Drilling Down on the Deductibility of Paid Executor Compensation

By:  Avi Dahary

The uncertainty surrounding whether compensation paid to an estate executor is deductible and if so, how much of it is deductible, has meant that most tax treatments of this issue are to the extremes — either deduct the full amount of paid compensation or none at all. Needless to say, both treatments are often unsatisfactory.

Income Tax Act rules state that executor compensation paid by an estate or trust for the purpose of gaining or producing income from a business or property may be deductible in computing income of the trust for tax purposes. The use of the word “may” is what causes uncertainty about when it qualifies or which part of the compensation is deductible. This article aims to bring clarity to the issue.

From a qualitative perspective, the facts of each situation will determine the permissibility of claiming the deduction as well as the magnitude of that deduction. For example, let us consider a case where more than 90 per cent of the estate’s holdings are public securities that are divided into several portfolios where each is managed by a different investment manager. If the Canada Revenue Agency (CRA) audits a claimed deduction for compensation by this estate, the agency’s mandate is to determine whether the grounds for claiming the deduction are legitimate and supported.

The CRA could claim that since the executor has retained the services of investment managers — and the estate has paid them investment management fees and already claimed a deduction for such fees — it would be unjustified to further claim a deduction for executor compensation, given the executor doesn’t manage the investments. By not managing the investments, the compensation paid to the executor doesn’t help generate more or less income from the investments.

On the flip side however, the estate could well be within its right to claim a deduction for the part of compensation that relates to the investment income generated. The reasons to claim a deduction include: one, the executor took a prudent decision to retain investment managers because he/she did not hold the requisite time and skills for this task; two, the executor took a prudent diversification decision to divide the securities held by the estate into several portfolios managed by different investment managers; and three, the executor can demonstrate he/she actively ensured that the investment strategy that was developed is implemented and maintained on an ongoing basis.

From a quantitative perspective, the preparation of estate or trust accounts can serve as a good basis to numerically support the part of the compensation that relates to the income generated for the estate. If the estate accounts are prepared accurately, a statement of compensation can be prepared that would separate the compensation between capital and income. The part of compensation that relates to income can therefore be accurately determined and utilized as the amount to claim as a deduction for tax purposes, thereby generating a well-supported claim in case of a CRA audit.

The issue of whether to claim and how much to claim as a deduction for paid executor compensation doesn’t have to be answered with all or nothing. A well-established, legitimate and supported claim can pass muster in the case of a CRA audit.