The tax side of an estate, explained to an executor.

There is more than one return, and that is good news

A death can give rise to several separate returns, and this is usually to your advantage rather than a burden, because certain credits and the graduated rates can be claimed more than once.

The final return

Sometimes called the terminal return. It reports income from 1 January to the date of death, plus everything the tax rules treat as having happened on death.

The rights and things return

An optional separate return. Rights and things are amounts that had been earned at the date of death but not yet received: declared but unpaid dividends, matured but uncashed bond coupons, unpaid salary or vacation pay, some farm and business inventory items.

You can elect to report these on a separate return rather than on the final one. Because it is a separate return, it gets its own graduated rates and a further claim to certain personal credits, which in the right circumstances saves a meaningful amount of tax. There is a deadline for making the election, so it is worth identifying early.

Other optional returns

Depending on circumstances, further separate returns may be available for a partner or proprietor with a fiscal year end that does not match the date of death, and for income from a testamentary trust. Same principle applies: splitting income across returns can lower the total.

The estate's own returns

Once someone dies, their estate is a separate taxpayer, and income earned after the date of death belongs to it rather than to them. That means T3 trust returns for the estate, for as long as it holds assets that earn income.

For a period after death an estate can qualify as a graduated rate estate, which is taxed at graduated rates rather than the top rate that applies to trusts generally. That status is time limited and depends on conditions being met, so it is worth knowing about at the start rather than discovering after it has lapsed.

Deemed dispositions: the part that creates the tax bill

Immediately before death, a person is treated as having sold everything they owned at fair market value. Nothing is actually sold and no money changes hands, but the resulting gains are taxable on the final return.

That is what turns a lifetime of holding a cottage, a portfolio or a farm into a tax liability in a single year. It is also why the final return is frequently far larger than any return the person filed while alive.

The main relief is the spousal rollover. Property passing to a spouse or common law partner, or to a qualifying spousal trust, generally transfers at cost rather than at market value, deferring the tax until the survivor's own death or an earlier sale. Whether property qualifies depends on how the will is drafted and how the transfer is made.

Other things that come into play: the principal residence exemption, which still has to be claimed and reported; capital losses on the final return, which have special rules allowing broader use than in an ordinary year; and charitable donations by will, which have their own more generous treatment.

Registered plans, where the answer depends on a form nobody remembers filling in

This is the area where outcomes differ most, and it usually turns on a beneficiary designation made years earlier.

RRSPs and RRIFs

On death, the value of a registered plan is generally included in income on the final return, which can be a very large amount in a single year. That result is avoided where the plan passes to a qualifying survivor, broadly a spouse or common law partner, or in some circumstances a financially dependent child or grandchild, in which case a rollover is available.

The trap is a plan left to adult children while the estate has other beneficiaries. The tax lands on the final return, payable by the estate, while the plan itself goes directly to the named children. The people who inherit the RRSP and the people who pay the tax on it are then not the same people, and estates have been litigated over exactly this.

TFSAs, where the wording matters

There are two quite different designations and they are easily confused.

• Successor holder, which only a spouse or common law partner can be. The TFSA simply continues as theirs. No tax, and it does not use up any of their own contribution room. This is almost always the better outcome
• Beneficiary, which anyone can be. The TFSA ends at the date of death. The value at that date is paid out tax free, but any growth after the date of death is taxable to the recipient

A spouse named as beneficiary rather than successor holder gets a worse result than they needed to, for no reason other than which box was ticked at the bank. Worth checking on your own accounts while you can still change it.

RESPs and RDSPs

Both have their own rules on what happens to the plan, to accumulated income, and to government grants and bonds, which can be repayable in some circumstances. Worth dealing with specifically rather than assuming they follow the same pattern as an RRSP.

The clearance certificate

Before distributing the estate, an executor should obtain a clearance certificate from the CRA confirming all amounts have been paid or secured.

The reason is personal. An executor who distributes the estate and leaves tax unpaid can be held personally liable for it, and recovering money from beneficiaries who have already spent it is not a pleasant exercise. The certificate takes time to obtain, so it belongs in the plan from the beginning rather than at the end.

What to gather

You do not need all of this to make the first call. It is here so you can see the shape of it, and it can be gathered gradually.

Where a lawyer comes in

The will, the appointment of the estate trustee, probate and the Estate Administration Tax, and any dispute among beneficiaries are legal matters. I work alongside your lawyer rather than in place of them, and if you do not have one for the estate, that is the first call rather than this one.

Some executors also use a trust company, particularly where the estate is large, the family situation is complicated, or nobody wants the job. That is a reasonable choice and worth asking your lawyer about.

Questions