This article reviews the tax compliance and planning issues related to death and taxes.
A final income tax return covering the period from January 1 to the date of death is due by the later of April 30 of the year following death or 6 months after the date of death. It includes all the normal incomes received prior to death but also may include certain estate incomes.
A deceased taxpayer is deemed to have disposed of all assets at the time of death.
In the case of non-sheltered investments, the taxpayer with a surviving spouse as the beneficiary has the choice of electing the proceeds to be either original cost or the market value at the date of death. The former choice results in no death taxes now because it passes the future tax liabilities to the survivor. The latter choice does create tax liability at death. This choice can be made security-by-security. The spouse inherits the investments at whichever value is chosen. While the deferral choice is usually the best, sometimes it is a smarter tax planning decision to pay tax now, if a lower marginal rate is available.
A principal residence generally is not subject to tax, however any recreational or investment real estate is deemed to be sold as like non-sheltered investments.
RRSPs and RRIFs can be left to the surviving spouse with no tax consequences unless prudent tax planning suggests otherwise. An example of the latter is if the first spouse to die has a small RRSP or RRIF and is in a low tax bracket whereas the surviving spouse has a large registered plan and is in the top bracket.In most cases, the first spouse to die leaves everything to the remaining spouse. When the surviving spouse dies, the entire value of the RRSP or RRIF must be taken into income on that final return, usually pushing the income into the highest tax bracket.
Until probate is complete and the assets can be distributed to the beneficiaries, the assets of the decedent pass to a newly created legal entity, a testamentary trust called “The Estate of ——”. Any income the assets earn between the date of death and final distribution are subject to tax in the trust’s hands.
The tax brackets in a testamentary trust are the same as those for an individual. Sometimes this provides a useful tax planning tool. A trust income tax return must be filed within 90 days of the anniversary of its creation (the death of the taxpayer) or within 90 days of the final distribution of all the assets.
Canada does not have estate taxes but the U.S. does. If a Canadian citizen owns real property or other assets located in the U.S., there may be an estate tax based on the value of these assets. The Canada-U.S. Income Tax Treaty provides relief from this tax in most cases except those of very large estates situated in the U.S.
There are special rules related to medical expenses and donation bequests (these appear in previous articles which now appear on our website), as well as capital losses on death.