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The position of executor: from cradle to grave – Part V

By Avi Dahary

Personal and Estate Income Tax

Part four of this series covered the executor’s duty to ascertain and discharge the debt obligations of the deceased.

This part of the series will cover the executor’s duty to ensure that the deceased’s and estate’s tax matters are in compliance with current tax rules.

If there was any doubt until now, on whether the executor should retain the services of estate professionals, it should be put to rest at this point because it is critical to retain the services of a skilled accountant who is well versed and experienced in tax matters relating to deceased individuals and estates.   

It is common after the death of an individual for the executor to seek out and retain the accountant who historically prepared the deceased’s personal tax returns in order to also prepare the deceased’s final income tax return. This potentially is a mistake. The executor should undertake a due diligence interview process to choose the suitable accountant. 

The accountant retained should have a strong familiarity with tax issues relating to final income tax filings as well as estate tax filings.  For example, he or she should have a solid experience in: a) the various tax filings available for a deceased person, b) the tax rules specific to the death of taxpayer, c) the elections that may be available for a deceased individual, and d) current tax rules relating to testamentary estates.

Much is at stake here for the executor as he or she is personally liable for any of the deceased’s unpaid personal taxes and unpaid taxes owed by the deceased’s estate.

Here are some issues the executor should consider and discuss with the accountant who will be assisting with tax compliance matters:

1. Personal tax return for the prior year and for years that are in-arrears: The executor should ensure that all tax filings are up to date and current, and that a tax return is prepared and filed for any prior year for which a tax return has not been filed. Furthermore, paying any assessed arrears penalties, interest and outstanding tax balances.

2.Final tax return: This tax return is the last personal tax return for the deceased and is for the period from January 1 in the year the death occurred to the date of death. There are specific rules for the filing deadline for this tax return. This tax return is different from the historical tax returns in that there are special rules that apply to the final tax return. 

As stated previously, these may include various tax filings available, tax rules specific to the death of taxpayer such as the deemed disposition of assets and reporting of capital gains and losses, and elections that may be available such as electing on a rollover to a surviving spouse at fair market value instead of at cost in order to trigger capital losses that can offset other capital gains. When it comes to compiling the information and documents necessary for the preparation of this tax return, a good starting point would be to read Part IV of this series (“Taking Inventory of Estate Assets”). 

The asset inventory list the executor compiles will provide a good indication of the various sources of the income that is anticipated to be reported on the final tax return.

3.U.S. estate tax: The executor should determine if the deceased owned any assets that are located or deemed to be located in the United States, ascertain the market value of these assets at the date of death, and contact a U.S. tax specialist to determine if any U.S. tax filings are required and whether there is U.S. estate tax payable.

4. Estate tax returns: From a tax perspective, there is a continuity of events after the date of death whereby a new tax entity is born. The deceased’s estate, which is referred to as a testamentary estate because it came to be as a result of the death of an individual. 

There are specific tax rules relating to testamentary estates the accountant hired by the executor should be well-informed of the current tax rules in this area. An estate tax return should be filed yearly until such time that the estate is wound-up.  If the income generated by the estate needs to be allocated to beneficiaries on a yearly basis, the executor should ensure to undertake the proper tax reporting to the beneficiaries.

5. Clearance certificate: Once the executor has filed all personal and estate tax returns and all returns have been assessed and all taxes paid, the executor should file a request with the tax authorities for a clearance certificate.  This should be done prior to distributing the estate residue to beneficiaries. 

The request should be made for the date of death as well as the wind-up date of the estate.  When the tax authorities receive the request, they will proceed with their own due diligence process to ensure all taxes have been paid or sufficient security has been obtained.  Upon completion of this process, the tax authorities will issue a clearance certificate naming the executor and relieving him or her from liability for any unpaid taxes.

Stay tuned for part six of this series in which I will discuss issues relating to administrating and maintaining the estate.

The position of executor: from cradle to grave – Part IV

By Avi Dahary

The determination and discharging of debts and liabilities

In part three of this series, I discussed identifying the assets that become part of the estate immediately after death and compiling a list of them in order for the executor to bring them under their control to safeguard them.

This part of the series will cover the executor’s duty to ascertain and discharge the debt obligations of the deceased.

It’s not uncommon for those who are newly introduced to the role of executor to be under the impression that when the deceased died so did all their debts and liabilities. In many cases, executors are shocked to learn they may be “on the hook” in some cases where these liabilities remain unpaid, such as the deceased’s owed personal income tax, as well as any outstanding estate taxes.

There is a long list of potential debt obligations of a deceased person and those that become debts of the estate, and while it isn’t practical for me to address every type in this short commentary, I will highlight a few.

The first step is to read the deceased’s will to become informed about any specific debt obligations that may exist, as well as the powers granted to the executor in discharging them. If the executor is not intimately familiar with the deceased’s financial affairs, it would be advisable to advertise in the local newspaper for creditors. This would also be suggested if the executor was closely familiar with the deceased’s financial affairs but the estate is a complicated and sizeable one.

The next step for the executor is to contact the bank where the deceased kept accounts and inquire about any debts they had. It’s also advisable to contact the deceased’s accountant and lawyer, both of whom may be familiar with debts they held personally or through a corporation.

The most common areas of debt and liabilities that executors will encounter are:

  1. Household expenses: If the deceased owned a home, these liabilities would include charges relating to its upkeep. In this case, the executor would need to ensure all outstanding amounts owing regarding utilities, telephone, cable, property tax, etc. are paid. Some of these expenses may apply if the deceased rented their residence but the executor should read the lease agreement to determine whether further amounts are owed and/or whether other obligations exist. In cases where the deceased lived in a retirement residence or nursing home, the executor would need to contact the facility’s management to determine if there are any amounts owing or refunds due back to the estate.
  2. Mortgage and credit card debt: If the deceased owned a home, the executor would likely determine if there’s a mortgage on it by checking the bank account transactions obtained from the bank. Where there are mortgage payments being withdrawn from the account on a regular basis, the executor should followup with the bank to determine the mortgage amount that remains outstanding, as well as inquire about any other mortgages or loans the deceased may have been obligated under. When communicating with the bank, the executor should also ask whether the deceased held any credit cards and if so, whether there are owed balances.
  3. Personal and estate income tax liability: The executor will need to file a final personal tax return for the deceased as of the date of death. A final tax return is different than the usual personal tax return filing in that specific tax rules come into play at death, which, in many cases, result in the deceased having a personal tax liability at death. In addition, for as long as the deceased’s estate is ongoing, the executor will need to file tax returns for the estate, which may result in the estate owing tax.

Stay tuned for part five of this series in which I will discuss various personal income tax issues that arise on death as well as, tax issues for the estate.

The position of executor: from cradle to grave – Part III

By Avi Dahary

Taking Inventory of Estate Assets

In part two of this series, I explored the initial steps one needs to take when they are named an executor in a deceased’s will. In this part of the series, I will discuss identifying the assets that become part of the estate and compiling a list of them in order for the executor to bring them under his/her control and safeguard them.

Reading the will and consulting with the family members of the deceased who were familiar with his/her affairs is a good starting point for identifying possible or actual assets. The executor will need to visit the place of residence of the deceased and search for, and through, documents that identify the deceased’s bank and investment accounts, business interests, real estate properties, mortgages, life insurance policies, safety deposit boxes, jewelry, art or other collections, and any other item of value.

In some cases, the deceased may have a safe in the home. It’s up to the executor to ascertain the code or hire a company to open the safe in order to take control of the items inside. If cash is found, it’s necessary for the executor to count it and take appropriate steps to safeguard the money until it is deposited into the estate’s bank account as soon as possible. If the amount of cash is large or the value of jewelry found in the safe is high, the executor would be prudent to consider hiring a security company that specializes in transporting and storing such valuables as cash, gold, diamonds, etc. for safekeeping until such time as they can be liquidated or transported to a permanent secure location.

If the deceased owned a business, it may be necessary for the executor to visit it, meet with existing management and ensure steps are taken for operations to continue uninterrupted. A change in circumstances due to the death of the business owner may bring about a need to make changes in the management team. The executor needs to take steps to ensure that the management team is fit and capable of continuing its operation in a competent manner. It’s necessary for the executor to obtain access to the company’s financial records, statements, tax returns, directors’ resolutions, and minute book, etc. These could be found with the firm’s accountant or corporate lawyer.

The executor will need to visit or write to any identified bank, investment firm and insurance company in order to obtain an inventory of bank accounts and balances, accounts with the underlying cash balances and securities, and life insurance policies with details of the insured amounts, terms and beneficiaries of the policies.

In addition, the bank will provide to the executor details related to any outstanding loan or mortgage the deceased was obligated under, and any credit card with balances owing.

If a real estate property is involved, the lawyer for the estate would do a title search to ascertain title to the property and find out what encumbrances there are, if any, against it such as mortgages, liens, etc.

As well as learning about any debt obligations, the executor needs to determine whether any outstanding amounts were receivable by the person at the date of death. These could include salary or wages, pension, if the deceased was a partner in a partnership, then any income due from that, and death benefit from a workplace pension or the Canada Pension Plan, etc.

At this stage, the executor has made an inventory of the assets that are under his/her control and it would now be the time to determine whether they are sufficiently insured, and if an uninsured asset needs to be insured adequately to safeguard it from any loss, damage or decline in value. Ensuring estate assets are adequately insured protects the executor, the estate and ultimately, the residual beneficiaries.

Stay tuned for part four of this series in which I explore determining what debt obligations the estate has and the discharging of those obligations.

The position of executor: from cradle to grave – Part II

By Avi Dahary

Fact gathering

In part one of this series, I provided an introduction to the position of estate executor, including basic principles to follow and implement. This post will explore the initial steps one needs to take when becoming an executor by virtue of being named as such in a deceased’s will.

Often after a death, emotions are tender; old family dynamics rise to the surface and people affected by the deceased’s passing may not think clearly.

It may seem obvious, but the first thing an executor needs to do is to find and read the deceased’s last will carefully. I use the word “carefully” to emphasize the importance of this task given the will contains the deceased’s wishes and intent on how his/her estate is to be administered and distributed. To that end, it may be wise to contact the lawyer who drafted the will (or another wills and estates lawyer) to assist in interpreting it and provide clarifications. I cannot stress enough how important it is to obtain the assistance of legal counsel who is competent in the area of wills and estates. It will prove to be invaluable in smoothing the way in the administration of the estate.

Some of the more immediate determinations to be ascertained from the will are: whether there are any special instructions regarding the funeral and/or whether the will calls for any body organs to be donated.

The executor would either make the funeral arrangements or assist the immediate family in doing so. The executor, where possible, may also provide to the family funds from the estate for paying the funeral expenses.

A death certificate should be obtained from the funeral home as proof of death as this will be used at various times, including applying for the Canada Pension Plan (CPP) Death Benefit, liquidating bank accounts and investments, selling the principal residence of the deceased, etc.

Consultations with legal counsel should be ongoing and include determining who the beneficiaries are and what they’re entitled to in accordance with the will, as well as applying for a certificate of appointment of estate trustee with a will and serving such on parties who have an interest in the estate. Legal counsel should also be in a position to introduce the executor to other professionals — such as an accountant, investment counsel, auctioneer, etc. — who specialize in providing services to executors and who could prove to be invaluable in the process of administering the estate.

This would also be a good time to consider whether one should obtain executor insurance protection. In some cases, when one becomes an executor, he/she may (knowingly or unknowingly) be exposing themselves to personal liability for which he/she may not be willing to carry the risk. This would be the time to consult with your legal advisor to determine if insurance protection would be advisable to offset the risks involved in the administration and ultimate distribution of the estate. One should also consider that this is not solely for the protection of the executor but also for the eventual protection of the estate’s beneficiaries.

Stay tuned for part three of this series in which I explore taking inventory of estate assets.

The position of executor: from cradle to grave

By Avi Dahary

Part I – An introduction to the position

This is the first of a 10-part series in which the position of estate executor is explored from the time an individual is named or appointed to the time an estate is wound down.

I have found that unless you’re a ‘professional’ executor, meaning you are or have been an executor of a number of estates that allowed you to garner experience in that role, you probably need considerable professional and skilled guidance in performing your duties — this cannot be stressed enough. I would recommend that even a ‘professional’ executor should obtain some guidance and assistance in fulfilling his/her role.

To start, an executor has a fiduciary duty, which means that he/she has been entrusted with managing and administering the deceased’s estate with the highest standard of care and in the best interest of all beneficiaries.

In assisting many executors whose position has been challenged, I have found some basic principles that could help them avoid many of the objections they often face. These principles can be summed up as follows:

  1. Get informed – There’s no shortage of literature with regards to the duties of an estate executor so do yourself a big favour and read as much as possible on this topic. The more you get informed, the more you are aware, the more you will appreciate and comprehend the magnitude of your duties. And please be careful not to fall into the trap of thinking “how hard can it be?” If you don’t get informed, you’ll find the answer to this question the hard way. The safe attitude to take as executor is summed up perfectly by two lines in the song ‘Carry On My Wayward Son’ by Kansas: “And if I claim to be a wise man, well it surely means that I don’t know.” So please don’t pretend to know it all because you probably don’t.
  2. Obtain professional, skilled advice and assistance – It is critical to obtain advice and guidance from a lawyer, and I don’t mean any lawyer, I mean a lawyer who specializes in estates, trusts and wills. And, if need be, that lawyer can refer you to other specialists. The same goes for choosing professionals who are important service providers to executors such as an accountant, investment manager, appraiser, auctioneer, etc. Yes, there is a dollar cost associated with retaining the services of professionals but this is money well spent and it provides all parties with a vested interest in the estate, including the executor, a sense of comfort that estate matters are being handled appropriately.
  3. Communicate, communicate, communicate – This cannot be overemphasized and preferably the executor communicates in writing (so things are documented.) The practical dimension of communicating is that it paves the way for clarity and minimizes the possibility of misunderstandings. The psychological dimension is that it provides comfort to those with an interest in the estate that their needs, concerns or issues are addressed, and therefore it minimizes the risk of disputes and confrontation. Here, the well-known adage of “less is more” will not work and will most likely produce the unintended effect where, as author Seth Godin put it “The less people know, the more they yell.” And this leads me to the last but not least principle,
  4. Transparency – As the executor, your basic objective is to be perceived as honest and fair by all parties who have an interest in the estate. By communicating and making full disclosure of available information in a transparent manner you are presenting yourself as someone who is open to collaboration and co-operation as opposed to someone with a hidden agenda. In the words of the Dalai Lama: “A lack of transparency results in distrust and a deep sense of insecurity.” Since the executor is in a position of trust and is interested in maintaining that trust, providing full disclosure in a transparent manner is a good way to achieve that goal. Of course, like most things, there are no guarantees that this will gain the executor full co-operation, given that in some cases, there will be one or more beneficiaries who are predisposed to being doubtful and mistrusting but, in many cases it will go a long way in gaining goodwill.

Please stay tuned for part two of this series in which I explore the initial steps one needs to take when becoming an executor.

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.

Executors: Prepare for CRA’s due diligence on deceased’s real estate

Occasionally, an estate executor may be in a situation where a deceased’s estate includes a real estate property that consists of attached principal residence and commercial space, which sparks a number of tax-related issues.

First, there would be a deemed disposition declared on the deceased’s final personal tax return. This deemed disposition would be in respect of the commercial property space since the principal residence space would fall under the principal residence tax exemption (unless part of the principal residence was rented to a third party, discussion of which is beyond the scope of this article). Therefore, the first challenge for the deemed disposition purpose would be to determine the space allocation between the principal residence and the commercial enterprise.

The next task for the purpose of the deemed disposition would be to determine the market value of the property. This in itself can be a difficult endeavour since the nature of the property is both residential and commercial. In particular, one needs to consider the nature of the business occupying the commercial space as well as what portion of the commercial space is land and what is building.

Only when these issues are vetted can a proper valuation be attached to the commercial space when declaring the deemed disposition on the deceased’s final tax return.

This brings us to the executor’s ultimate tax-related objective and that is to obtain the Clearance Certificate from the Canadian Revenue Agency (CRA) for the deceased’s tax liability up to the date of death (this discussion does not relate to, or consider, the need for a further Clearance Certificate for the period from the date of death up to the wind-up date of the deceased’s estate.)

When CRA receives the request made by the executor for a Clearance Certificate, it is almost a certainty that they will perform their own due diligence with respect to the value of the real estate (and would include work on both the residential and commercial space.) Most likely the matter will be referred to CRA’s Real Estate Appraisal Section.

That section will request further information such as:

1) Documents showing a property valuation by a realtor or certified valuator;

2) Supporting market data utilized in the preparation of that valuation;

3) If there are any environmental issues relating to the property, the CRA will enquire whether there were any environmental investigations conducted and if so, to provide them with the reported findings;

4) Enquiry on whether any part of the commercial space was leased or rented to any third parties or did the deceased operate a business in the commercial space and reside in the residential space; and

5) If any part of residential and/or commercial spaces were leased to a third party, to provide to them copies of the lease(s) in effect at the deemed disposition date.

Only after conducting a thorough investigation to substantiate the value of the property will the CRA issue a Clearance Certificate.

It follows, then, that when valuing real estate for the purpose of a deemed disposition in a deceased’s final personal tax return, particularly in cases where the property consists of attached principal residence and commercial space, executors are advised to take the valuation process very seriously as they will likely be called upon to provide strong evidence to support their valuation.

Attorneyship, guardianship accounts and separating between capital and revenue transactions

aviPeriodically, I am asked to comment on attorneyship or guardianship accounts that were prepared by someone else for court-passing and in some cases the first observation I have is that the transactions recorded in the accounts are separated between the capital account and the revenue account (i.e. between capital receipts, capital disbursements, revenue receipts and revenue disbursements.)

In those cases, one of the first questions I ask of those retaining my services is why the separation? And in most cases, the answer I get is one of three: “I’m not really sure” or “Well, isn’t that how estate accounts are done?” or “That’s how we always do them.”

Unfortunately, none of these responses is a sufficient reason to separate between capital and revenue transactions when preparing attorneyship or guardianship accounts. Keep in mind that I am only addressing the capital and revenue transactions and not any transactions relating to the attorney/guardian investment activities.

When we consult the Substitute Decisions Act, 1992, Ontario Regulation 100/96: Accounts and Records of Attorneys and Guardians, it states under paragraph 2(1) that “The accounts maintained by an attorney under a continuing power of attorney and a guardian of property shall include, … (c) an ongoing list of all money received on behalf of the incapable person, including the amount, date, from whom it was received, the reason for the payment and the particulars of the account into which it was deposited; (d) an ongoing list of all money paid out on behalf of the incapable person, including the amount, date, purpose of the payment and to whom it was paid.”

There are other requirements listed in the regulation, but for purposes of this subject matter, only (c) and (d) are relevant.

Therefore, on one hand the regulation simply requires an accounting for money received and money disbursed (i.e. receipts and disbursements.) It doesn’t call for the breakdown of transactions between capital receipts, capital disbursements, revenue receipts and revenue disbursements.

On the other hand, one might refer to Rule 74.17 (3) on “Form of Accounts” contained in the Rules of Civil Procedure that states that “Where a will or trust deals separately with capital and income, the accounts shall be divided to show separately receipts and disbursements in respect of capital and income.” Therefore, one might conclude that because estate accounts separate between capital and revenue as a result of this rule, then it stands to reason that attorneyship or guardianship accounts should also separate between the two.

This is not necessarily the case.

In an estate situation, there may be a requirement to separate between capital and revenue transactions because the will instructs to do so and because there may be two classes of beneficiaries with different beneficial interests (i.e. residuary versus income beneficiaries.) In an attorneyship or guardianship situation, the incapable person is still alive and is both, the residuary and income beneficiary.

Separation between capital and revenue transactions in attorneyship or guardianship accounts would be necessary if there is a stipulation to do so in a relevant legal instrument (e.g. a certificate of appointment, court-order, management plan, or other trust instrument.)

However, it is my opinion that if there’s no such requirement, there’s no benefit in separating between capital and revenue transactions in attorneyship and guardianship accounts and doing so only increases the time and cost of preparing these accounts as well as promotes confusion.