My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with BDO. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. My posts are blunt, opinionated and even have a twist of humour/sarcasm. You've been warned. Please note the blog posts are time sensitive and subject to changes in legislation or law.

Monday, November 25, 2019

Do You Have To File Taxes for Someone Who Died?

Thinking about taxes on a yearly basis is not fun. When dealing with the death of a loved one, it can make a challenging situation even more of a headache and forces one to face the only real certainties in life; death and taxes. In this blog post, I will walk you through the tax returns an executor needs to file at the time of death, allowing you to ease the stress of an already difficult experience.

Before tackling the filing of the tax returns, make sure that there is a legal representative in place, and that all authorities have been notified. These authorities include the Canada Revenue Agency (CRA), Service Canada, and the deceased person’s financial advisors and institutions. Once those initial steps have been taken, it is time to turn your attention to the tax returns and forms that come into play after a death.

Before I get to the returns that must be filed on death, I would like to thank Christopher Bell of BDO Canada for his assistance with this blog post. A quick backstory. Assisting with this blog post was one of the final things Chris did as a senior tax accountant before he changed career paths from income tax to digital project management. In a related story, I am now persona non grata with our tax department.

Final personal tax return


A final return must be filed for all taxpayers in Canada after they die. This return is a personal tax return (known as the "terminal return") just like in every other year and is filed from January 1st of that year up to and including the date of death, but there are some special rules that need to be followed when filing this return. Please note: that unless otherwise noted, this blog post assumes the tax return is being prepared for a single person who passed away or the last to die spouse.

The first thing to keep in mind is that income paid to the deceased will need to be prorated between the final return and the estate return (discussed below) based on the date of death. For example, some investment income slips such as T5's may be issued for the calendar year, but if the date of death was say July 31st, you need to prorate the income from January 1st to July 31st for the terminal return and from August 1st to December 31st for the estate return. If you are unsure whether the amount was prorated, you should confirm with the issuer of the income slip.

Capital assets


The Income Tax Act deems all capital assets of a taxpayer to be disposed of immediately before the death of a taxpayer and considers the proceeds from selling these items to be received at that time at fair market value (referred to as a deemed disposition). Based on the cost of these assets, this deemed disposition may result in a capital gain or a capital loss. For example, if you own 100 shares of a bank stock that cost $30 and are worth $50 at death, the deemed capital gain is $2,000 ($50 - 30 x 100 shares).

The exception to these rules is when assets are transferred to a surviving spouse or common law partner. The deemed disposition is then deferred to the earliest the surviving spouse sells the shares or dies. In some cases, it may make sense to “elect out” of the automatic tax-free transfer of capital property to the surviving spouse noted above. Tax planning for the death of the first spouse was discussed in greater detail in this blog post along with the related administrative headaches (many of these administrative issues also apply upon the death of the last surviving spouse).

Under this election, it may be tax effective to trigger taxable capital gains on the final return of the deceased spouse, as the election may reduce the amount of tax paid overall. This is usually limited to circumstances where the deceased spouse had a very low tax rate, had unused capital losses carried forward or had alternative minimum tax carryforward, among a few other possibilities. The election is made on a security-by-security basis at the fair market value.

In some circumstances it may make sense to elect to trigger a capital loss or losses at death instead of a capital gain. This would be for example to offset capital gains on the terminal return.

If there are capital losses on the final return, you can go back up to three taxation years prior to the death of the taxpayer and claim them against capital gains that tax would have previously been paid on using Form T1A.

Alternatively, if there is a net capital loss in the year of death, you can apply these losses against other income on the terminal return. You must first reduce the net capital loss by any capital gains deductions the deceased had previously claimed to date, and the remainder can be reported as a negative capital gain on Line 127 of the tax return.

These topics surrounding capital gain and losses are quite complex and are best discussed with a trusted advisor.

Pensions


Where the deceased was single or a surviving spouse, the fair market value of the RRSP or RRIF is deemed to be received immediately before death and is considered income on the terminal return.

Where there is a surviving spouse or common law partner, you can generally avoid these taxes on death by naming the surviving spouse or common law partner of the deceased as the beneficiary of the RRSP/RRIF, and then to file an election for the assets held in the plan to be transferred to the beneficiary’s RRSP or RRIF on a tax-deferred basis.

If the spouse is not named as the beneficiary of the RRSP/RRIF, the estate representatives can generally elect on the final return for the tax-free transfer to still happen as long as the RRSP/RRIF funds are left to the spouse under the terms of the will. Please seek professional advice in this situation.

Tips to complete the final personal tax return


  • You can still elect to split pension income on the final tax return, so long as the deceased and their spouse or common law partner previously jointly elected to do so on their tax returns prior to death.
  • All assets held in the name of the deceased are deemed disposed of at death, including personal items such as jewelry, paintings, and boats. There are special rules around these assets that need to be considered and should be discussed with your financial advisor.
  • RRSPs and RRIFs can also be transferred tax free to financially dependent children or grandchildren under 18 in certain circumstances.
  • TFSA accounts are fully tax free to the beneficiaries; however, any income earned between the date of death and the distribution is taxable to the beneficiary.
  • TFSA accounts can also be transferred to the spouse or common law partner of the deceased tax free, and the account will continue to exist. The survivor can also elect to transfer the amount to their TFSA if they prefer to not maintain two accounts, as this is considered a qualifying transfer.
  • Any unpaid amounts (including bonuses, dividends, etc.) must be accrued up to the date of death. This amount can be included either on the final return or on the return for rights or things, which we discuss a little later in the post. There is sometimes a benefit to filing this separate return, but it is circumstantial and should be discussed with a financial advisor.
  • You will need to send a copy of the death certificate in along with the final return, so keep a copy at hand.


Final return due date


The due date of the final return depends on when the person passed away. See the below chart for the due date of the final return.

Date of death
Tax return due
January 1 to October 31
April 30
November 1 to December 31
6 months after the date of death
If the deceased or their spouse/common law partner operated a sole proprietorship in the year of death:
January 1 to December 15
June 15
December 16 to December 31
6 months after the date of death

The surviving spouse’s return will always be due April 30 or June 15 respectively, meaning that no extra time is granted to file their return despite the death of the other person.

Optional returns


You may choose to file optional returns to report income that you would normally report on the final return. The benefit of doing this is that you can reduce the total taxes owing by the deceased by claiming certain tax credits and using lower marginal tax rates. It is best to consult a trusted advisor to discuss this type of planning in detail.

There are three types of optional returns:

Return for rights or things


The return for rights or things covers amounts that were payable to the deceased at the date of death and, had the person not passed away, would have been paid to them and included in their income. This return enables the representative to report the asset values at the time of death. Some examples of assets that would be listed on this return are:
  • Unpaid salary, commissions, and vacation pay
  • Dividends declared prior to death
  • Old Age Security benefits that were payable to the deceased
  • Unmatured bonds coupons and bond interest that was unpaid
  • Work in progress for professionals operating as a sole proprietor
This return is due at the later of 90 days after the CRA sends the notice of assessment or reassessment for the final return and one year after the date of death.

Return for a partner or proprietor


This return is filed for a person who was a sole proprietor or partner of a business prior to death. This return is only filed if:
  • the business’ fiscal year-end does not end on December 31; and
  • the person died after the year-end of the business but before the end of the calendar year.
If this return is filed, it would cover the period from the first day of the business’ new year to the date of death. If a legal representative chooses not to file this return, the business income would instead be reported on the final return. This return is due on the same date as the final return.

Return for income from a graduated rate estate


This return can be filed if the deceased received money from a graduated rate estate (GRE) prior to death. This return is rarely filed, and the income is normally included on the final return. This return is due on the latter of April 30 (or June 15 if the deceased was a sole proprietor) and six months after the date of death. If you want to know more about this, we recommend you refer to a blog we previously posted, written by Howard Kazdan here for some background information, but you should contact your professional advisor for detailed guidance.

Estate Returns (T3 Return)


In addition to the returns noted above, the estate of the deceased must file T3 tax returns each year until the estate is wound up. Typically, the returns are filed based on a year starting from the day after the date of death and ending one year later, although you may elect to have a December 31 year-end for these returns as well. Estate returns and any balance owing are due within 90 days of the year-end of the trust. Winding up an estate could take several years and is a lengthy topic on its own.

Even if the estate is wound up quickly, the executor may file at least one estate return (the “executor’s year”). And there may be tax advantages to filing even when it is not mandatory. One is having income earned in the estate taxed at graduated personal rates (instead of the higher marginal rates of the beneficiaries) – basically, a way to effectively have another return on death for the income earned in the first year of an estate.

When filing the first T3 return after the death, make sure to include a copy of the will.

Clearance certificate (Form TX19)


If you are serving as the legal representative for a deceased taxpayer or trustee of an estate, getting a clearance certificate is advisable prior to distributing any assets from the estate. A clearance certificate is issued by the CRA upon request, and certifies that either the liabilities payable to the CRA have been paid or security has been accepted in place of payment. If a legal representative chooses not to obtain a clearance certificate, they could be held personally liable for the amounts outstanding up to the value of the assets that were paid out. I previously wrote a blog specifically on clearance certificates, which you can read here.

Reduce the stress with a plan


As you can see, there is a lot to do with taxes at the time of a person’s death, and the sooner you begin to organize and plan for it, the smoother the process will go. A lot of the stress that goes along with filing these returns can be mitigated through proper estate planning and having trusted financial advisors in place to guide you and your loved ones through the process. On top of this, having a good plan in place will ensure that you avoid unnecessary probate and income tax, which will save you money.

Plan to Sell Your Business? You may be Interested in this Survey! 


If you’re a financial executive or business owner, here's your chance to share insight on how you plan to sell your business. My colleagues at BDO are conducting a survey in partnership with Financial Executives International Canada. The survey will be open until November 27 and will generate research to be released in 2020. Take the survey here.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.

Monday, November 11, 2019

The ins and outs of Registered Retirement Income Funds

The RRIF (Registered Retirement Income Fund) occupies an odd space for most Canadians. Everyone has heard of them – hands down, they are the most enjoyable financial vehicle to pronounce; the acronym is pronounced as it is spelled – but many people don’t realize the nuanced and sometimes surprising ways that a RRIF can help them and their families increase their income.

To clarify this piece of the retirement puzzle, I invited my colleague Jeffrey Smith to share his insight on this post of The Blunt Bean Counter. Jeff is a Manager in BDO’s Wealth Advisory Services practice, based in Kelowna
BC.

What is a RRIF?


A RRIF is a way of turning your retirement savings into income. This is achieved by converting your Registered Retirement Savings Plan (RRSP) into a RRIF no later than December 31 of the year you turn 71. You do have the option to convert all or a portion of your RRSP into a RRIF even before the year you turn 71. However, if the whole account is converted, you can no longer make RRSP contributions to the account and will have to open a new RRSP account. (In addition to converting the RRSP into a RRIF, you could also deregister the RRSP and take a lump-sum payment or purchase an annuity.)

The income earned in the RRIF still maintains its tax-deferred growth status; however, once the RRSP becomes a RRIF, there is a minimum amount that must be withdrawn annually. This withdrawal is fully taxable as income.

How do withdrawals from a RRIF work?


Once you convert your RRSP to a RRIF, you will be required to take out the annual minimum beginning the following calendar year. For people under 71, this amount is based on a formula:

1 / (90 – age) 

For example, at age 65 it would be 4%, based on this calculation:

1 / (90 – 65) or 1 / 25 = 4%

If the RRIF value on January 1, 2019 is $100,000, and the minimum RRIF withdrawal 4%, minimum RRIF income in 2019 will be $4,000 ($100,000 x 4% = $4,000). The 4% would apply to the value of the RRIF on January 1 and have to be drawn from the RRIF during the calendar year.

For people age 71 and older, the minimum withdrawal is calculated by applying a percentage factor that corresponds to your age and RRIF value at the beginning of the year.

For example, at age 71 that amount is 5.28%, at age 80 the minimum amount rises to 6.82%, and by age 90 the minimum percentage is 11.92%.

If your spouse is younger than you, their age can be used to calculate the minimum withdrawal. This allows you to withdraw less money from the RRIF in earlier years and thus extend the life of your RRIF. This is a very important tax planning feature of the RRIF and should always be considered in your RRIF and retirement planning.

There are no income tax withholding requirements on the minimum RRIF withdrawal; thus, be sure you either request tax be withheld by your financial institution, or you set aside the appropriate amount of tax related to your minimum RRIF withdrawal

For amounts taken in excess of the minimum amount, withholding taxes of 10% to 30% would apply, depending on the total amount withdrawn in the year, similar to redeeming RRSPs. Therefore, if you don’t need the income, don’t withdraw more than the minimum. It is also very important to understand that statutory withholding rates may be less than your actual marginal income tax rate, and as noted above with the minimum withdrawal, you either need to set aside the extra tax or ask for your financial institution to withhold a higher amount from any withdrawal.

RRIF: Specific situations


There are specific situations where someone may want to create a RRIF. Example situations may include:
  • Retiring early
  • Taking a leave of work to assist with a sick family member
  • You are 65 and have no other qualifying pension income to use your pension income tax credit (which depends on having $2,000 in qualifying pension income)
  • Extended sabbatical leave. If the leave is temporary, you can convert the RRIF back to an RRSP and continue contributing to the RRSP when you return to work, provided you are age 71 or younger at the end of the year.
While creating a RRIF to access the $2,000 pension credit is typically a sound idea, the other situations should be discussed with your investment and/or tax advisors to determine whether the benefit of creating the RRIF is more tax efficient than utilizing your RRSP (i.e. whether to withdraw a RRSP lump-sum in a low income year because you retired early versus creating the RRIF).

What happens to your RRIF when you die?


The three most common outcomes for a RRIF on the death of the owner are:
  • Spouse or common-law partner is named a successor annuitant;
  • Spouse is named a beneficiary
  • Estate is designated a recipient

Successor Annuitant


If the surviving spouse is named as the successor annuitant, they would essentially take over the RRIF as if nothing had happened. For clarity, if your spouse is named as the successor annuitant, the RRIF would continue to exist and your spouse would now be the annuitant. The spouse would continue to receive the RRIF payments that were set up. They would also be required to withdraw the annual minimum amount in the year of death if it was not already paid.

Naming your spouse as the successor annuitant typically has the benefit of administrative ease and simplified tax reporting.

Beneficiary


If the spouse is the sole beneficiary of the RRIF, the entire eligible amount of the RRIF is transferred to the spouse’s RRSP (provided the spouse is age 71 or younger by the end of the year of transfer) or RRIF, or used to purchase an eligible annuity by December 31 of the year following death. To be clear, under the beneficiary option, the RRIF ceases to exist and your spouse has the option to undertake the rollover transfer.

The eligible amount of the RRIF is the full value of the RRIF account minus the RRIF minimum for the year of transfer that was not actually paid that year.

Estate


If the estate was designated as the RRIF recipient, the executors of the estate will control the RRIF assets. Assuming there is a surviving spouse, the executor and RRIF carrier could agree to name the spouse as the successor annuitant as long as the spouse is a beneficiary under the will. This would have the benefit of creating a tax-deferred rollover.

If nothing is done, the value of the RRIF will be included in the deceased’s final tax return as taxable income.

If a financially dependent child or grandchild under the age of 18 is a named beneficiary under the RRIF, they could purchase an eligible annuity and thus save the estate from incurring the tax.

The many ways to use an RRIF


Every Canadian has unique circumstances, and RRIFs can be used in a surprising number of ways. Customization is key. Work closely with your advisor to obtain guidance on when to convert your RRSP into a RRIF, how to ensure beneficiary designations are made, and how to tax-plan your retirement and estate needs to save you and your family money in the long run.

The content on this blog has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The blog cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information on this blog or for any decision based on it.

Please note the blog posts are time sensitive and subject to changes in legislation.

BDO Canada LLP, a Canadian limited liability partnership, is a member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms. BDO is the brand name for the BDO network and for each of the BDO Member Firms.