Filing Tax Returns for a Deceased Person
TAXATION AT DEATH AND PERSONAL TAX PLANNING
Extension of Time for Filing Returns
Along with the extended deadline for the filing of the basic terminal return, there is a special deadline with respect to one of the elective T1 returns. This terminal return is needed when a qualifying spousal trust is created. There is no late filing penalty until 18 months after death (interest runs from normal deadlines) (ITA, s. 70(7)(a)). The personal representative is given time to determine whether or not, based on the notice of assessment, any additional tax saving could be introduced by identifying rights and things and declaring them as part of a separate return.
Income Splitting and Non Arm’s Length Dispositions
Though there are statutorily sanctioned breaks, much of estate planning can be regarded as an ongoing battle of wits between estate planners and those drafting tax legislation. There are two techniques, which the former engage in and the latter try to prevent: income splitting and dispositions at less than fair market value. Income splitting is the technique of shifting property from a high income taxpayer to a lower income taxpayer in the hopes of having the lower income taxpayer rather than the high income taxpayer report the income for tax purposes. Income splitting is expressly rendered nugatory in certain circumstances because of the attribution rules. Firstly, where one spouse transfers or loans any property to the other on any basis other than a sale at fair market value, income and capital gains from the property are deemed to be income and capital gains to the transferor. Secondly, where one person transfers or loans any property to a minor person with whom he or she does not deal at arm’s length, or a nephew or niece, any income, but not any capital gains, is deemed to be income of the transferor until the minor attains the age of majority. It is, therefore, possible to freely split income with adult children, but before doing so it is essential to take careful account of the property that is transferred. If it is cash, there should be no problem; but if it is capital property, a “deemed disposition at fair market value” which could have adverse tax consequences will arise.
In view of this, there are rules to prevent indirect income splitting. Payment of income to a trust beneficiary, consequent to a transfer or a loan, is treated as essentially equivalent to a transfer to the beneficiary. However, the main purpose of a transfer or a loan to a corporation (other than a “small business corporation”, which is a private corporation using substantially all its assets to earn active business income primarily in Canada), is to reduce the transferor’s income and to benefit a spouse. Non arms length minor or nephew or niece owning at least 10% of the shares of the corporation results in deemed attribution at a prescribed rate (ITA, s. 74.4).
Moreover, when an individual transfers property to a trust and retains the capacity to benefit from the trust, all of the income and capital gains of the trust are attributed back to him or her (ITA, s. 75(2)). If there is a loan from one individual to any other non arms length individual and one of the main reasons for making the loan is the reduction or avoidance of tax, then income from the loaned property is attributed back to the lender (ITA, s. 56(4.1)). Thus, a parent who lends money to an adult child to pay off a mortgage will not be subject to attribution, because the loan produces no income. However, a parent who lends money to a child, who invests it, could be subject to attribution. Furthermore, if such a loan bears a below market interest rate, that will be of no consequence, and a market interest rate will be deemed to exist.
Transfers at fair market value, or loans at commercial interest rates, or in respect of business income, are not subject to attribution. Also, there are a series of rules that deem dispositions at amounts that the parties would not normally choose to apply. When a transferor either gives property, or sells it at less than fair market value to a person with whom he or she does not deal at arm’s length, he or she is deemed to have disposed of it at fair market value (ITA, s. 69). As regards the recipient, who acquires the property as a gift, is deemed to receive it at fair market value, while the recipient who pays below market consideration for the property is deemed to have acquired the property at that value. As a result, this puts him or her in a worse position than if he or she had received it by gift, because he or she is now stuck with a below market cost base. Between spouses, a presumptive rollover rule applies, but they can elect that the transfer takes place at fair market value.