Who should help an executor with estate tax returns?

A reader recently sent me the following question about who should be hired to prepare tax returns for an estate. It's a great question really, since we lawyer are always saying that executors should "hire an accountant" but not everyone knows where to turn.

Here's the question:

"What type of person should I be looking for to help me prepare terminal (and other tax returns) for my father who died last year? CA vs CGA vs CMA? I'm so confused."

I posted this question to my LinkedIn group called "Canadian Will and Estate Professionals" to see what the accountants in the group (and the other estate lawyers) would say about this. The general answer seems to be that an executor should look for a CA (Chartered Accountant).

However, every person who answered the post commented that the individual accountant's experience with estates and trusts is far more important than the letters after his or her name. I would agree with that.

In larger cities, you can get in touch with large accounting firms who have accountants working exclusively in different areas of tax, such as personal income tax, corporate tax, or estates/trusts. However, not everyone has access to a firm like that. When shopping for an accountant to help you with estate returns, ask how much experience the accountant has with estates. (Note that this is a different question than "do you do estate tax returns?")

You can also ask your estate lawyer for some names, as all of us work with accountants on our files on a regular basis.

One of the people who replied to my post suggested that executors avoid tax preparers, as opposed to accountants. This of course brought a reply from a tax preparer to counter that warning. My experience using tax preparers to work on estate returns hasn't been good. One of my clients who went to a tax preparer to have the deceased's terminal return prepared was told to "go away. You can't do a tax return for a dead person".

That of course was completely wrong; you can and should do tax returns for dead persons and their estates. This is why I agree with my colleagues' advice that the individual's experience is most important. Not all tax preparers are as poorly trained as the one that my client was unfortunate enough to encounter, by any means. Make sure you're comfortable with the expertise of the person to whom you trust your estate returns.

Canada Revenue Agency - what to do when someone has died

Here is an extremely useful link for executors from Canada Revenue Agency. It's called "What to do when someone has died" and contains information about which tax returns need to be filed. It also contains information and forms for dealing with RRSPs and RRIFs of a decceased person. Personally, I would never try to handle an estate without consulting an accountant, but I like to be as informed and prepared as possible to make the most of my consultation. This page is also great for just getting that overview of what your job as executor is going to take. Click here to visit the page. I'll add it to my "interesting links" section so that executors can find the link in the future.

Be aware of deadline for filing estate tax returns

This article from the Financial Post talks about the deadline for an executor to file a return on behalf of the estate, and gives some great information about the various returns that might be needed. Check it out by clicking here.

Why does a trust have to file a tax return?

Some time ago I posted about the tax returns that an executor must file, including both the final return for the deceased and the trust returns on behalf of the estate. Click here to read that post. I've been asked a follow-up question, that is "why does a trust have to file a tax return?"

The simple answer is that when a person passes away, Canadian law states that a new taxpayer is created. That new taxpayer is the estate. Because the assets in an estate are temporarily held on behalf of the beneficiaries, the estate is a form of trust. A trust exists whenever one person or entity holds property or funds on behalf of another person.

Most estates are completed within a year of the deceased's passing away, unless of course there is a lawsuit to be settled or complicated business affairs to be wound down. For that year, the assets in the estate may earn income in the form of interest, dividends or capital gains. The new taxpayer - the estate - will report that income on a return just as individuals do, and pay tax on it if applicable.

In many estates, money is paid into a trust account for a minor or handicapped adult. Once the money has been paid into this trust specifically for that person, the taxpayer is this new trust, not the estate. If there are no trusts set up in a Will and the executor immediately pays out all assets to the beneficiaries, the executor may not have to file any tax returns for the estate.

My suggestion to all executors would be that you check with an accountant about whether or not you have to file a tax return for the estate. I can give you general information here, but if you consult an accountant you will have the chance to crunch the actual estate numbers and get individualized advice.

Estate losses - turning bad into good

Here we go with more good tax information for executors. In this article, Derek de Gannes talks about tax possibilities when a deceased has paid tax on a capital gain, but then after death the assets lose value. Click here to read the article.

What is a T3 tax return?

When a person passes away, his or her executor files a tax return for the last year of the deceased's life. That is a T1 tax return. Executors are sometimes surprised to find that they may have to file a tax return for the estate itself, as opposed to for the deceased person. A tax return for an estate or trust is a T3 return.

An estate or trust is considered a "person" for taxation purposes. Just as a living person files a tax return each year to report income, so does an estate or trust.

An estate's tax year begins the day after a person passes away and continues for one year. Any income earned by the estate during the tax year is reported on a T3 return, and is set off against available deductions and exemptions just as it is for a living person. Income earned by an estate may be in the form of capital gain, dividends or interest. If an estate doesn't earn any income, it may not be necessary to file a T3 return.

If an estate carries on for many years, a T3 return has to be filed for each year. When the estate is wound up and all of its assets have been distributed to the beneficiaries, the executor should request a Tax Clearance Certificate from Canada Revenue Agency to show that all taxes owing have been paid.

I always advise my clients to consult an accountant to help with tax returns for an estate. While lawyers such as myself know the basics of estate tax returns, we are not qualified to complete the returns, and an executor should enlist the help of an accountant for that. Accountants can also give advice on whether tax owing on income earned by an estate or trust can be shared out among the beneficiaries rather than borne by the trust itself.

What tax returns must an executor file?

The rules for filing tax returns on an estate are the same all across Canada, as tax laws are federal. The Income Tax Act directs that a person acting as an executor must file certain tax returns on behalf of the deceased person, and on behalf of the estate. I have actually had a file where I instructed a client/executor in his duty to file on behalf of the estate, and he was turned away by the tax preparer on the basis that "you can't file a return for a dead person". Well, you can, and if you're the executor, you will probably have to do just that.

The first return that an executor must file is the T1 Terminal Return for the year that the person died. A T1 is the same return that each of us files each year. The return is for the period that starts on January 1 and ends on the day the person passed away. For example, if a person dies on July 12, the return is prepared for January 1 to July 12. As a general rule, the executor has six months to file this return, but can choose not to file until April 30 of the next year (when everyone else files taxes) if that is more than six months.

The executor must also find out whether the deceased person failed to file any tax returns for previous years. If so, the executor must have those completed and filed. Again, follow a general rule of six months as the deadline, but keep in mind that because these returns are overdue, there could be penalties or interest accumulating.

On some estates, the executor should also file a "rights and things" return. This is filed when there were sums of money due to the deceased that had not been paid to him or her yet as of the date of death, and because of that had not been included in the T1 Terminal Return. Some examples are work-in-progress, farm crops not yet harvested, and dividends that were declared but not paid.

The executor usually must also file a tax return on behalf of the estate itself. The time period for this return starts on the day after the person died, and runs for one year. Most estates are wrapped up in a year and won't require more than one return, but if the estate does go on longer, a return should be filed for each year. This return is known as a T3 Trust Return.

In some smaller estates, no T3 is needed because the estate itself earns no income. This is something you should ask an accountant about.

I strongly advise executors not to prepare the returns themselves, but to find an accountant who is familiar with estates and trusts. This protects the executor personally in a couple of ways. First of all, getting accounting advice means you are less likely to miss important items on the return, or to miss deadlines. Secondly, if by some chance there is a mistake that leads to a financial loss on the estate, you are protected from personal liability by having sought out professional advice instead of just "winging it".