Death triggers major tax issues

Jack normally paid approximately $40,000 a year in personal income taxes. He paid that amount, plus or minus, in 2008 and 2009. It was a little less in 2010 after he retired. In 2011, his personal income taxes jumped to $260,000, more than six times higher than in previous years.

He did not get a job. He did not sell his business. He did not inherit or win the lottery. What made 2011 so different? Jack died. Death can come with a high cost in personal income taxes.

Canada does not have an estate tax as they do in the United States and the United Kingdom. An estate tax is levied against a deceased's overall wealth. Instead, Canada charges a tax against a person's income in their year of death, and death triggers sweeping personal income under the Income Tax Act. The distinction might seem to be a fine one, or at least that is how it felt to Jack's heirs when the taxes were paid out of his estate.

Here is how it works. Jack had an RRSP of $500,000. As a general rule, all of the value of a person's registered investments are taxed in the year he or she dies. The RRSPs were taxed just like a big paycheque payable to Jack the moment before he died. That meant most of the $500,000 was taxed in the absolute top tax bracket, triggering taxes of just under $200,000.

Jack also had shares in a holding company. The company held cash and investments. Death triggers capital gains and deemed dividends on shares. After the accountants worked their magic, the company was liquidated and Jack's estate paid roughly $40,000 in taxes.

He also had a personally owned stock portfolio. His death triggered capital gains and losses there, too. Thankfully, the market had performed so poorly for him the gains were offset by the losses.

His niece was named as the executor under his will. It was her job to liquidate his estate and give out his wealth to the beneficiaries directed by his will. First, she had to pay his taxes. She hired an accountant and they filed a "year of death" tax return for Jack. That covered all of his income earned in 2011, including his regular income while he was alive and the big income inclusions, described above, that were triggered by his death.

The estate took 18 months to wind up. During that time, the estate assets earned additional income. Who pays the taxes on the income while it is in the estate? The estate is a taxpayer in its own right, just like a trust is. The niece had to pay those taxes on behalf of the estate. She filed a special income tax return for the estate, called a T3. She actually had to file two T3 tax returns as the estate was open for more than a year.

When she filed the last of the tax returns, and before she distributed the last part of the estate to the heirs, she asked Canada Revenue Agency (CRA) to issue a Clearance Certificate. That was for her own protection. She was responsible for making sure the taxes were all paid. A Clearance Certificate is a document from CRA confirming the government was satisfied with how the taxes had been completed.

A variety of measures are available that can reduce a person's taxes at death. The executor should make sure full tax advantage is taken in connection with charitable gifts, if any, made as a result of death. There are capital gains exemptions available for business owners and farmers. There are some "rollovers" available that defer and reduce the taxes on farm property and on registered investments. If the deceased owned a house, or recreation property, the principal residence exemption is often available to reduce taxes.

It is the executor's job to reduce the taxes by any measures that are legally available. Next month's column, and the columns that follow it, will deal with those measures.

Jack was a real person. Details were changed to preserve confidentiality.

John E. S. Poyser is a Winnipeg lawyer with the Wealth and Estate Law Group. Contact him at 947-6801 or jpoyser@inksterchristie.ca

Republished from the Winnipeg Free Press print edition May 16, 2012 B7