Death and taxes
We have been saddled with a mind-numbingly complex tax system. Perhaps the only ones who can see any redeeming virtue in this fact are the tax accountants and lawyers who make a living from this confusion. Unfortunately, the system is never more complicated than when there is a death in the family, especially if there’s a significant estate involved.
No estate taxes, but…
While Canada does not have death, inheritance, or estate taxes, the net result is much the same. The fact is that your survivors may be faced with a significant tax bill upon your death. This means that the importance of tax planning cannot be overstated. Just be careful not to become so focused on tax savings that other important goals of estate planning are ignored.
While a full review of tax issues relating to estate planning is beyond the scope of this site, here are some of the key issues.
The general tax consequences of death
All your assets will be disposed of at fair market value on your death. You say you don’t recall having set things up that way? It doesn’t matter, the Income Tax Act says it’s so. It’s called a “deemed disposition”. The governmendoes it for you.
At the time of your death, most of your property is assumed (“deemed”) to be sold at its then fair market value. Any resulting accrued capital gains will be included in calculating your income in the year of your death, and taxed accordingly. In the case of jointly-owned property, you will be treated as though you had disposed of a one half interest immediately before death (unless there is any evidence to suggest otherwise). Needless to say, this may result in a significant tax bill if you owned real estate, an investment portfolio, shares of private corporations, etc.
As well, all money in registered plans (RRSPs, RRIFs, etc.) is deemed to have been received as income in the year of death. Whereas capital gains receive a beneficial tax rate, this type of income does not – it will be taxed at your top marginal rate, which could mean that up to half the assets in such plans will end up in government coffers.
Protection for spouses
A special case is made for the surviving spouse. If certain property is left to your spouse, or to a spousal trust, then the transferred assets attract no tax on your death.
In the case of stocks, real estate, etc., you are deemed to have disposed of your assets at a certain adjusted cost base, and your spouse assumes that cost base. Therefore, no capital gain will be triggered. The tax is postponed until your spouse sells the asset or dies.
In the case of registered plans, here again the assets can pass directly to the spouse without tax.
Two criteria must be met for this exception to apply.
You must have been resident in Canada immediately prior to your death.
Your property must have been transferred on or after your death to one or the other (or both) of the following:
your spouse (who was also resident in Canada immediately prior to your death)
a qualifying spousal trust. This is defined as a trust created by your will whereby your spouse is entitled to receive all the income of the trust that arises during their lifetime, and no other person may receive any of the income or capital from the trust. Lastly, the trust must also be resident in Canada immediately after the property is settled in the trust.