Table of Contents
- Who Pays the Taxes for the Estate of the Deceased?
- What Happens if Assets go to the Beneficiaries Without Tax Clearance?
- How do the Tax Authorities Calculate the Tax Payable on an Estate?
- Which Assets are Taxed, and Which are Not?
- When to Request a Tax Clearance Certificate for the Deceased
- Deferment of Payment of Estate Income Tax
There is virtually no inheritance tax in Canada. It is because the deceased is taxed, with his assets valuated at a fair market rate as of the time “immediately before his death.” Thus, almost everything, barring a few, owned by the deceased at the time of his death is directly taxed. Some assets are either exempt from estate taxes or roll over to the intended beneficiaries, with the tax up for payment at a subsequent transaction.
Following is a detailed discussion of what is taxed, when, and how it is taxed.
Who Pays the Taxes for the Estate of the Deceased?
The deceased pays them. All the assets find their way to the deceased’s final tax return. However, the Personal Representative for the deceased, appointed through his codicils (the auxiliary documents of will) or otherwise by a court, is responsible for ensuring that all the assets are taxed adequately before the estate goes into distribution.
In Canada, estate taxes are calculated based on the value of the deceased’s estate ‘immediately before their death.’ The deceased’s representative must ensure the payment of taxes on the estate. Only then does the Canadian Revenue Agency (CRA) issue a clearance certificate for the final distribution of property to beneficiaries.
What Happens if Assets go to the Beneficiaries Without Tax Clearance?
If the legal representative enables the distribution of assets without tax clearance, he could be personally liable for the unpaid taxes up to the total value of the assets distributed. This fact underscores the importance of following the correct procedures. If the legal representative has attained the clearance certificate, the tax responsibility for the future then lies with the beneficiaries.
How do the Tax Authorities Calculate the Tax Payable on an Estate?
The law relies on the principle of Deemed Disposition for this purpose.
- The Principle of Deemed Disposition
Deemed Disposition is the imaginary selling of the deceased’s assets.
The Canadian Revenue Agency assumes that the deceased disposes of all his properties at a fair market price. Quite clearly, it is an imaginary sale and not a real one. The sale price thus calculated helps to determine the taxes payable. Primarily, only the gain in the value of the price, called Capital Gain (Market Value at the time of death minus original purchase price), is liable for taxation because the government had already received tax on the original cost of the property when the previous owner sold it to the deceased.
Which Assets are Taxed, and Which are Not?
With a few exemptions, most of the assets are subject to taxation. The following section elaborates on taxables and non-taxables:
“Rights and Things” and “Deemed Withdrawal”
The Canadian Revenue Agency considers for taxation assets already in the deceased’s possession or name and those that he never received but was entitled to demand during his lifetime. Such assets, which he could have received but did not, are regarded as Rights and Things.
On the other hand, Deemed Withdrawal, like Deemed Disposition, is an imaginary withdrawal of all the receivables the deceased could collect from the above-mentioned resources.
Hence, estate taxation is a matter of both possessed and yet-to-be-possessed assets.
The receivables subject to such “imaginary withdrawals”:
- Unreceived salary
- Unrealized proceeds from a business
- Resource Properties (Any license or privilege to explore or store earth resources)
- Matured uncashed coupons
- Farm crops
What other Rights or Things are subject to tax on the person’s demise:
- Bank Accounts (including those offshore)
- investments including:
stocks
bonds
trust units
options
mutual funds
bonds
trust units
options
mutual funds
- Vehicles and vessels
- All property of the deceased held in someone else's name
- All other property, wherever situated, including:
Goods
Intangible property
Business interests
Insurance
Intangible property
Business interests
Insurance
- Registered Retirement Savings Plan in an Estate
A Registered Retirement Savings Plan (RRSP) is a plan registered with the Canadian Federal Government to which one can contribute for retirement purposes. A Registered Retirement Savings Plan (RRSP) is generally tax-free.
RRSP is taxable when:
When a person transfers property to a family member in his will, tax is payable before the purported transfer takes place.
RRSP is not taxable when:
Its transfer to a spouse takes place. Like other assets that are not taxable when transferred to a spouse, a registered retirement savings plan is also eligible for this waiver.
- The Waiver for the Principal Residence
The owner can choose one such residence as the principal residence, for which no tax shall be payable at the time of inheritance. Such residence can go to anyone within or without family without tax liability.
If the Principal residence is attached to the deceased’s farm:
In that case, there are two options: sever it from the farm or calculate the tax for the whole property and then deduct $1000 from the sum and another $1000 per year for each year the owner lived in Canada.
- The Spousal Privilege
Assets that pass over to a de facto spouse are not taxable. Such a transfer is a roll-over. This transaction does not fall under the categorization of deemed disposition. It is not that no capital gains tax will ever be payable on such assets; it’s more like a deferred tax, which will become due at the death of that spouse.
- A Share from a Partnership is Also Subject to Tax/ Deemed Disposition:
If the deceased had profits to receive from a partnership, such will also be a part of the terminal/final tax returns from the last financial year to the date of death.
- An Interest from a Partnership will NOT have Tax Liability when:
The deceased’s interest passes on to a beneficiary, who continues the business in place of the deceased. It can happen owing to a will or an earlier contract. The beneficiary will then receive the profits and file the returns.
- Canada Pension Plan and Old Age Benefits
The legal representative will also declare these receivables as part of the final return. These are liable for tax as if the deceased had already received them immediately before his death.
- Shares to be subject to Deemed Disposal:
The tax authorities deem that the deceased sold all the shares in his name at the fair market price immediately before his death. Considering this, the legal representative will reflect them in the deceased’s final tax return.
- Insurance Money not subject to Estate tax:
Insurance money is free from taxation because the courts hold that it is not an asset the deceased possessed “immediately before death.” Only after his death did the beneficiaries of insurance money become entitled to it. So, the recipients of insurance money will file returns for that money on their own behalf.
Consider the Insurance Money while Writing your Will:
The insurance money, being tax-free, often settles the expenses and debts the deceased owes. Therefore, a person must decide beforehand who should get that money. Otherwise, an imbalance in the shares of beneficiaries can arise. Those who get insurance money might receive a more significant share than they are entitled to, as no tax liability lies on insurance money, unlike the proceeds from other assets.
- Lifelong Learning Plan Withdrawal is also Taxable.
If the deceased made a lifelong learning plan withdrawal, the legal representative needs to state it in the terminal/final tax return of the deceased.
Lifelong Learning Plan withdrawal is not taxable when:
The common-law partner or the deceased’s spouse can jointly sign a letter stating they elect to repay towards the lifelong learning plan. In such a scenario, the stated withdrawal will be free from tax.
- Estate Taxes in Case of Beneficial and Legal Ownership
Here, it is pertinent to define these two types of ownership first.
A legal owner is a natural person or an entity possessing the title to a property, the actual owner.
On the other hand, a beneficial owner either partly owns a property or, without owning it, has interests in it. Those interests can include holding a share or being entitled to proceeds.
How estate taxation works in case of beneficial and legal ownership
Suppose a property goes from a deceased legal owner to a child who doesn’t have a legal or beneficial interest in the property. In that case, the whole property will be subject to deemed disposition.
Contrarily, if the child has a legal and beneficial interest in a part of the property, only the part owned by the father will be subject to deemed deposition.
When to Request a Tax Clearance Certificate for the Deceased
You can request a clearance certificate after:
- You have filed all returns
- The revenue agency has sent notices of assessment
- No appeals, requests, or outstanding balances are pending
Will Creating a Trust Save you Estate Taxes?
Generally, it will not. Setting up a family trust may be another case. Gone are the days when trusts could save you a lot of tax. Following is an elaboration:
Usually, tax is marginal; that is, it applies in brackets. The total value of assets is divided into brackets, with the tax rate increasing as we move from low-value to higher-value assets.
Marginal tax leads to less high taxation.
Now, coming to a trust: A trust incurs the highest rate of marginal tax on the total sum of its assets in case of undistributed income. So, a trust, without specific provisions, may be good for the security of your dependents, but there are better choices for saving tax.
It cannot, however, be overlooked that family trusts still offer many tax advantages in terms of tax-free dividends, income splitting, and lifetime capital gains exemptions that are available to family trust members. You need to check with your tax specialist how your circumstances allow you to avail of tax benefits.
Deferment of Payment of Estate Income Tax
Beneficiaries can elect to defer the payment of income tax on the estate by filling out a form and submitting it to the Tax Services Office in the area where the deceased resided before his death. In this case, they pay the tax in 10 consecutive annual instalments. They will pay the first instalment on the day the tax on the estate was originally due.
In short, Estate taxation is a vast area of property laws. Prior estate planning, with the help of a tax specialist, is always an excellent decision. It will save your loved ones from a lot of discomfort.