During the administration of an estate, taxable income can be generated in the form of interest, dividends, capital gains, etc. after all debts and specific bequests have been paid. The Canada Revenue Agency (CRA) was asked if an estate could distribute the remaining taxable income to the residual beneficiaries.
The CRA confirmed that the ability of an estate to distribute the remaining taxable income to the residual beneficiaries would depend on the wording of the will. If there is no indication in the will from which assets the testamentary gifts must be paid, the executors can make the payments they wish provided they act impartially, follow the classification of the gifts, and pay all liabilities of the deceased and the estate. In this case, the executor can pay the residue of the estate (including taxable income before tax) to the residual beneficiaries and a tax deduction can be claimed by the estate.
This will not be the case if the executor is required by the will to pay the income tax liability on the income earned by the estate and pay the remaining after-tax assets to the residual beneficiaries. In this case, the estate could not distribute taxable income to the residual beneficiaries and the estate could not claim a tax deduction. The income would be taxed in the estate and the residual beneficiaries would receive an after-tax capital distribution from the executor.