Taxes at Death
While there are no true "estate taxes" in Canada there are
three potential taxes or pseudo-taxes that may be incurred at death:
Income Tax Due to Deemed Disposition
In the year of death, a final (terminal) tax return must be filed by
the estate's executor/liquidator that includes all income earned by the
deceased up to the date of death. Also included in income at death is the
net capital gain recognized under the deemed disposition rules.
The deemed disposition rules of the Income Tax Act treat all capital
property owned by the deceased as if it was sold immediately prior to
death. Thus, all unrecognized capital gains and losses are triggered at
that point with the net capital gain (gains less losses) included in
income.
The Income Tax Act does contain provisions to defer the tax owing
under the deemed disposition rules if the asset is left to a surviving
spouse or to a special trust for a spouse (spousal trust) created by
the deceased's Will. This provision allows the spouse or the spousal
trust to take ownership of the asset at the deceased's original cost.
Hence, no tax is payable until either the spouse or the spousal trust
sells the asset or until the surviving spouse dies. The tax is then
payable based on the asset's increase in value at that point in time.
A Special Note about RSPs and RIFs
In addition to the potentially significant tax liability from
recognized capital gains, it is also necessary to deregister
(i.e. collapse) any registered assets such as Retirement Savings Plans
(RSPs) or Retirement Income Funds (RIFs) at the point of death. The
full value of the RSP or RIF must be included on the deceased's final
(terminal) tax return. There are exceptions to this deregistration
requirement if the RSP or RIF is left to the surviving spouse, a
common law spouse and in some cases to a surviving child or grandchild.
An RSP or RIF can be transferred tax-free to a surviving spouse's
own plan. Also, the RSP or RIF can be transferred tax-free to a
financially-dependent child or grandchild who is under age 18, or who
is mentally or physically infirm, even if there is a surviving spouse.
The registered funds must be used to purchase a term-certain annuity with
a term not exceeding the child's 18th year.
Provincial Probate Taxes
Upon death, the executor of your estate will typically be required to
file for probate with the provincial court. The estate's executor must
submit to the court the original Will and an inventory of the deceased's
assets. Upon acceptance of these documents by the court, letters probate
(called "Certificate of appointment of estate trustee with a
Will" in Ontario) are issued. This document serves to verify that
the submitted Will is a valid document and confirms the appointment of
your executor.
With the executor's submission to the court, he/she must also pay a
probate tax. This tax is based on the total value of the assets that flow
through the Will. The rate charged varies between provinces with some
provinces having a maximum fee. All provinces except for Alberta and
Quebec levy potentially significant probate taxes.
Probate is not required for a notarial Will in the province of Quebec
and for those that have other types of Wills drafted in Quebec the probate
tax is very nominal.
In situations where the estate is extremely simple and does not require
any involvement with a third party such as a financial institution, the
Will may not need to be probated. As well, probate taxes can be reduced by
using strategies such as the naming of beneficiaries, Joint Tenancy With
Right Of Survivorship agreements and the use of living trusts.
U.S. Estate Tax
In addition to the taxes payable in Canada, you may also be subject
to a tax bill from the U.S. Government. Canadians that own U.S.-sourced
assets such as real estate, corporate stocks and certain bonds and
government debt are required to pay U.S. Estate Tax based on the market
value of their U.S. assets at death. Any assets that are considered
"U.S. situs" property (i.e. deemed to be located within the
United States) will be subject to this tax. Most people do not realize
that investing in the securities issued by a U.S. corporation such as
IBM or Microsoft in their Canadian brokerage account may result in a U.S.
Estate Tax liability for their estate.
While changes to the Canada-U.S. Tax Treaty have reduced the number
of Canadians that may be subject to this Estate Tax, for many individuals
with significant net worth, U.S. Estate Tax will still represent a
significant tax burden to their estate. Potential methods of reducing
the total cost of U.S. Estate Tax include the following:
- Use life insurance to cover the U.S. Estate Tax bill, allowing
your total estate value to be maintained
- Sell your U.S. assets prior to death. This is the simplest method
of avoiding the tax, but timing is everything with this strategy as the
sale could result in an immediate Canadian tax liability
- Individuals with substantial U.S. holdings may wish to consider
using a Canadian holding corporation since the assets would be owned
by the Canadian corporation and not by the individual
- Reduce the value of your estate below the current threshold
- Hold Canadian mutual funds that invest in the U.S. market. While
the fund may hold U.S. assets, it is considered a Canadian asset, and
is not subject to U.S. Estate Tax
- Hold the asset in joint ownership. This may serve to defer the
tax until the other tenant dies, assuming the surviving tenant can
prove that he/she acquired their interest in the asset using their own
capital
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