Legal Fees Paid by the Executor
The Tax Court decision on their deductibility
by Jamie Golombek
If you've ever acted as an executor, you'll no doubt be aware that any fee you charge or collect for the administration of an estate is taxable. Consequently, expenses you incur in the estate's administration may also be deducted to the extent they are not recoverable from the funds of the estate.
A recent case decided in March (Flood v The Queen, 2006 TCC 186) involved the deductibility of legal fees paid by an executor to challenge the Canada Revenue Agency's (CRA) income tax assessment of the deceased's final tax return (the "terminal return").
Robert Flood is a senior real estate and estates and trusts solicitor in Brockville, Ontario. His mother, Irene Flood, passed away in July 1998. Robert was both the executor and a beneficiary of his late mother's estate.
The following January, Mr. Flood, acting as the "Executor and Trustee of the Estate of Irene Flood" filed Ms. Flood's 1998 T-1 terminal return.
On the terminal return, the executor must include, among other things, any income received by the deceased up to the date of death. The return must also report the deemed disposition at fair market value of all capital property owned by the deceased at death.
Accordingly, Ms. Flood's terminal return did indeed report a capital gain arising from the deemed disposition of vacant land. The deemed proceeds were reported as $71,000, which was arrived at by Mr. Flood by averaging the value from a letter of opinion provided by a real estate broker and the assessed value of the property.
Two months later, the return was assessed by the CRA "as filed" and, in October 1999, Mr. Flood applied for a Clearance Certificate. Having not heard anything for a few months, Mr. Flood contacted the CRA, which informed him that it had obtained an internal appraisal of the property that placed a value of $500,000 on the property. Mr. Flood immediately obtained an appraisal of the property, which valued it at $260,000, and retained a lawyer to represent him before the CRA.
In May 2002, the CRA issued a Notice of Reassessment revising the deemed proceeds upwards to $260,000. Mr. Flood, through his lawyer, filed a Notice of Objection to the Reassessment.
When Mr. Flood filed his own, personal 2002 tax return, he claimed a deduction of over $9,000 in legal fees paid to the lawyer dealing with his mother's estate. The CRA disallowed Mr. Flood's legal fees claiming that "legal fees are only deductible if they are incurred for the purpose of gaining or producing income from a business or property and are not outlays of a capital nature. Therefore, legal fees incurred for the purpose of filing an objection to an assessment of income on an estate's return would not be deductible by you. However, the fees may be deductible on the estate's return".
Mr. Flood objected, arguing that there is nothing in the Income Tax Act "that even remotely resembles the above statement" made by the CRA regarding the deductibility of legal fees.
Under the Act, a taxpayer is permitted to deduct fees and expenses "paid by the taxpayer ... in relation to an assessment of tax, interest and penalties under the Act". Mr. Flood argued that the wording in the Act does not specify that the amounts paid for by the taxpayer must actually relate to that specific taxpayer's assessment.
The CRA maintained that the only person who can deduct the costs of objecting to an assessment is the person against whom the assessment was issued.
The judge ruled the CRA's interpretation to be an "unnecessarily narrow view of the provision". The judge went on to state that "[while] it would be unreasonable to permit a stranger or volunteer who had no pecuniary interest to deduct the fees of contesting someone else's assessment ... if someone has a pecuniary or other interest in the outcome that was not too remote, I see no reason for prohibiting such a person from deducting this expense incurred by him or her".
The judge allowed Mr. Flood's appeal, with costs, and permitted the full deduction of the $9,000 in legal fees from his 2002 return.
Executors (or even relatives) charged with the administration of an estate with complex tax issues now have yet another reason to seek professional legal and tax advice, where warranted, knowing that at least the legal fees they're paying should be tax deductible.