Taxes at Death
The old saying that, "there are only two certainties in life - death and taxes" holds true even at death. There is no escaping it, but there are ways to lessen the burden of this unanticipated beneficiary, called the government. 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 the deemed disposition rules
- provincial probate taxes
- U.S. Estate Tax on your U.S. assets
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.
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 RSPs or 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.
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 previously discussed 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.
Changes to the Canada-U.S. Tax Treaty have reduced the number of Canadians that may be subject to this Estate Tax. The tax rate charged on U.S. assets ranges from 18% to 55% of the taxable U.S. estate value. What has changed in the Tax Treaty is the amount of U.S. assets that are exempt from this tax.
Under the rules now in effect, a Canadian resident can claim a prorated tax credit of US$220,550 in 2001 (US$229,800 in 2002) against the estate tax owing. This credit can serve to shelter estate assets of up to US$675,000 in 2001 (US$700,000 in 2002). Unfortunately, this credit is prorated based on the following formula:
In addition to the changes to the tax credit, you are now able to claim any U.S. Estate Tax paid as a tax credit against the tax payable in Canada attributable to the deceased's U.S source income in the year of death. Previously, the U.S. tax was not recognized in Canada, resulting in the double taxation of these assets.
The Tax Treaty also states that if your total estate is valued at less than US$1.2 million and you do not own U.S. real estate then you will not be subject to the U.S. Estate Tax. If you do own U.S. real estate but your total estate is less than
US$675,000 (year 2001 value) then there will be no U.S. Estate Tax to pay.
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:
For more information on U.S. Estate Tax, refer to the RBC Investments publication, Tax Implications Of Investing In The United States.
- 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 US$1.2 million threshold and dispose of your U.S. real estate. This might be achieved by gifting assets, but you may incur an immediate U.S. tax liability on the disposal of the U.S. real estate and be required to file a non-resident U.S. tax return reporting the disposition.
- 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.