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How We’re Taxed when We Die

A pertinent question often asked in respect of taxation at death is: Would there be any estate taxes or succession duties? Strictly speaking, the answer is “no”. In Canada, there is generally no tax on wealth or the value of an inheritance; Canada instead taxes income. However, this is not always true for property held in other countries. For example, in the U.S., an estate tax is levied on the value of the capital of an estate. Therefore, Canadians owning assets with a U.S. situs (such as real estate and securities traded on U.S. exchanges) could be subject to U.S. estate taxes on the value of those assets. Despite the fact that Canada only taxes income, certain specific rules have the effect of casting the “income net” more widely in the year of death. However, there are several special concessionary rules applicable only to taxation at death.

Creation of Two Taxpayers

On the death of a person, income earned or deemed to be earned between the end of the last taxation year and his or her death is included in his or her T1 tax return, due in the year of death. As it deals with the income earned between January 1 and the date of death, it is known as a “terminal” return. Furthermore, the day after the taxpayer’s death is the first day in the fiscal period of a new taxpayer, the estate of the deceased, which is taxed in accordance with the principles applicable to the taxation of trusts. This estate of the deceased files a special tax return known as a T3 Trust Return. Primarily, therefore, the personal representative has to determine whether or not a payment due in consequence of a taxpayer’s death is or is not taxable. Thereafter, he or she has to decide whether the income is reportable in the terminal return, or is taxed elsewhere. Finally, he or she has to ensure that returns for prior years that should have been filed are actually filed.

Change to Accrual Basis

Individual taxpayers are to report income on a cash basis (subject to the obligation to report compounding interest from certain investments on an annual accrual basis; Income Tax Act (ITA), s. 12(4)). Income that is payable periodically, in the year of death, is deemed to accrue to a taxpayer on a daily basis (ITA, s. 70(1)(a)). Consequently, this accelerates the taxation of income. For instance, if an individual taxpayer purchased a Guaranteed Investment Certificate on September 1 to mature and pay interest the following February 1, he or she would ignore the income accruing through December 31 and report it all the next year. However, a taxpayer dying on December 1 would have to accrue the income from September 1 to December 1. So, the money paid on February 1 would cover the whole six month period, but the estate would report for tax purposes only the income earned after December 1. It is not uncommon for personal representatives to forget to make this deduction.

Deemed Realization

Death brings about a “deemed realization immediately before death” for tax purposes of such items as non-depreciable capital property (ITA, s. 70(5)), and depreciable capital property and RRSPs (ITA, s. 146(8.8)). This provision forms the basis of estate planning, simple or complex. In a simple case, for instance, if a taxpayer acquires a stock portfolio in 1975 for $10,000 and holds it until his or her death when it is worth $100,000, he or she will, in the interim, only have paid tax on the dividend income earned by the portfolio. The portfolio is “deemed to be sold” upon death for net proceeds of $90,000 (proceeds of $100,000 less cost of $10,000), 50% of which will be brought into income and taxed at a rate to be determined when all sources of income are added together. It would be seen that only 50% of a capital gain is taxable, the remainder is not and need not be reported. Should the taxpayer wish that his or her heirs retain the whole portfolio, he or she would have to provide adequate liquidity from other sources. If the intention is to make a specific gift of the portfolio by will, then he or she has to be aware that some other interest in his or her estate would be paying the tax burden enabling the gift to take effect.

It would be seen that the provision of deemed realization at death brings about a capital loss in cases where the fair market value of the property at the time of death is less than the adjusted cost base of that asset to the taxpayer. However, it is to be noted that a capital loss cannot be brought about as a result of the disposition or deemed disposition of property for personal use, meaning property owned by the taxpayer that is used primarily for the personal use or enjoyment of the taxpayer and family, such as an automobile or furniture. The death of a taxpayer leads to deemed inclusion in his or her income in the terminal year of the unpaid balance year of his or her RRSP, RRIF, or annuity purchased with the proceeds of an RRSP. It’s an irony that payments made from registered pension plans are taxed not on a deemed receipt basis, but on a cash basis, with the result that they are taxable to the estate or its beneficiaries.

Don’t do anything before fully understanding your rights and obligations.  Contact the lawyers at Levy Zavet PC (Levy Zavet) in Toronto, Ontario for all of your tax law, estate planning and estate administration needs.