Pitfalls when filing the T3 tax return

Filing the T3 tax return for the estate is one of the executor’s core jobs. But it’s not an easy one. Here are some of the most common T3 challenges executors should watch for.

Start with the form itself

Brent England, partner at Hutcheson & Co. Chartered Professional Accountants in Victoria, B.C., says most challenges stem from the lack of awareness of what a T3 is and why it’s required.

“Just doing the T3 to begin with is something that gets missed so many times. There are a lot of moving pieces,” he says.

“Unless it’s absolutely the dead simplest estate out there, people who aren’t comfortable doing the T3 should really be getting a professional to do it.”

One of the issues executors may be unaware of is capital gains. If the estate holds property that increases in value before being sold or passed on to heirs, it has to declare and pay tax on them. “[Some executors] sell assets out of the [estate] and never report the capital gain, thinking it was already dealt with on the [individual’s terminal] tax return,” he says.

This can be a big issue if a principal residence is held for a year or two in a rapidly rising market such as Toronto or Vancouver before being sold. “If it’s the principal residence, it’s not taxable on the date of death,” England says. “But if it goes up in value after that, that part is taxable as a capital gain.”

Another challenge: dealing with the many questions on page two of the T3 tax return. While not all are relevant to those filing a T3 on behalf of an estate, others are extremely important.

Take question three: Did the trust distribute assets other than cash to a beneficiary during the tax year? If an executor distributes real estate or securities, for example, “you have to be careful,” says England. “You don’t just say ‘Yes.’ You have to disclose what that is, and all of the beneficiary’s information, including their name and address.”

Question nine is also critical: Did the trust receive any additional property? “That’s called tainting a trust,” England says. “And certainly if it’s a Graduated Rate Estate (GRE), and it gets assets from anywhere else for any reason, it’s automatically not a GRE anymore.” This could happen if a beneficiary borrows money from and then re-contributes to the trust.

Losing GRE status means the estate is taxed at the highest marginal tax rate the day after it ceases to be a GRE. The estate will also lose benefits such as flexibility in claiming donation tax credits.

Even after all the questions are answered and the form has been filed, the executor’s job isn’t done. “One of the most important things is making sure you file for clearance at the end of the process,” England says. “What that does is give CRA a chance to review it, and absolves the executor and trustees of further liability.”

Executors who do not obtain clearance are liable for any taxes or penalties due, even if estate assets have long since been distributed to heirs.

Handling foreign income

Ken Michalak, an accountant in Toronto, says handling foreign income and property is a particular challenge for executors. CRA rules require executors to declare an estate’s property in a foreign jurisdiction. If the cost of the foreign property exceeded $100,000 at any time during the year, executors may also have to file Form T1135. And, depending on the jurisdiction, they may also need to file a foreign tax return.

Michalak has encountered executors who aren’t even aware that CRA requires them to declare foreign property or income. “Every once in a while, one of my clients says, ‘Oh I got a question from the tax department; they’re wondering whether I’ve reported this money sitting in Poland,’” Michalak says.

In the past, unscrupulous executors might have successfully brushed aside such headaches, but times have changed. “The requirement has always been there,” Michalak says. “But through computers and close associations with foreign jurisdictions and tax treaties, the tax department has easy access to information from around the world.”

Michalak adds that CRA has become more stringent about collecting what’s owed. “You have to report worldwide income,” he says. “I can’t defend you in non-reporting. So if you’re not sure about something, you better find out.”

Common pitfalls with the T3

• Not realizing a T3 needs to be filed—or assuming it’s the same as a T1 final return
• Not reporting foreign property and income, and not filing additional tax returns in that foreign jurisdiction if required
• Not reporting capital gains if assets have risen in value between the date of death and the day they are sold/distributed to beneficiaries
• Not declaring the estate a Graduated Rate Estate (GRE), and therefore requiring assets to be taxed at the highest marginal rate
• Providing incomplete information on estate accounts, capital transactions or the cost basis of estate securities

James Dolan is a Vancouver-based financial writer.