What is an Estate Executor’s Income Tax Liability Post-Distribution?

In a recent Alberta decision, the court found that an executor of an estate was liable for the estate’s income tax liability after she failed to hold back the appropriate amount and attempted to recoup it from the money already paid to the beneficiaries of the estate.

What Happened?

The husband signed a will in 1970 appointing his wife as executor and leaving everything to her if she survived him for thirty days, failing which his estate would be distributed one-half to his sister and one-half to three siblings-in-law. His sister predeceased him, which meant his sister’s children (his nieces and nephews) would become the beneficiaries.

The husband and wife separated and signed a separation agreement in 1978 in which the wife agreed to renounce her right to the administration of the husband’s estate.

The husband died in 2008, at which time the wife signed a document entitled “Renunciation of Probate and Relinquishment of Entire Interest in Estate” in which she renounced her right to administration of the estate and acknowledged that she had no claim against any of the property in the estate.

Following the husband’s death, one of his nieces applied to court to be the administrator of the estate and for instructions on the distribution of the estate. Instead of going to trial, however, a mediated settlement was reached in 2011 pursuant to which the wife would apply for probate, with the estate to be divided 55% to her and 45% to the husband’s nieces and nephews.

The wife retained an accountant in December 2011 to prepare the final income tax return from the estate and to estimate its tax liability. That accountant advised that a $25,000 holdback was sufficient. The wife then distributed the balance of the estate in the proportions agreed to in the mediated settlement.

The first accountant, however, did not file the required return. When a second accountant was retained to do so in November 2012, he determined that the holdback was inadequate; in fact, the income tax due was $57,333 in addition to his accounting fees. As a result, the wife owed $60,772 and paid the difference of $35,772 herself. She then sought repayment of 45% of those amounts from the nieces and nephews, which amounted to $16,097. She later changed the amount claimed to $23,600.

Issues 

The issue was whether the nieces and nephews, as beneficiaries, were obligated to indemnify the wife for the income tax payment.

Parties’ Positions

The wife argued that beneficiaries were obligated to indemnify the executor for income tax liability.

The nieces and nephews argued that under s. 159 of the Income Tax Act only the executor is liable for unpaid taxes. Section 159 requires that a personal representative obtain a clearance certificate before distribution of an estate and imposes personal liability for the tax liability of the estate on those who do not do so.

Decision

After determining that the case was suitable for summary judgment, the court noted that the negotiated settlement agreement did not specifically deal with an indemnity. Rather, three specific costs were identified in the agreement, all of which related to legal and mediation costs.

Beyond those exceptions, probate and administration costs were to be paid from the estate “in the usual course” under the agreement.

Turning to the parties’ arguments, the court first found the wife’s position untenable. It found that none of the arguments presented by the wife supported the idea that beneficiaries are obligated to indemnify an executor for a tax liability.

With regard to the nieces and nephews’ argument under the Income Tax Act, the court stated:

“It should be noted that Parliament could have chosen to make all beneficiaries of the estate liable as well but chose not to do so. On public policy grounds that is sensible – the beneficiaries have no control over when or how much is distributed.

Presumably for similar reasons, Parliament chose not to deal with whether a legal representative could seek indemnity from beneficiaries. There may be situations where that would be equitable, but certainly there would be other situations where that would be inequitable.”

Ultimately, the court found that the nieces and nephews, as beneficiaries, were under no obligation to indemnify the executor for income tax or penalties imposed as a result of her failure to obtain a clearance certificate before distributing the estate.

As a result, the court dismissed the wife’s application and found that, as executor, she was personally liable for the tax liability.

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If you have been named as an executor of an Estate, it is important to talk to an experienced Estates lawyer as soon as possible to help you address the significant legal and financial responsibility that you now have, to help you to manage the legal issues you may be facing, and to effectively mitigate any risks and liabilities stemming from the Estate, all while protecting it and taking care of any beneficiaries.

The friendly, personable and professional team of Estate lawyers at DBH Law in Calgary have more than 25 years of experience helping our clients face the daunting task of acting as an executor of an Estate. We help our clients make informed decisions all the while avoiding unnecessary expenses and potential Estate disputes.

The exceptional lawyers at DBH Law are responsive and concise, and can provide you with legal guidance on all of your Estate planning needs, including probate and Estate administration. We can be reached online or by phone at 403.252.9937.