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Ian M. Hull Headshot

The Tax Burden of Estate Planning

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In our most recent blog entry, we discussed the role of an estate trustee in determining the assets and liabilities of the estate. An important next step in the administration is to satisfy the tax burden of the estate, while ensuring compliance with the ongoing duty to account.

An estate trustee may be required to file multiple tax returns on behalf of the estate. First, the terminal return is filed, reflecting the most important tax paid by the estate. At death, income tax becomes payable on the deemed disposition of certain assets at fair market value, as if they had been sold by the deceased the day prior to death. All capital gains become payable at this time, and must be recognized when the terminal tax return is filed.

Cottages can present issues during an estate administration, as they normally will not qualify as a principal residence of the deceased, and their transfer at death can trigger extreme tax liabilities, especially with such significant increases in value. Some advisors recommend transferring the ownership of a cottage to its intended beneficiary earlier rather than later, in order to avoid taxation on further increases in value.

Following the filing of the terminal return, a second return is often necessary, if the estate generates further income during administration. An estate trustee may not have a duty to obtain a clearance certificate from the Canada Revenue Agency ("CRA"), but it is almost always a good idea to do so. A clearance certificate will ensure that the CRA is satisfied with the payments made on behalf of the estate, and relieve its trustee of personal liability.

Last month, we wrote about charitable giving and some of the associated tax benefits. Donating to charity brings with it the same tax-based incentives from which donors benefit during life. If testamentary gifts are made to charities, charitable tax credits can significantly reduce the tax ultimately payable by the estate.

An estate freeze can also reduce the tax burden of an estate and effect a smooth intergenerational transfer of wealth. In an estate freeze, taxes on the increase in value of the shares after the date of their transfer will not become payable until their eventual disposition. This mechanism of tax deferral is directly tied to the estate plan and can be of great benefit when planning for the transfer of a company within the family.

The best time for tax planning is during the testator's lifetime. Speaking to advisors and revising estate plans for preferable tax treatment can make a significant difference in seeing estate assets distributed as the testator intends, rather than a greater portion of the estate ending up in the CRA's hands. Post-death tax planning is much more restrictive, with few options available for estate trustees in limiting the taxation of the estate.

Satisfying the estate's tax (and other) liabilities and subsequently making final distributions are not the last of an estate trustee's duties. An estate trustee has a fiduciary duty to maintain accounts and to provide same to shield from personal liability, if required. There is no magic to informal accounts -- records can be kept in a spreadsheet that simply matches numbers to those in receipts.

This is the absolute minimum in terms of information that could be required by the court in the production of formal accounts. An estate trustee is expected to adhere to a certain standard, and can be held to that standard at law. If an individual who is unhappy with the administration of the estate chooses to challenge the adequacy of an estate trustee's records, he or she may begin an application to compel a passing of accounts.

An estate trustee can be relieved of the obligation to account by the execution of a release, signed by everyone with a financial interest in the estate, which generally will not be obtained until the end of the administration. Where an estate trustee may not be in the position to obtain a release, or if minors or beneficiaries who are incapable are involved, an application to the court to formally pass accounts may be the best way to limit personal liability.

Ian Hull and Suzana Popovic-Montag are partners at Hull & Hull LLP, an innovative law firm that practices exclusively in estate, trust and capacity litigation. To watch more Hull & Hull TV episodes, please visit our Hull & Hull TV page.