There are many myths circulating about how taxes apply when a person dies. Much of this misunderstanding may come from people reading too many U.S. publications and thinking that concepts like gift tax and estate tax apply in Canada.
They do not. Canada does not assess a tax on the actual value of an estate. It's a little trickier than that.
As you read the following, remember that none of these taxes have to be paid if the deceased person leaves a living spouse. More on that later.
Under Canadian tax law, a person who dies is deemed to have sold, an instant before death, all property they own alone. Recall that selling certain capital property that has appreciated in value results in half the capital gain being included in taxable income.
For example, if the deceased person had owned a rental property with an adjusted cost base (for tax purposes) of $100,000 and the market value on the day of death was $200,000, the gain would be $100,000, half of which would appear as income on the final tax return.
If this person owned shares of a company with the same cost base and current market value, the capital gain and income-inclusion treatment would be the same.
A principal residence would generally not be included in income, though the executor would have a choice of which residence to declare as "principal" if the person also owned a cottage or other non-rental residential property. (See my blog for lots of detail on these rules.)
For investments such as GICs, Canada Savings Bonds, savings accounts or term deposits on which tax has been paid each year -- or any capital property that has not gained in value -- there is no special tax on death.
That final tax return must also include all regular income earned in the year so far, including employment, net self-employment, pension, net rental and professional income as well as interest and dividends received while alive.
Now comes the big taxable amount for many people -- de-registering all RRSPs, RRIFs and related registered accounts such as LIRAs and LIFs. All are deemed cashed in on the day of death, and the entire amount of the plan becomes taxable income on the final tax return.
Since the RRSP or RRIF value is taxed on top of regular income (and any net capital gains), it is often taxed at a high or top tax rate.
TFSA withdrawals are not taxable, either on death or while alive.
Here's some good news for married people.
Subsection 73 of the Income Tax Act allows for a tax-free rollover of assets between spouses when the deceased person leaves a living spouse or common-law partner. (This can also work for transfers to children or grandchildren in the case of farm property.)
This means a widow or widower can opt to pay no tax on capital gains in the year of the first death and instead defer declaration of those gains until the properties are actually sold or the surviving spouse dies.
A similar option exists for a spouse who receives the RRSP, RRIF, LIRA or LIF assets. These can be rolled into the registered account of the surviving spouse, with no tax payable on the first death.
In all cases, the taxable amounts will have to be claimed when passing these assets on to another generation.
There are several situations in which the surviving spouse might opt out of these rollover provisions.
For example, if the person dies early in the year, if shares were eligible for the $750,000 lifetime capital gains exemption, if the deceased had capital losses carried forward or unused credits from large donations or other sources, it might make more sense to claim some of the income on the final return.
While technically not a tax, Canadians pay probate fees in the province in which the will is probated, based on the value of their estate.
Probate fees can be reduced by techniques such as joint ownership with right of survivorship, by naming individuals as beneficiaries where this is allowed, such as on registered accounts and most life insurance products.
However, there are times -- such as when using testamentary trusts for longer-term tax benefits -- that these short-term techniques should be avoided. Again, good advice is recommended, especially if you have a sizable or complicated estate.
This is where good tax advice pays off.
David Christianson is a fee-for-service financial planner with Wellington West Total Wealth Management Inc., a portfolio manager (restricted).