In what order do we pay debts and taxes, and how do we avoid being personally on the hook?

The order debts get paid in

Funeral and testamentary expenses, and the cost of administering the estate, are paid first, then the deceased's debts, then taxes owing, and only after that any gifts the will makes. Secured debts, a mortgage on a specific property, generally follow that property unless the will says otherwise. An estate trustee who distributes before debts and taxes are dealt with can be personally liable for the shortfall.

Filing the deceased's tax returns

The trustee files the deceased's final personal income tax return, called the terminal return, covering income up to the date of death, and may need to file returns for earlier years if the deceased had not. Capital property is generally treated as sold at fair market value immediately before death, a deemed disposition under the federal Income Tax Act, which can trigger capital gains even though nothing was actually sold. A separate return may also be needed for the estate itself, for income earned after death and before distribution.

The clearance certificate

Before distributing what is left, request a clearance certificate from the Canada Revenue Agency under section 159 of the Income Tax Act. It confirms all tax the deceased and the estate owe has been paid or secured. Without it, a trustee who distributes and a tax debt later surfaces can be made personally liable for that debt, even after everything has been paid out to beneficiaries.

We request the clearance certificate on the estate's behalf and hold back distribution until it arrives, so personal liability never lands on the trustee.

Advertising for creditors

The Trustee Act lets an estate trustee publish a notice to creditors and, after the period it sets has run, distribute without a duty to search out claims that were not made known in response. This does not erase a genuine debt, but it protects a trustee who acted properly and gave creditors a fair chance to come forward.

What happens if the estate can't pay everyone

An estate that cannot pay everyone owed is insolvent, and the trustee follows the priority the law sets rather than paying whoever asks first or is easiest to deal with. Beneficiaries receive nothing until debts and taxes are dealt with in full; a trustee who pays a favoured creditor or beneficiary out of turn risks having to make up the shortfall personally.