The Two Certainties in Life: Death and Taxes - Impact on Your Personal Income Tax Return

Last week you read that upon your death, you are deemed to have disposed of your assets for income tax purposes (unless you leave them to your spouse). Today, you'll get a closer look at these rules.

For purposes of this post, I am assuming your spouse has predeceased you, or you leave your property to someone other than your spouse; so that there is not a tax-free transfer available upon your demise.

General Rule

Upon death, you are deemed to have disposed of your property for proceeds equal to its fair market value (“FMV”). This is known as a deemed disposition. The deemed disposition being equal to the excess of the FMV over the adjusted cost base of the property (“ACB”). For example, say you purchased 1000 shares in Blunt Bean Inc. for $150,000 and the shares are worth $275,000 upon your death. Your executors would have a $125,000 capital gain to report on your terminal tax return (final return from Jan 1st of the year you die to the date of your death).

For most people, there are two basic categories or property upon death, those being non-depreciable capital property and capital property.

Non-Depreciable Capital Property

Non-depreciable capital property would typically include shares, bonds, land (note: depending on the circumstances, land may not be capital property) and partnership interests. As noted above, upon death you are deemed to have disposed of your non-depreciable property for proceeds equal to its FMV. To be clear, that means the $125,000 capital gain in the example above is reported on your terminal return, notwithstanding you never sold the shares of Blunt Bean Inc. Thus, upon your death, for tax purposes you have in essence been “deemed” to have sold all your non-depreciable capital property even though there is no actual sale.

If you left the shares of Blunt Bean Inc. to your daughter, the ACB of the shares to her will become $275,000, which accounts for the fact your estate already paid tax on the increase in value from $150,000 to $275,000.

If the deemed disposition results in a capital loss, the losses offset any capital gains on the terminal return. If your capital losses exceed your capital gains in your final return, you can then deduct those excess losses against other income in the year of death, or in the previous year to the extent you have not previously claimed the capital gains exemption.

Principal Residence

Your principal residence is technically subject to the deemed disposition rules. However, if you only have one house (no cottage) and have lived in that house since it was purchased, your estate will typically be able to claim the principal residence exemption on your behalf and that property will be tax-free. It is important to note that your estate may have a capital gain or loss when it sells your principal residence, if the value of your principal residence has increased or decreased from the deemed value on the date of your death. This can occur where it takes a while to sort out the estate and the principal residence is not sold for months or even years.

Some Exceptions to the Deemed Disposition Rules

There are a couple significant exceptions to the deemed disposition rules:

(1) There is no deemed disposition on your cash holdings; however, if you hold foreign currency, you could have a foreign exchange gain.

(2) There is also no deemed disposition on your TFSA; however, there are various rules relating to what happens after your death to your TFSA. Taxtips.ca has a good summary here.

Depreciable Capital Property

Depreciable capital property would typically include buildings owned for rental purposes by the deceased taxpayer, and equipment used in an unincorporated business.

For depreciable property the same deemed disposition rules apply. However, there can also be recapture of prior depreciation (capital cost allowance claimed) where the FMV exceeds the undepreciated capital cost allowance (“UCC”) or instead of a capital loss, there may be a terminal loss where the deemed proceeds are less than UCC which can be used to offset other income in the year of death.

RRSP/RRIF

At the date of your death, the value of your RRSP or RRIF is included as income on your terminal return. For example, if your RRSP has a FMV of $560,000 on the day you die; your terminal return would reflect income of $560,000. The estate is supposed to receive a tax slip for the $560,000 RRSP/RRIF value upon death, but it has been my experience, that these slips are often not issued or are issued incorrectly, so you need to be diligent that the correct value is included on the terminal return. (As noted at the outset, I have assumed your spouse has already passed away, so the RRSP cannot be transferred tax-free to your spouse. However, the tax may be deferred if the beneficiary is a financially dependent child or grandchild under 18 years of age, or a financially dependent mentally or physically infirm child or grandchild of any age).

Note: See the comment section below for an interesting point made by Jean-Pierre Laporte about using a personal  pension plan to avoid the deemed disposition in relation to RRSPs.

Asset Rich but Cash Poor

Under the deemed disposition rules, it is possible to have a large deemed capital gain and a large associated income tax liability, yet not have the liquid assets to pay that liability. For example, you have significant real estate assets that appreciated considerably before your death, but little cash. In these cases, the estate may qualify to file form T2075 which allows for taxes to be paid in ten or less annual installments, with interest. In order to utilize this provision, security would have to be provided to the CRA.

The above is just a general overview of the income tax rules upon death. There are various other detailed rules I have not discussed that may relate to the death of an individual. Next week, I finish this discussion when I review the rules relating to the ownership of shares of a private corporation.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

The Two Certainties in Life: Death and Taxes - The Impact on Small Business Owners

In my two prior blog posts in this series on death and taxes, I discussed with you the general income tax rules as they relate to the death of an individual. Today, I am going to discuss the income tax issues that arise on death, where you own shares in a private Canadian corporation (“CCPC”).

Note:You may own shares in a private corporation (typically a Canadian company controlled by non-residents) as opposed to a CCPC  or shares in a private foreign corporation. Although the general deemed disposition rule will apply upon death, for purposes of this blog post, I am not considering any issues related to these type entities. Please seek specific advice if you own such shares.

It has been my experience that some owner-managers of CCPC’s are surprised to find out that their shares are subject to the general deemed disposition rules upon death. The rule being: that upon your death, the shares of your CCPC (assuming the shares are not transferred to your spouse) are deemed to have been disposed of for proceeds equal to the fair market value (“FMV”) of those shares and a capital gain results to the extent that FMV (which is often difficult to determine for a CCPC) exceeds the adjusted cost base (“ACB”) of those shares.

There are two reasons I typically hear as to why the private company owner-manager does not think their shares are subject to the deemed disposition rules:

(1) They thought the corporate taxes they paid each year took care of that issue.

(2) They thought if they left the company to their children, their kids would be the ones who pay the tax (as per my blog on estate freezes, this tax can be mitigated, but not eliminated by undertaking an estate freeze).

The owner-manager may also be surprised to hear that their shares are potentially subject to double taxation if proper steps are not undertaken to alleviate this liability. Double taxation can occur where the estate pays tax on the deemed disposition reported on the owner-manager’s terminal tax return, and then the estate pays further tax when it removes the assets from the corporation in the form of dividends to the estate.

There are two tax planning strategies that can generally eliminate any double tax; however, both techniques have some potential restrictions:

(1) The first is known as a subsection 164(6) loss carryback. In simple terms a loss is created on a share redemption by the estate that reduces or eliminates the capital gain that arose as result of the deemed disposition on death. It should be noted that new legislation related to the changes to “graduated rate estates” could impact this planning in the future, as the loss carryback may be restricted.

(2) The second, known as the pipeline strategy allows the estate to remove the corporate funds tax-free by in very simple terms, transferring the deceased owner-manager’s shares to a new corporation and using redemptions and a netting of promissory notes to remove those funds tax-free.

However, a pipeline strategy can be problematic in certain circumstances.

Capital Gains Exemption

In many cases the owner-manager can avail themselves to the $800,000 capital gains exemption ("CGE") to utilize against any deemed capital gain. However, as discussed in this post, it can be problematic to access the exemption where the corporation has excess cash or the owner-manager dies suddenly without implementing the proper planning.

In summary, as morose as this sounds, if you own shares of a private corporation, you and your tax advisor should be proactively planning for your death, which includes monitoring on an ongoing basis, whether your shares will qualify for the CGE.

The planning process would in general start with a determination of your potential income tax liability on death, including an estimate of the liability related to your private company shares. This will lead to a discussion of whether or not your estate will have enough liquidity to cover that anticipated liability or if you need to consider purchasing life insurance to cover any taxes potentially owing upon your death. The discussion should then morph into a succession planning discussion, and whether or not an estate freeze/sale to family member would make sense in your situation, or what plans you have in regard to an exit strategy.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

The Two Certainties in Life: Death and Taxes

We have all heard the famous quote “In this world nothing can be said to be certain, except death and taxes”. Did you know the person who uttered this profound statement was none other than Benjamin Franklin?

This blog post and the two follow-up posts, will share with you the income tax consequences of Benjamin's second certainty, the always popular subject of dying.

Deemed Disposition

Ignoring the fact that the U.S. Income Tax Code in the 1700's may have been slightly different than today, Franklin's view on death and taxes was that of an American. This distinction is very important. The U.S. tax system taxes you on the value of your estate upon death, while Canada deems you to have disposed of your property at death, at its fair market value, which triggers income tax on any unrealized capital gains (paper gains).

I will explain this “deemed disposition” in greater detail later on, but simply put, if you own shares in say Bell Canada that are worth $40 upon your death, that you purchased for $15, you/your estate are deemed to have a $25 ($40-$15) capital gain per share, if your assets are not left to your spouse.

Probate Fees

Depending upon the province in which you live, you may also be subject to probate fees (Estate Administration tax in Ontario) on the value of your estate at death. However, notwithstanding people plan around probate fees, often to their detriment; these fees/taxes are typically fairly immaterial to an estate in Canada (1.5% versus 40% Estate tax in the U.S. or higher, depending upon the state and size of your estate). Here is a summary of the probate fees for each province. For purposes of this blog, and the two follow-up blog posts I have written, I am just going to focus on the “deemed disposition” upon death and ignore probate fees.

Personal vs Corporate

 

It has been my experience that most people are not clear about how the income tax system works upon their death. In particular, shareholders of private corporations are often surprised when I inform them that any increase in value of the shares of their private corporate shareholdings are subject to income tax upon their death (they often think the yearly corporate tax they pay has covered this liability). This does not even account for the fact that without proper tax planning, there could be double taxation in respect of their corporate shareholdings.

In order to deal with the distinction between the personal and corporate income tax consequences, I have made this topic a three-part blog series. Next week, I will deal with the personal income tax consequences of you dying, and the following week, I will discuss the income tax consequences of dying when you own shares in a private corporation.

Just Die First

 

You can avoid all these messy income tax complexities upon death by just dying first☺ if you are married or in a common-law relationship. This is because if you leave your property to your spouse or common-law spouse, the property passes to them at the adjusted cost base of the property and the capital gain is deferred until the surviving spouse or common-law partner dies, or they sell the property during their lifetime.

Consequently, the deemed disposition rules typically only apply in the following three situations:

(1) Your estate elects out of the automatic transfer to your spouse (this can be done on a property by property basis).

(2) You are the last to die spouse.

(3) You leave your property to your children or other beneficiary, instead of your spouse.

Next week, I will discuss in greater detail, the personal income tax consequences of passing away. 

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation.

Gifting and Leaving Money to Your Grandchild

Many grandparents ask me about the tax and practical ramifications of gifting or bequeathing money or assets to their grandchildren. Some wish to make gifts while they are alive, others choose to make gifts upon their passing, and still others give both while alive and after passing.

I wrote the first draft of this blog post prior to COVID -19, but it is more relevant than ever, given many people have been laid off, lost their jobs or been set back financially, and many grandparents want to help them until they regain their financial footing. Today I will discuss some of the tax and other planning considerations for grandparents wishing to make these gifts or transfers.

Please note for brevity, I will use “grandparent” in lieu of “grandparent/grandparents” and “child” in lieu of “child/children” where applicable.

Tax Considerations

In Canada, unlike the United States, there is currently no gift tax. (Here’s hoping this remains the case.) While there may not be a gift tax, a grandparent may need to take specific steps for effective tax planning. Remember, you should never make a gift that puts your own retirement finances at risk.

Deemed Disposition

The deemed disposition rules are one of the tax issues that apply to gifts. A grandparent will be subject to a deemed disposition tax where they gift or transfer an asset (other than cash) that has appreciated in value to a grandchild, as the CRA will tax the capital gain.

For example, Grandma Johnson is very tech savvy and purchased 100 Shopify shares at $250, which are now worth $1,200 or so a share. She decides to gift the shares to her grandson Tom. Grandma Johnson will have a deemed disposition, resulting in a capital gain of $95,000 ($1,200-250 x 100 shares). 

In English, this means she will have to report a capital gain on her personal tax return of $95,000, even though she gifted the shares and did not sell them. If she is a high-rate taxpayer, she will owe approximately $25,000 in tax on shares she did not receive any money for. Thus, she potentially has a cash flow issue.

The folly of gifting a principal residence

Occasionally a grandparent thinks they will save money on tax and probate by transferring or gifting their principal residence (PR), or a part of it, to their grandchildren.

In truth, a grandparent generally should not gift a principal residence, as any gain on disposition of the PR will be tax-free as long as they continue to own and live in the PR (in addition, typically, a grandparent will need most if not all the value of their home to fund their retirement). While the deemed disposition of their PR in most cases will be tax-free, the grandparent will lose their principal residence exemption going forward on the portion of their PR that they transferred to the grandchild. Not only that - the grandchild will be taxable on any future growth of their share of the PR, assuming the grandparent continues to live in the home and the grandchild does not move into the house.  

Appreciated assets left in a will 

If a grandparent leaves appreciated assets in their will to a grandchild, the grandparent will again have a deemed disposition (this time triggered by their death as opposed to a gift) that must be reported on their terminal tax return (January 1 to date of death).

Takeaway #1 - You will generally want to gift cash. If you wish to gift assets with appreciated values, ensure you have enough excess cash to pay the income tax on the deemed disposition and you do not put your own retirement lifestyle at risk. You should also speak to your financial advisor or accountant before undertaking any substantial gift.

Takeaway #2 - Never transfer your home without first obtaining professional tax advice.

Attribution

Where a gift of money or assets is made during a grandparent’s lifetime to a minor child (under 18 years old), the grandparent will be subject to attribution on the gift, as well as the tax on the deemed disposition (on appreciated assets other than cash) discussed above.

This means that the grandparent reports the income – dividends or interest, for example – and pays the tax at the grandparent’s marginal rate, not at the grandchild’s tax rate. For example, if you gift marketable securities that pay a dividend of $500 a year, you pay tax on the $500 dividend.

In summary, capital gains realized by a minor child are not subject to attribution, but income such as interest and dividends is subject to attribution. There is no attribution if your grandchild is 18 and over. 

Attribution on assets left in a will 

Where a grandparent passes away and assets are bequeathed to a grandchild, there is no future attribution of income.

Takeaway #3 – If you intend to gift marketable securities to your minor grandchild, it may make sense to gift non-dividend paying stocks to avoid the attribution rules on dividends. This is not a rule, but an option to consider.

Attribution – RESPs, TFSAs and RRSPs

For children 18 years old and over, there is no attribution if you contribute to their Registered Education Savings Plan (RESP), Tax-Free Savings Account (TFSA) and Registered Retirement Savings Plan (RRSP). A minor child (under 18) cannot have a TFSA, so attribution is a moot point. However, assuming they have contribution room, a minor can have an RRSP and there is attribution on gifts for RRSP contributions. There is no attribution on RESP contributions on behalf of a minor.

See the detailed discussion in Part 2 of this post (in two weeks) for traps and tax considerations before making these contributions.

Avoiding attribution – Prescribed rate loans

A grandparent can avoid the attribution rules by making a prescribed interest rate loan (the current rate is 1%) to a family trust. Prescribed rate loans are not subject to the Tax on Split Income (TOSI) rules.

Note, when I say trust above, I mean a properly set-up legal trust, not an informal “in-trust” account in the grandparent’s name. Informal in-trust accounts are not legal trusts and can cause unintended income tax and family issues and should be avoided.

Family Law

Grandparents (and parents) should always obtain family law advice for significant gifts. The laws are different for each province. In general, most gifts or inheritances are excluded property when the funds are not co-mingled or used for a matrimonial home; however, always first check with your family lawyer.

Grandparents often lend or gift grandchildren money to assist them in buying a house. There are various trips and traps when the loan is not legally documented and the interest on the loan not paid.

Takeaway #4 – Each province has its own Family Law Act and you should obtain family law advice for any significant gift or loan of cash made to a grandchild. Doing so will hopefully avoid your grandchild losing part of the value of that gift upon a marital break-up because the gift or loan was not property set up or the grandchild did not understand how to keep the property excluded.

That's all for Part 1 of this key topic that I get asked about a lot. In Part 2, we'll cover gifting by grandparents using a Registered Education Savings Plan (RESP), Tax-Free Savings Account (TFSA), or Registered Retirement Savings Plan (RRSP). We will also briefly discuss estate planning considerations for grandparents.

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.

The Importance of Tracking Your Adjusted Cost Base from an Inheritance

From an income tax perspective (I am obviously ignoring the emotional issues) receiving an inheritance provides two tax related benefits. The receipt of the inheritance is typically tax-free and you may also receive a “bump” (increase) in the adjusted cost base (“ACB”) of any capital property inherited.

However, over the years, I have seen cases where people pay unnecessary income tax and/or have disputes with the CRA because they (1) forget or are not aware of the cost base bump (2) have misplaced documentation or never obtained documentation (3) have switched accountants (or the original work was prepared by their parent’s accountants and is no longer accessible).

Today, I want to remind those of you who have inherited capital property, to ensure you have in place the documents (easily accessible) to support the ACB of any inherited property when you sell the property in the future.

Taxation on Death

I think to provide context for my comments, I first need to explain how the Income Tax Act works when someone passes away.

In Canada, where you receive cash or a cash like inheritance, there are no income tax implications. Where you inherit capital property, such as stocks and real estate, you will have no immediate income tax implications, plus you will inherit the “bumped-up” cost base of the capital property to the deceased.

By “bumped-up” I mean the following. When a person passes away there is a deemed disposition of the deceased persons capital property at the fair market value ("FMV") of the property right before the person's death (this is typically the last spouse or common-law partner to die, as the income tax allows a tax-free transfer of property to a surviving spouse or common-law partner).

For example; say your mother passed away in 2015 and she owned 1,000 shares of Royal Bank (ignoring stock splits) that were worth $80 a share at her passing, that had been purchased for $12,000 in 2001. (Note: The Royal Bank shares could have been transferred to your mother as a tax-free spousal transfer from your father on his passing or the shares could have been purchased directly by your mother, it is the same tax result).

Your mother’s estate would have filed a final (terminal) income tax return reporting a deemed capital gain of $68,000 (FMV at death of $80,000-$12,000 original cost). This deemed capital gain is known as a deemed disposition on death and occurs despite the fact the Royal Bank shares were not sold. This is because your mother was the last surviving spouse and owned the shares at her date of death. Your mother’s deemed disposition FMV of $80,000 becomes the new cost base of your inherited shares. So, if you sell the Royal Bank shares in the future, the gain would be equal to your sales proceeds less your bumped-up cost base of $80,000. 

The same thing would occur if your father/mom owned real estate. The fair market value at your mothers passing would become your new ACB, although there would be an allocation between land and building. The rules relating to the inheritance real estate can get tricky for a non-arm’s length decedent. You should speak to your accountant to get an accurate understanding of your cost base and allocation between land and building.

While I use parents in the above example, the same result occurs if you inherited the capital property from a relative or friend etc.

A totally separate but interrelated ACB tax issue, is the 1994 Capital Gains Election. In 1994, the $100,000 capital gains exemption was phased out. However, individuals were eligible to make an election on their 1994 personal tax return to bump the value of their capital properties by up to $100,000. Where you inherit capital property, if possible, before the accountant files the terminal return of the deceased, you should ask them if they have the 1994 election on file, or if not, see if you can find the deceased's 1994 return to determine if an election was made in 1994. If the election was made, it will likely have no impact on your inherited ACB, but it may reduce the tax on the terminal tax return of your parent or relative etc.

Supporting Your "Bumped- Up" Adjusted Cost Base

Now that I have provided the income tax context, I can discuss the importance of documentation, as without the documentation, you will not know the inherited cost base of your capital property.

The key documents you hopefully already have on hand or can dig up from a box in storage are:

1. The terminal income tax return of your last surviving parent. This return will reflect the deemed disposition of any capital property held on your parent’s passing on Schedule 3 -Dispositions of Capital Gains (or Losses). The proceeds of disposition on this form will form the new ACB of the inherited property to you. Using my prior example, Schedule 3 would reflect proceeds of disposition of $80,000 for the 1000 RBC shares held on death and the $80,000 would become your new ACB.

2. It is possible a parent who pre-deceased their spouse left property directly to you. If that is the case, you would need their terminal tax return to review their schedule 3.

3.  Tax reorganization memos from your parent’s accountants if they undertook any post-mortem tax planning for your parent(s) private corporations. Depending upon the reorganization, there could be ACB increases, although in many cases, the key planning is creating tax-free promissory notes.

An interesting capital asset is the principal residence (“PR”) of your parents or anyone else you inherited property from. If the house was inherited and not sold immediately (say you kept the PR as a rental property), then the FMV of the PR on the death of your parent becomes important. However, prior to 2016, when the sale of a PR had to start being reported on Schedule 3 (and from 2017 onwards when it had to be reported on Schedule T2091) administratively the CRA did not require you to report the sale of your PR if it had always been your PE and the sale was exempt from tax as your PR. 

Thus, you may need to obtain a real estate valuation for the value of the PR at the deceased's passing, since there may be no record of the FMV on death.

If you have inherited capital property from your parent’s or any other person, hopefully you already have the documentation discussed above in place. If not, it would be a very useful project to try and obtain the documents before you decide to sell the asset and are forced to scramble to find information that can be twenty or thirty years old.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

When Spouses Don’t Leave All Their Assets to Each Other - The Income Tax Implications

You must admit, nobody has as many uplifting titles for their blog posts as I do. I have previously had such cheery titles as “Stress Testing Your Death” and “Is it Morbid to Plan for an Inheritance”. So today, in keeping with my "Morbid Mark" theme, I will discuss the tax implications that can occur when one spouse passes away, and does not will all of their assets to their surviving spouse.

Deemed Disposition Upon Death

Upon death, you are deemed to have disposed of your capital and non-depreciable property (typically your principal residence is tax-free) for proceeds equal to the fair market value (“FMV”) of the assets immediately before death. If the FMV of any property is greater than the original cost of that property, your executor must report a capital gain on your income tax return for the year of death (known as a terminal return).

For example, if John passed away on September 1, 2013 and he owned shares of Bell Canada worth $40 on September 1st, that he had purchased for $28 several years ago, his estate must report a deemed capital gain of $12 per share on his terminal return. The same would hold true for a rental property, which may also have additional potential issues, such as the recapture of capital cost allowance (depreciation).

Automatic Spousal Rollover

There is an exception to the deemed disposition rule, where the property passes to the deceased spouse, common-law partner or a "qualifying spousal trust". In this situation, the transfer takes place at the adjusted cost base (ACB) of the property, not the FMV of the property and the deemed capital gain is deferred until the spouse or common-law partner dies; or the property is disposed of by the spouse or common-law partner. So if John was married to Mary and left everything to her in his will, the Bell Canada shares would transfer to Mary tax-free at a cost base of $28.

In the good old days of Ozzie and Harriet, the automatic provision was fairly standard. People stayed married and both spouses would usually have mirror wills, leaving all or most of their property to each other.

Today, with the high rate of divorce, second families and spouses who have independent thoughts, it is not that unusual for spouses to have different wills or wills in which they only leave some assets to their current spouse.

Where spouses have different wishes in their wills and don’t leave all their property to their surviving spouse, the deemed disposition rules noted above come into effect. The resultant income tax liability can in some cases be large and where assets are not liquid, the payment of those taxes can sometimes be problematic.

Why Would Spouses Have Different Wishes

There are a myriad of reasons why spouses may not have mirror wills or leave all their assets to each other. Here are some common reasons:

1. Second families- A testator may structure their will to only leave a certain amount to the surviving spouse, or to a spousal trust for their surviving spouse so they can leave other property and monies directly to their children from the first marriage; this triggers the deemed disposition rules on the property left to their children.

2. Black Sheep Children -One spouse may have an issue with one of their children and be concerned their surviving spouse will turn around and leave money to the black sheep child when they pass away.

3. DINKS – The “double income no kids” cohort often have other family members they wish to benefit from their estate, such as parents, siblings, nieces and nephews. They are confident that their surviving spouse has enough assets of their own and will not need a large inheritance in order to have a prosperous retirement. According to estates lawyer Katy Basi “The wills that we draft for childless testators are often long and sometimes quite complicated. The tax implications of the estate plan need to be carefully considered.”

4. Charitable Wishes – Spouses often have different charitable views. One spouse may want to leave a significant portion of their wealth to charity while the other does not. In this case, the concern is not an income tax issue, as the donation(s) eliminate most of the tax liability, but the issue becomes a question of whether assets must be liquidated to enable the executor to make the donations in the will.

As I have been told my blog posts are too long, I will stop here today. On Wednesday, I will discuss the income tax implications, liquidity concerns and planning issues when spouses don't leave all their assets to each other.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.

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.

Financial & Tax Planning for the Terminally Ill - Part 2

Last week I wrote about organizing your affairs should you unfortunately be diagnosed as terminally ill. Today I will discuss some financial and tax planning considerations if you have been given a finite period to live.

Probate Fees & Income Taxes

Upon death, your estate will be subject to probate fees (more properly called estate administration fees in Ontario) and income taxes.

In order to minimize your probate fees and/or income taxes, I recommend you obtain tax and/or legal advice.

Probate Planning

This type of planning is complex and if not properly executed, can lead to income tax and legal issues. I have set out below some of the considerations in respect of probate planning. Again, get advice before considering any of the following planning strategies:

Joint Tenancy

In order to avoid probate fees, many people transfer their assets into joint tenancy, with the right of survivorship. This means that upon the death of one of the joint tenants, the property passes to the other tenant automatically. The risk with this type of transfer is if the property is capital property (such as stocks or certain real estate) that has appreciated in value, the transfer (if to anyone other than your spouse) will create a deemed capital gain and income tax liability.

So for example: if you transfer 100 shares of Bell Canada that cost you $2,000, either directly or into joint tenancy with your son and those shares are worth $5,000 today, you will have to report a capital of $3,000 if transferred directly, or $1,500 if transferred into joint tenancy; even though you just transferred the shares and did not sell them on the open market.

Where you are terminally ill, the deemed disposition may not be as large an issue as for a healthy person since you may only be accelerating the income tax liability a few months or years. This deemed gain upon death is discussed in greater detail below.

If you transfer a bank account or stock into joint ownership with one of your children to help you manage your money while you are alive, that child becomes the sole owner of that account when you pass away. That child may consider the account is theirs even if that was not your intention and decide not to share it with the other siblings. This can lead to estate litigation, especially where your intention is not documented.

Gifting

Similar to the issue above with joint tenancy, when you gift property to someone other than a spouse there may be a deemed capital gain where the property has appreciated in value. Thus, if you wish to make a gift, you should consider gifting cash instead of property to avoid any income tax issues (be careful to ensure any gifts are consistent with your wishes in your will- i.e. if you split your estate equally with your three children in your will, the gift should be 1/3, 1/3,1/3, or you may need to amend your will). However, care must be taken to ensure you will not need that money to live on or pay medical bills during your illness. I suggest you only gift money you are absolutely sure you will not need to live on.

Consolidation of Accounts

Many of us have multiple bank accounts, investment accounts, RRSPs etc. If you are terminally ill it may make sense to consolidate these accounts into one or two accounts to simplify your executor’s life. You may also want to consider liquidating certain investments so your executor does not have to deal with these decisions. However, you need to consider the investment merits of liquidation versus the “ease of administration” issue.

Estate/Income Tax Planning

As a courtesy to your executor, gather up you prior tax returns and put them in a box or file cabinet and ensure you advise your executor where they are located. If you made a 1994 capital gains election (a special election for that year only, that allowed you to “bump” up the cost of certain capital property), provide a copy of that return.

Income Tax Smoothing

If you are terminally ill and have a finite period of time to live, from an income tax perspective, you will want to minimize your tax bill over the remainder or your life by smoothing your income as best as possible. Smoothing your income involves utilizing the lower marginal rates, rather than just the high rate on death. Typically this would be done by drawing on your RRSP or RRIF. This may have the secondary advantage of providing funds to live on.

Capital Gains

Upon death, if you do not leave your assets to your spouse or you are the last spouse to pass away, you have a deemed disposition of your assets at fair market value. See my blog on death and taxes for more details. You can utilize any capital losses against capital gains in the year of death and can carryback any excess capital losses for three years. In addition, where you cannot use all your capital losses on your terminal return, the losses are deductible against all income on your terminal return or the year proceeding death.

Purify capital gains exemption

The same deemed disposition rule holds true for shares in any private corporations you may own. As discussed in my blog “Corporate Small Business Owners: Beware; the Capital Gains Exemption is not a Gimme” shares you hold in a small business corporation may be offside the rules to claim the $800,000 Capital Gains Exemption (indexed to $813,600 in 2015) where you have significant cash and/or investments in your corporation. In order to meet the criteria to qualify for the capital gains exemption, it is often advisable to pay a dividend from the corporation to reduce the corporation’s cash and near cash assets. Where you have a terminal illness, it is imperative you review the status of your corporation with your accountant to ensure your company is onside the rules or is “purified” to qualify for the exemption.

Charitable Giving

Consideration should be given to any charitable contributions you wish to make upon death or while alive. Any donations made in the year of death are not subject to any limitations and are 100% deductible. The tax savings are worth approximately one-half of the actual contribution. The rules for donations made in your will were made more flexible in the 2014 budget.

Medical Expenses

Medical expenses qualify as a non-refundable tax credit. In the year of death, medical expenses may be claimed for any 24 month period including the date of the person's death, which were not claimed in a prior year. Sometimes you may wish to amend a prior year’s medical expense claim to utilize the 24 month period option. However, as you would typically have significant medical expenses if you are terminally ill, there is often not much to be gained by using the 24 month option as you would receive a full tax credit.

This topic is unpleasant and dealing with financial and tax planning may be the last thing on your mind if you are terminally ill. However, engaging in financial planning for your own demise is prudent and your final act of kindness for your family and/or executors.

This site provides general information on various tax issues and other matters. The information is not intended to constitute professional advice and may not be appropriate for a specific individual or fact situation. It is written by the author solely in their personal capacity and cannot be attributed to the accounting firm with which they are affiliated. It is not intended to constitute professional advice, and neither the author nor the firm with which the author is associated shall accept any liability in respect of any reliance on the information contained herein. Readers should always consult with their professional advisors in respect of their particular situation. Please note the blog post is time sensitive and subject to changes in legislation or law.

When Spouses Don’t Leave All Their Assets to Each Other - The Income Tax Implications - Part 2

On Monday, I addressed deemed dispositions, automatic spousal rollovers and the reasons behind spouses deciding not to have mirror wills. Today, I look at the income tax liability and liquidation issues that arise when spouses do not leave all their assets to each other.

Tax Liability

The debts of an estate are paid from the residue the estate. This can be problematic where the intention is to leave a certain amount of money to a spouse and the rest to say the children of a first marriage. For example, an RRSP will transfer to your surviving spouse tax free, but the assets left to the estate for the benefit of the children will be subject to tax and the children will only get the net proceeds. This result is often not the intention of a parent who ignores the tax aspect of their legacy.

Often wills leave specific assets to certain beneficiaries and the residual of the estate to others. For example, if a son is the beneficiary of a specific asset, let's use a cottage, the son gets the cottage and the estate has the tax liability for the deemed disposition of the cottage. Again, that is not the intention of the deceased who assumes his son will be responsible for the tax liability on the cottage.

Lynne Butler of the blog Estate Law Canada says “It's possible to draft a will to state that the person receiving an asset should also pay the tax bill associated with the asset, but almost nobody ever does that. I think more people would do that if they were only aware that it was possible.”

In order to ensure you don’t “stick” your estate with a large tax liability, you may wish to consider Lynne’s advice when drafting any will, but especially where spouses have different wishes.

Liquid vs Illiquid Assets

As discussed on Monday, the deemed disposition rule can result in the estate being left with a large income tax liability; the ability to pay that liability is a function of the liquidity of the remaining assets. Where spouses have different wishes on death, your estate planning needs to consider if you are leaving the estate and/or your spouse with enough liquid assets to pay the deemed income tax liability.

For example, say Sue and her spouse Edward have equal ownership in a rental property. But Sue wants to leave her estate to her children from her first marriage while Edward wants to do likewise to his children from his first marriage. If Sue were to pass away first, there would be a deemed disposition of her 50% ownership in the rental property. Because much of Sue’s wealth is tied up in the rental property, it may be problematic for the estate to pay the income tax liability on her deemed disposition without liquidating the real estate to pay the income tax liability and Edward may not be amenable to doing such.

In situations such as these, where spouses have different wishes, they need to consider ways their estate can pay their final tax liability without a forced liquidation of assets. One possible solution is the use of insurance. Many people purchase insurance to cover their anticipated income tax liability on their death. Another alternative where there are significant liquid assets is to ensure the estate always maintains enough cash to cover any potential income tax liability on death.

Plan

Where spouses have different wishes upon death, the income tax consequences can get ugly. While in good health, spouses either independently or jointly, need to review these consequences with their accountant(s) or lawyer(s) to ensure they have considered the possible consequences and have a plan.

Next week, I will continue with this somewhat morbid theme and post a two-part guest blog by Katy Basi on "qualifying spousal trusts". Katy will discuss how they work and why you would consider using them. Katy is back by popular demand after guest posting on New Will Provisions for the 21st Century in respect of RESPs and Digital Assets.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs. Please note the blog post is time sensitive and subject to changes in legislation or law.