Choosing an Estate Year-End: Tax Year vs. Calendar Year

Unless you work in accounting or own a corporation, you probably have never thought of a tax “year” being something other than January 1^st to December 31^st.

For individuals, the tax year and the calendar year (January 1^st to December 31^st) are the same. All the income an individual earns, from January 1^st up to December 31^st, is included in their income for that year. With a few exceptions, our tax credits and deductions are also determined using December 31^st as the cut-off. All income slips and investment statements also report using the calendar year-end which is very convenient when you are filing your individual T1 tax return. (Imagine if employers did not issue annual T4 slips on a calendar year basis and you had to track your income and deductions manually!)

In the year of death, a taxpayer’s date of death becomes their tax year-end date. Income earned from January 1 up to the date of death is included in the deceased’s income for that tax year. Everything that happens after the date of death is part of the deceased’s Estate, which is considered a separate taxpayer from the deceased.

If a taxpayer dies on January 1, their tax “year” is only one day.  Income earned on that day will be included in income on their T1 tax return (referred to as a Date of Death T1).  The first day of the Estate’s first tax year will be January 2^nd.  The Executor can then choose any date as the tax year-end date for the Estate, up to the one year anniversary of the date of death. The year-end date chosen in the first year becomes the tax year-end for every year after until the Estate is ready to be distributed. (Effective December 31^st, 2015, Estates will only be able to have an off-calendar year end for the first 36 months. They will then be required to convert to a December 31^st calendar year-end.)

By electing to use a date other than the date of death, the Executor is shortening the first tax year.  This may be useful in some situations:

• Tax splitting opportunities – Splitting large amounts of income received in the first year over two tax years to take advantage of lower marginal tax rates.
• Deferring income – Designating the first tax year end to be the day prior to the receipt of a large income amount.  The large income amount will then be taxed in the second tax year thereby postponing the tax due date on that income.
• Managing tax rates – Federal or provincial governments have announced future or retroactive changes to tax rates. If tax rates are rising, it may be beneficial to choose the first year-end just before the changes take affect.
• Minimizing impact of late-filing penalties – The Executor may have missed the filing deadline for the first Estate year-end (default: one year from the date of death).  If a large amount of income is received near the end of the first year, choosing an earlier year-end date defers the taxation of that large sum.  This reduces the taxes payable, and therefore late filing penalties, on the late-filed first year tax return.
• Estates with large amounts of investment income and equity trading will benefit from a December 31st year-end since tax slips and statements are prepared using the calendar year-end.
• Choosing a year-end date outside of the regular “tax season” will make it easier for the Executor to find an available tax accountant.

There are a couple of downsides to shortening the first tax year of an Estate.  It could result in an extra tax return needing to be filed if all of the assets have not been realized within that shorter first tax year.  If all assets are realized within the first 12 months, the second return would not have been necessary if the year-end was the first year anniversary of the date of death.  Also, choosing a shorter tax “year” sets an earlier deadline for your Executor to act on some tax saving opportunities available only in the first tax year. This can be a challenge depending on the assets the Estate holds.

The first day of my Estate tax year will be January 2^nd. My Estate can elect to use any date as the tax year-end date, up to the one year anniversary of my death. A December 31^st year-end seems pretty logical here and I have only shortened my tax year by one day.The year-end date chosen in the first year becomes the tax year-end for every year after until the Estate is ready to be distributed. (Effective December 31^st, 2015, Estates will only be able to have an off-calendar year end for the first 36 months. They will then be required to convert to a December 31^st calendar year-end.)

I would recommend Executors contact us within 6 months of the date of death.  This will provide adequate time to plan for the required tax filings of the deceased and their Estate and minimizing taxes payable.  The end objective is always to maximize the distribution to the beneficiaries, minimize the wait for the distribution, and protect the Executor from liability.

Until next time,

Heather