Is there a death tax in Canada?
There are no taxes that apply directly to inheritances in Canada. However, this doesn't mean property and assets left to heirs will not be taxed. These taxes are applied before the estate is distributed. It's as if the deceased were being taxed rather than their heirs.
The tax is applied beforehand, so the person getting taxed is the deceased, not the heirs.
Tax laxes determine what will be taxed, when it will be taxed, and at what rate. These laws rely on four main principles: deemed disposition, deemed withdrawal, earned income for the year of death, and the duties of the executor.
Good to know: Be aware that probate fees apply in all provinces and territories except Quebec. These fees will be calculated and sent by a court.
Deemed disposition
When a person dies, the Income Tax Act will act as if some of their assets were sold at market value. Of course, it’s not a real sale. The Canada Revenue Agency calls this a deemed disposition. It applies to most property.
The proceeds of the deemed disposition are used to calculate the capital gain. This is the difference between the original purchase price and the market value at the time of death. It's the profit on the sale of the property.
Half of this profit, or capital gain, is taxable.
What property does deemed disposition apply to?
As a general rule, deemed disposition applies to the deceased's capital property. This includes:
- Income properties
- Non-registered investments (securities, mutual funds, exchange-traded funds, etc.)
Will deemed disposition apply to all property included in your estate?
No. Here are some of the exceptions and conditions you should be aware of:
- Rollover to surviving spouse: Subject to certain conditions, deemed disposition does not apply to property transferred to an eligible spouse (in the eyes of the law: see the marital status under federal legislation or de facto union under Quebec legislation). This property will therefore not be taxed until the death of the surviving spouse. This is similar to a tax deferral. There are no forms to fill out; assets left to a spouse automatically roll over.
- Exemption for the principal residence. The capital gain, or profit, on the deceased's principal residence is not taxable. If the deceased had more than one residence, a calculation can be performed to determine the capital gain on each residence and then the option that involves lower taxes can be selected.
- Life insurance: The death benefit paid to beneficiaries of a life insurance policy is not taxable. This amount may be included in the estate, used to pay any debts or used to cover taxes so the heirs don't have to sell any inherited property.
Good to know: A testamentary spousal trust can be used to defer taxes (what must be paid on the deemed disposition). It can also be used to ensure that the heirs you choose receive your estate following the death of your spouse.
Since estate laws are complicated and your wishes are unique, it's always a good idea to draw up a will with the help of a legal professional. This is the best way to make sure you don't forget anything.
Deemed withdrawals
Another rule applies to registered plans, like RRSPs or RRIFs when you die: deemed withdrawal.
At death, all registered investments are considered to have been withdrawn and the full amount is taxable.
How can you limit the taxes payable on deemed withdrawals?
There are ways to limit the taxes payable upon death on registered investments. For instance, the amounts can be transferred directly or indirectly to an eligible person. This means the amounts will not be taxed, since they aren’t considered to be withdrawn.
There are many possible strategies for managing registered accounts and plans. Talk to a professional to find out which strategy is best for you.
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Income for the year of death
What happens to the deceased's outstanding income?
Outstanding income is income that was accrued by the deceased up to the day of death but not collected—such as interest earnings on a GIC. This income must be included in the deceased's final tax return.
What happens to the deceased's earned income?
Earned income—salary, business income and pension income received up to the date of death—must be included in the deceased's final tax return.
For certain types of income, there may be other returns to limit the taxes payable at death. For example, a return for rights or things can be filed for unpaid dividends declared before the date of death.
Duties of the executor
When can the estate be distributed?
The executor (liquidator in Quebec) is responsible for meeting legal requirements and carrying out the wishes of the deceased. Before distributing assets, they must complete the following steps to obtain a clearance certificate:
- Notify the Canada Revenue Agency of the death
- File the necessary tax returns
- Obtain notices of assessment
- Pay or secure all amounts owing
Good to know: If the deceased was a Quebec resident, a certificate authorizing the distribution of succession property must be obtained. The steps to follow are similar. The person appointed as the executor can also request a certificate authorizing the partial distribution of property. This makes it possible to distribute some of the property to the heirs before the estate settlement process is completed.
Should I dispose of my assets before I die?
To decide, you should consider your wishes and the impact on your taxes. You'll need to perform some calculations. Gifts of certain assets before death are treated as if they were sold and the capital gains are taxable as they are at death.
However, you may be able to reduce the total tax amount by spreading gifts out over several years.
To make sure your wishes for your estate are carried out, you should draw up a will with the help of a legal professional and plan your estate while taking taxes into account. There are many rules, and your situation is unique.
Would you like to discuss this with us? Contact your National Bank advisor or your wealth advisor at National Bank Financial. Don't have an advisor?
