Executors should get clearance

A clearance certificate is a document from the CRA that states the deceased owes no taxes under the Income Tax Act and assures the executor that the taxman will not pursue the estate for unpaid taxes.

“Anyone acting in the capacity of executor, personal representative or trustee should consider getting a clearance certificate in order to protect themselves from personal liability,” says Leanne Kaufman, vice president, professional practice group, with Toronto-based Royal Bank of Canada’s wealth-management division.

If an executor distributes assets to the beneficiaries of an estate without having the clearance certificate, Kaufman says, the executor may be personally responsible for any previous unpaid taxes of the deceased, including interest.

The executor or trustee may not know the tax situation of the deceased. If the CRA deems that the deceased person owes taxes, the agency will send the bill to the executor or trustee, who will then be on the hook for those taxes.

“If the trustee distributes assets to beneficiaries and there are still liabilities owed to debtors, the debtors can demand the debt be repaid by the trustee,” says Hank Bulmash, a chartered professional accountant with Bulmash Accounting in Toronto. “Then, the trustee is in an awkward position because he doesn’t have any money.”

The executor or trustee then must go back to the beneficiaries and ask for the money back in order to pay off the debtor, Bulmash says. And the beneficiaries can say: “That’s not our problem.”

In other cases, an executor or trustee, might not be a family member and unaware of financial arrangements the deceased taxpayer had made outside his or her will.

Bulmash gives the example of a trustee who distributed the assets of an estate, not knowing that the deceased had a registered retirement income fund (RRIF) worth $250,000, for which an adult child was the designated beneficiary. When the taxpayer died, the RRIF money went directly to the beneficiary, outside the estate, without the trustee’s knowledge.

“The beneficiary isn’t liable to pay taxes on the RRIF income; the estate is,” Bulmash says. “It falls into the terminal tax return of the deceased.”

In this case, according to Bulmash, the CRA approached the trustee with a tax bill for $100,000. Says Bulmash: “He essentially had to mortgage the real estate [left in the estate] to pay off the tax bill.”

If the trustee in this case had obtained a clearance certificate before distributing the estate’s liquid assets, he would have been made aware of the tax bill and could have paid it using the estate’s assets.

A clearance certificate also can help in cases in which the heirs are siblings who don’t get along. For example, an adult child who is both executor and beneficiary might distribute assets among his siblings, then find out taxes are due. He or she might have difficulty recovering monies from estranged siblings and thus be personally liable for the unpaid taxes.

The amount by which a personal representative can be liable is limited to the value of the estate’s assets that were distributed, even if the tax bill exceeds that amount.

For example, let’s say the estate is worth $300,000. However, it turns out, upon reassessment, that the deceased owed $350,000 in back taxes. If the executor distributes the full $300,000 to the beneficiaries before paying the taxes and obtaining a clearance certificate, the executor could be liable to the CRA for $300,000 – but not the remaining $50,000.

This doesn’t mean that an executor or trustee can’t distribute any assets before getting the clearance certificate – only that he or she should hold back enough money for any unforeseen tax liability that may arise.

“If the estate is large enough,” Kaufman says, “a portion of the assets can be distributed while [the executor or trustee] waits for that tax clearance certificate. You don’t want to distribute the whole amount [of the] estate without that clearance certificate.”

If the deceased’s assets are held by your client through joint tenants with right of survivorship, Kaufman says, those assets don’t pass through the deceased’s estate and, therefore, your client -the joint owner – is not responsible for any taxes owed to the CRA by the estate of the deceased.

A person seeking a clearance certificate must apply for one through an application provided online by the CRA (www.cra-arc.gc.ca).

Obtaining the certificate is free of charge, but getting it processed and returned to your client could take anywhere from six to 18 months.

Although obtaining a clearance certificate is the responsibility of the executor or trustee, there are ways in which you can help a client in this position:

– Make sure your client is aware of the need to get a clearance certificate.

– Ensure your client has received appropriate advice from an accountant or lawyer who specializes in estates.

– Ensure all other regular tax filings for the deceased have been completed and that your client has received the deceased’s final notice of assessment. The government will not process the clearance certificate until all the tax returns have been assessed.

– Help out with filling in the application form.

– Assist in providing information required for the process, such as capital gains and losses – especially if the deceased was your client. This information is required for both the deceased’s final income tax return and the clearance certificate.

– Manage expectations. Settling an estate can take months, depending on the complexity of the will, in addition to the six to 18 months it can take to get the clearance certificate.

© 2013 Investment Executive. All rights reserved.