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Wednesday, October 24, 2012

If I leave money to my executor, is it taxable?

If you leave money to your executor in your will, does your executor have to pay tax on it? Well, that depends on what your will says about it.

Let's say you want to leave your executor, Jack, a gift of $100,000. You can leave a gift of money to anyone you want to in your will, whether or not he is the executor. You would simply say "I leave $100,000 to Jack". If it's a gift, the recipient of the money doesn't have to pay income tax on it. Inheritances are not taxed in the hands of beneficiaries in Canada. That seems pretty straightforward, doesn't it? But unfortunately, some people accidentally make it more complicated.

The problem is that money earned by an executor for doing the executor's work is considered by Canada Revenue Agency to be earned income. Jack did work for the estate and was paid. Therefore, it's subject to income tax. When the will says to give Jack $100,000 for acting as the executor, Jack must add the amount of the fee he receives to his income for the year.

Again, this rule is pretty clear. Based on this rule, the solution arrived at by those people who hope to avoid the need for the executor to pay tax is to call the money going to the executor a gift, even though it's really only being given to them because they are executors. They believe that throwing the word "gift" in there will keep the executor's fee away from the tax man. I've seen many wills over the years, drawn by lawyers and non-lawyers alike, that say to give $100,000 to Jack as a gift to thank him for all his hard work on the estate.

As it happens, leaving this money to Jack to thank him for his work on the estate indicates that Jack is receiving the money for acting as executor. The fact that he worked for the money will override the word "gift". Jack would be obligated to pay tax on the $100,000 even though the will says to give it to him as a gift.

You may decide to leave your executor a gift without mentioning the work on the estate to avoid Jack having to pay tax on the money. That may or may not work out for your estate, though it is the best thing for Jack. The downside for not mentioning an executor's fee is that Jack would be entitled to claim an executor fee in addition to the "gift" because it will look as if you simply neglected to talk about Jack's fee. As I said, good for Jack, not so great for the estate.

As a general rule, if you're congratulating yourself on finding an easy way to get around a tax or estate-planning rule, you're probably just walking right into a problem you don't see coming. Just ask yourself why, if it's that easy, everyone isn't doing it. Professional advice is worth the money.

2 comments:

  1. In some cases, money you inherit from a person who passed away is taxable. These taxes generally don't apply if the deceased person, termed the "Decedent" by the IRS, was your spouse or if the money you inherit is less than the current tax year limits. However, if any of the money or property value you inherit is taxable, not reporting that income to the IRS can lead to penalties and additional fees.
    Professional Legal Network

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    1. Hi, thanks for your comment. Are you referring to American citizens who inherit from a Canadian estate? If so, I greatly appreciate your input because as a Canadian lawyer I wouldn't have your knowledge of the American system. As for your last comment, about not reporting income, I totally agree. Honesty really is the best policy.

      Lynne

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