Written by Caroline Poulin, LL.Mfrom Demers Beaulne
Unlike other jurisdictions, Canada and Quebec do not personally tax individuals who inherit property. Under our tax system, taxes apply to the individual’s income tax return upon death and to the estate’s tax return after that. Because of this, it is often best to plan for potential tax-related items in advance. Below is a brief overview of some important things to keep in mind.
Decedent’s tax
For tax purposes, a person is deemed to have disposed of all of their capital property at fair market value immediately before death. In this case, the capital gain accumulated on each asset will be taxed based on the decedent’s final income tax return, resulting in a capital gain taxable at 50%. The decedent will also be considered to have cashed out their RRSP or RRIF in full, and the plan’s balance will be added to their current income. These items will be added to the income earned by the decedent between January 1 and the date of their death.
The tax resulting from the deemed disposition of the decedent’s property can be very high. The amount of tax payable will have to be paid by the executor from the estate assets, which may significantly reduce the value of the property to be distributed to heirs.
Income tax return
If certain assets held by the estate generate income between the date of death and the date of distribution (e.g., rental property, investment portfolio, etc.), this income will be taxed directly on the estate’s tax return. The estate must file an annual income tax return until final settlement is finished.
Spousal rollover on death
Certain tax strategies can reduce the amount of tax payable on the decedent’s final tax return. For example, a person may wish to make bequests during their lifetime. This planning allows the person to better manage the tax consequences of the disposition of their assets by controlling the timing of the disposition, and in turn the applicable tax rate, while contributing, during their lifetime, to the financial well-being of their loved ones. At the time of death, a bequest of certain assets to a spouse or a testamentary spousal trust allows certain assets to be transferred without tax consequences at the time of death through a tax rollover.
Special mechanisms can be put in place to reduce taxes payable on death where an individual holds shares in a Canadian-controlled private corporation. It is important to take a proactive approach. For a shareholder, a significant capital gain may have been accumulated on shares held. This unrealized gain can result in a significant tax liability upon death and liquidity risk.
Liquidity risk can be an important consideration for a corporation that has an obligation to redeem the decedent’s shares or for an executor who must pay the taxes due upon the person’s death. It can be useful to take out life insurance for this type of issue because insurance proceeds are generally tax-free.
Trust or estate freeze
With respect to unrealized gains on shares and the resulting tax consequences, certain plans such as implementing a trust freeze, or an estate freeze can reduce the taxable appreciation upon a person’s death.
It is also important to verify whether the shares held by an individual can be qualified shares so that the individual can use their capital gains deduction (CGD) against the gain resulting from the deemed disposition of the shares upon death. For 2022, the total amount of CGD is $913,630, which is indexed to $971,190 for 2023.
Tax planning can minimize taxes resulting from a person’s death and maximize the value of the estate assets.
Feel free to contact a member of our tax team to further discuss and assess potential tax consequences.
Frequently Asked Questions:
Who is exempt from inheritance tax?
The children and grandchildren of the deceased person are exempt from inheritance tax under certain conditions. Surviving spouses, brothers and sisters, and uncles and aunts of the deceased person are also fully or partially exempt.
How do you do a deceased person’s taxes?
Preparing a deceased person’s tax return is similar to preparing a living person’s tax return. The main difference is the deemed disposition of all property at death. An inventory of the deceased person’s assets is necessary to ensure that certain income or capital gains are not forgotten about.
Do I have to pay taxes on inheritance?
The deceased person pays taxes on their final tax return. The deceased person’s property is then given to their heirs after taxes. This means that you usually don’t have to pay any tax in Quebec and Canada on inheritance.
How much of an estate is tax-free?
A deceased person’s estate normally only pays taxes on the income generated by the assets received from the deceased person. The estate does not have to pay tax on the assets received, since the deceased person is taxed on the gains accumulated on their assets at the time of death.
Can I refuse an estate?
If you decide to refuse an estate, you must do so through a notary because the refusal must be notarized. In the event that there are estate assets, you may need to file for bankruptcy to facilitate the disposition of certain assets, including real estate.