in that year.  An estate return is not necessary for years where the estate had no income.  See below for discussion of fiscal years.

 

Calculating the income on the terminal return

This is the most time consuming task in estate income taxes

  • Start with income with T slips from Jan 1 to date of death
    • Dividends and interest
    • Income from employment RRSP and RRIF RRIF withdrawals in the terminal period (pension amount Box 16), are income in terminal period. The entire value of the RRSP/RRIF  account on the date of death is income that must be included on the terminal return.  T4RRSP Box 34/ RRIF Box 18.  Record on T1 terminal return line 129 for RRSP, Line 130 for RRIF (see below for roll-over). If the account value declines between death and cash-out (but not from trading after death), file RC249.  This should result in an adjustment of the income on the terminal return. Gains between death and cashout (not roll-over) are taxable income in the estate, reported on the T3.  Applies to TFSA too.
    • Pension income Canadian pension income will be reported on a T slip
  • Foreign income, especially pensions.  It is important to calculate foreign income properly.  T slips are not provided.  Be attentive to foreign pension income.
    • Capital Gains
      • Income arising from actual sales in terminal period (also applies to capital losses).  Fair value on death – adjusted cost base for the asset.
        • Deemed dispositions for all capital properties (foreign and domestic, with or without T slip) for fair value on death.  Applies to real estate, investments other than registered accounts (shares in public and private companies, mutual funds), personal property …

 

    • Principal residence – a subset of capital dispositions
      • If it was owned jointly, then the surviving joint owner(s) take title but must be reported.
      • If it was owned by the deceased alone or tenants-in-common, then there is deemed disposition for fair market value of the deceased’s ownership on death.  No deduction for realtor fees.  If the property will not be sold ‘promptly’ then a formal date of death appraisal is strongly recommended (some objective evidence of value is required).
      • Find purchase cost, often from land titles.
      • The gain from purchase to sale is a taxable capital gain
      • An exemption from tax on this gain –
        • Is possible for only one residence per year
        • Can be allocated among various properties over life if the property qualifies (perhaps for cottage)
        • Each spouse can claim one property per year
        • The disposition must be disclosed on the T1 terminal return (and Schedule 3 to T1)
            • To claim the exemption, file T1255

 

Tax Credits on the terminal return and earlier

  • Disability Tax Credit
    • Eligibility:  A person may be eligible for the DTC if they have a severe and prolonged impairment in physical or mental functions resulting in a marked restriction. A marked restriction means that, even with appropriate therapy, devices, and medication, they are unable or take an inordinate amount of time in one impairment category, all or substantially all (generally interpreted as 90% or more) of the time.
    • May not have been claimed on prior years?  If eligible, re-file prior years? Requires doctor to sign Worth about $1,400 per year. Can be the taxpayer or a family member who is disabled.

Deductions from income on the terminal return

 

    • Medical expenses.
      • Expenses over threshold of 3% of income.
      • Claimed on return of lower earning spouse.
        • Any 12 consecutive months ending in the year of filing.

 

    • Charitable donations
      • Can be bundled from several years
        • Max 75% of income in most years, 100% of income on terminal return

 

    • RRSP
      • Contributions to the deceased’s RRSP made prior to death can be deducted.
      • Trustee can make permitted contributions to a spousal RRSP after death, then deduct on terminal return
        • If there is a spousal roll-over of the RRSP or RRIF, record the transfer to the spouse on Schedule 7, Box 240.  In other words, for a spousal roll-over, report the income and an equal deduction.  Should show on the deduction slip as transfer under subsection 60(l).

 

T3 Estate Returns

 

    • Fiscal year
      • For the first three years after death, the fiscal year of the estate begins on the day after death and ends one year later.
      • Then, there is a stub year – from day after death to December 31.
        • All subsequent fiscal years fort the estate are calendar years (Jan 1 – Dec 31)

 

    • Income
      • It is highly recommended to minimize income in the estate and make tracking receipts and expenses as easy as possible:
        • Liquidate all assets ASAP.  Do not delay unduly.
        • Deposit all funds into a non-interest bearing estate account.  Do not try to generate income in the estate if the asset can be flowed out to beneficiaries.
        • Make interim and then final distributions as soon as practicable.
      • CPP Death benefit ($2,500)
        • Never reported on terminal return.
        • Reported as income on the return of the ‘person who received the benefit’ – either the estate, or a beneficiary or other relative
      • Interest (T5)
      • Dividends etc.  T3 No dividend tax credit or gross up.  Report the amount actually received.
        • Capital gains and losses
            • Gains and losses in asset values during each year of the estate.  Applies to gains/losses in TFSA, house …

 

    • Deductions on T3s.  Minimal deductions permitted.
      • Carrying costs: accounting fees for prep of T3 (not other matters).
      • Funeral costs are not deductible.
        • Trustee fees for administration of the estate are not deductible on the T3.  Some trustee fees might be deductible if directly related to generating income in the estate (e.g. investment advice).

 

The tax return of the surviving spouse in year of death

 

    • Roll-overs.  It may be possible to defer very significant amounts of tax by ‘rolling assets’ over to the surviving spouse of the deceased.  This is EXTREMELY powerful and important and is a key reason you should get professional advice to deal with the income taxes of the deceased.
      • RRSP – report transfer on terminal return
      • RRIF – report transfer on terminal return.
      • TFSA –  not reported.
        • It is possible to waive the roll-over, and step up the ACB for the acquiring spouse.  Must file an election to do this.

 

    • Distributions in specie to beneficiaries (not roll-over)
        • ACB stepped up to deemed disposition value

 

Other matters

Trustee compensation is a very important and often contentious issue.  If the trustee claims compensation they must ensure that all income tax remittances are paid and all filings made for both the estate and the trustee.  Trustee compensation:

 

      • Is taxable income for the estate trustee in the year they receive it.

      • Could be spread over the years the estate is administered.

      • If compensation is less than $500, complete and file a T4A

      • If compensation is greater than $500, the estate should open an employer account and then the estate should issue a T4 to the trustee.

    • Retroactive reporting and filing – complete and file a T4A for all amounts paid to the estate trustee.

Interim distributions

  • Estimate estate liabilities, especially income tax liabilities, trustee compensation, creditors …  This can be complicated if there is inadequate information about tax matters especially the adjusted cost basis for shares or cottages, whether the deceased was current on filings and payments …  Can be done on an ‘asset by asset’ basis.

 

  • Add an additional buffer for protection.

 

  • This permits calculation of a reasonable ‘holdback’.

Taxpayer relief – penalties and interest for late filing/payment

 

      • It is not uncommon to be late filing returns, especially the T1 terminal return.  Significant penalties and interest can accrue.

    • It is possible to request relief.  The grounds for relief must cite unavoidable reasons for the delay.  Delay caused by government (such as probate), and third parties like banks should be much more persuasive than trustee failings.  Good practice is to file the form together with an explanation from the trustee personally (signed letter, appended to the form). [we draft these].

Non-resident beneficiaries

 

    • As a general rule, for each non-resident beneficiary a filing is required by the beneficiary and by the estate trustee (notice to the CRA is required.  A special clearance certicate may be required.

 

    • Exceptions from the withholding tax and clearance certificate rules may apply if
      • The trustee is not related to the beneficiary, and
        • The distribution is only ‘after tax cash’, with all taxes paid by the estate.

 

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