As Mark Twain pointed out, the only two certainties in life are death and taxes.
And even in death you can’t escape taxation. In this article we’ll look at some of the tax issues that will arise after your death.
Final Tax Return
Your final tax return will include all income received in the year of and up to the time of your death. It will also include income earned during the year but not yet received at the time of your death. This is called accrued income and it includes amounts owed to you in interest, rent, royalty, annuity, employment income and other periodic payments.
Certain types of accrued income (e.g., declared but unpaid dividends) may be possible to report on a separate tax return with its own set of graduated tax rates, potentially reducing the tax ramifications associated with that income. Where accrued income is reported, the CRA will allow accrued expenses relating to that income to be claimed in the final return.
Deemed Disposition of Property
When a person dies, the CRA considers that right before death the person disposed of all capital property (including real estate, possessions, investments, and ownership of a company) at its fair market value, turning accrued gains or losses on the property into real capital gains and losses.
Capital losses on personal-use property are deemed to be nil, while capital gains will often (but not always) be exempt from tax. If you’ve gained more than you lost, and are therefore subject to capital gains taxes, CRA will let you use unused capital losses from prior years to reduce the net capital gain and balance you out. Tax will be payable on any remaining net capital gain.
Property bequeathed to your spouse in your will is generally exempt from the deemed disposition rule and instead will automatically transfer to your spouse without taxation. But you can pick and choose the assets you decide to bequeath, as some property makes more sense to use for offsetting other gains:
- shares of a private company that qualify for the $800,000 enhanced capital gains exemption, so as to realize the accrued gain and utilize your available exemption,
- unapplied capital losses from prior years that you can use to defer paying capital gains tax.
- property with an accrued capital loss that you can use to offset capital gains realized in the year of death, or carry back to offset previous losses.
Net Capital Losses
Net capital losses can be applied to your final return to offset any income you made that year or the year before. The goal here is to reduce your family’s stress level at a very difficult time. Your estate won’t be able to apply as much of your capital losses towards your final tax assessment if you claimed the enhanced capital gains exemption in your return in any preceding year.
Charitable donations made in the year of death and any unused donations from the preceding five taxation years may be claimed on your final return. A donation in the year of death that cannot be used on your final return may be carried back to the preceding taxation year.
Charitable donations made in your will are deemed to be made by your estate, and so may be claimed in the estate’s return or in your final return, or in the return for your first preceding taxation year.
RRSPs, RRIFs and RPPs
The fair market value of your Registered Retirement Savings Plan or your Registered Retirement Income Fund is included in income on your final return. If your spouse is the named beneficiary of your RRSP or RRIF, the plan and its assets would transfer into their RRSP or RRIF on a tax-deferred basis.
Any death benefits payable under a Registered Pension Plan will be included in the income of the person who receives the benefits. If that person is your spouse, it may be possible for your spouse to transfer the death benefit to their own RPP or RRSP on a tax-deferred basis.
In addition to the income taxes due on your final return, probate fees and property transfer tax may also be incurred. In B.C., probate fees apply at a rate of 1.4% on the value of your estate in excess of $50,000. Where your assets include real property, a recipient of such property may be subject to B.C. Property Transfer Tax (PTT) at a rate of 1% on the first $200,000 of value, and 2% on the remainder. There are a few limited exemptions from PTT (e.g., where you leave your principal residence to your spouse or your child).
Estate planning is the process of:
- identifying your assets and deciding what you want done with them after you die
- determining the income tax, property transfer tax, and probate fee consequences of your death
- devising a plan to minimize or defer the payment of those taxes and fees.
We’d recommend doing this carefully. Sometimes, a seemingly simple strategy to avoid one tax or fee inadvertently triggers another, more costly tax.
Most people don’t run into too many posthumous tax problems with regards to deemed disposition, because of the tax exemption on their primary residence. But for people with multiple assets of significant value, deemed disposition can be problematic. What if the family cottage that you wanted to leave for your children and grandchildren has to be sold to generate cash to pay the taxes arising on its deemed disposition?
If you are the owner of a private company, how will your estate finance the taxes payable on the deemed disposition of your shares? And do you have a plan to address the potential for double taxation if your company holds capital property?
For all these reasons, and so those who survive you aren’t left scrambling when they’re already mourning, proper estate planning is critical. If you’ve not started thinking about that, you should. It’s never too early to get prepared. Please, contact your DMCL advisor for further assistance with these matters.