Why Estate Trustees Could Personally Be on the Hook for Estate Taxes
Most people who act for the first time as an estate trustee face both a minefield, and a steep learning curve. The federal government planted one of the biggest landmines, through the Income Tax Act (ITA).
The government wants to ensure all taxes are paid before estate funds are distributed to the beneficiaries. That’s why smart estate trustees apply to the Canada Revenue Agency (CRA) for a “tax clearance certificate.” In issuing this certificate, the CRA confirms that the deceased and/or the estate have paid all taxes owed.[1]
Estate trustees could be personally liable
This is not just a prudent move, it’s mandatory. Section 159 of the ITA states this is something the estate trustee “shall” do, not “may” do. It also cautions that an estate trustee who distributes estate assets without a clearance certificate will be held personally responsible for any unpaid taxes, including interest and penalties.
In essence, a clearance certificate protects the estate trustee.
The CRA’s position
While the use of the word “shall” in s. 159 of the ITA would seem to indicate that an estate trustee is expressly prohibited from making any distributions without a clearance certificate, the CRA has taken a more practical position. It states, “You do not need a clearance certificate before each distribution, as long as you keep enough property to pay any liability to us.”[2] This position provides a level of reassurance to estate trustees and estate lawyers alike that making interim distribution(s)[3] prior to receiving a clearance certificate can be appropriate in the right circumstances.
Reducing estate trustee liability
Wait times for clearance certificates can be lengthy and an estate trustee may wish to distribute estate assets sooner rather than later. Fortunately, there are strategies an estate trustee can use to minimize their personal liability when making interim distributions without a clearance certificate.
One is to set up a financial safety net called a holdback. This is a sum of money that is set aside before making an interim distribution. It ensures adequate funds are available to cover any known or potential estate liabilities, including taxes.
It’s best to consult an accountant familiar with the estate, who can assess all the factors that may influence the amount of tax payable and determine how much money it would be wise to withhold for taxes. Those factors could include potential taxes owing on property sales or disposition of assets, past unassessed tax returns of the deceased, or post-death income that has not yet been assessed for tax. In addition to the amount required to be reserved for taxes, the estate trustee should consider other liabilities, such as further legal or accounting fees, when determining the holdback amount.
Another strategy is for the estate trustee to seek agreement and indemnity from the beneficiaries of the estate, asking them to agree to a clawback of funds, should one become necessary to pay estate liabilities, including taxes.
Addressing ITA s. 159 when writing a will
While not strictly necessary, it would be forward thinking to add language to a will to address this matter. It could authorize the estate trustee to distribute assets before obtaining a tax clearance certificate, provided the estate trustee believes no further taxes are owing and/or sufficient funds have been held back to satisfy any tax liability. The will also could authorize the estate trustee to seek indemnity from beneficiaries as a condition of distributing assets before obtaining a tax clearance certificate.
[1] Or that acceptable security has been provided.
[2] Canada Revenue Agency - Income Tax Information Circular IC82-6R13 “Clearance Certificate” dated May 25, 2022.
[3] An interim distribution is a partial distribution of the estate assets to the beneficiaries before the estate administration has been fully completed.