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TAXATION AT DEATH

  1. What am I taxed on in the year that I die?
  2. What are deemed dispositions?
  3. What happens to my pension tax credit the year I die?
  4. What happens to my personal and other non-refundable tax credits when I die?
  5. What happens to Alternative Minimum Tax upon my death?
  6. What happens to my CNIL balance when I die?
  7. What happens to my capital gains exemption upon my death?
  8. What happens to my charitable tax credit when I die?
  9. Am I taxed on jointly held, non-registered assets?
  10. Am I taxed on registered assets?
  11. May a contribution be made to my RRSP in the year of my death?
  12. Can a $6,000 Spousal RRSP contribution, relating to the receipt of pension benefits, be made in the year of my death?
  13. What happens to my retiring allowance payments?
  14. May I transfer assets to my surviving spouse with a deferral of tax?
  15. When I die, what happens to the assets in an inter vivos trust that I had established?
  16. Is an employer-paid $10,000 Death Benefit taxable?
  17. What happens to CPP I was splitting with my spouse?
  18. Are insurance proceeds taxable?
  19. Do the attribution rules stop when I die?
  20. What portion of the RRSP may be transferred as a Refund of Premiums to my surviving spouse's RRSP?
  21. What happens to my pension plan when I die?
  22. What type of tax return must the deceased file and when?
  23. What are the main planning ideas in the year of death?

Appendix:

  1. Checklist of Filing and Planning Requirements

1. What am I taxed on in the year that I die?

You are taxed on all the income which you have earned to the date of death as in every other tax year.

For example, any employment, pension, child tax benefit, unemployment insurance, RRSP, RRIF, rental, interest, business, or other type of income must be reported on a final or terminal tax return, and any tax owing remitted.

Furthermore, any capital property* owned by the deceased, is considered to have been disposed of (although no sale actually occurred) immediately before death. Any resulting capital gains on the deemed disposal will be subject to tax.

*Capital Property can include real property, mutual fund shares/units, small business shares, etc.

The tax bill at death can be particularly large, where a person who dies has:

  1. considerable property with accrued gains (all triggered at the same time)
  2. recapture on depreciable property deemed to be disposed of
  3. no spouse to transfer the property to (cannot use the Spousal rollovers)
  4. no capital gains exemption left (to offset the capital gain) (note the $100,000 exemption is not available after February 22, 1994, except for shares of qualified small business corporations and qualifed farm property)
  5. a CNIL (that precludes the use of an otherwise available capital gains deduction)
  6. no farm property (cannot use the Farm rollovers)
  7. non-qualified shares of a small business corporation (so cannot use the super capital gains exemption)

2. What are deemed dispositions?

Although the deceased has not sold all of the property he/she owns at the time of death, for tax purposes, all capital property is deemed to have been disposed of immediately before death as follows:

Non-Depreciable Property

Fair Market Value less Adjusted Cost Base = Capital Gain or Capital Loss

3/4 of capital gain is taxable

3/4 of capital loss ("net capital loss") can offset taxable capital gains in the year of death. A net capital loss can be carried back 3 years and applied against capital gains of those years, with any remaining amount used to reduce ordinary income either in the year of death or the preceding year. Alternatively, the net capital loss can be used against ordinary income in the year of death or the preceding year. Capital losses can only be applied against ordinary income to the extent that they exceed the capital gains deductions claimed by the taxpayer in previous years.

Depreciable Property

Fair Market Value less Cost = Capital Gain

3/4 of capital gain is taxable

Lesser of Fair Market Value and Cost less Undepreciated Capital Cost = Recapture or terminal loss

Recapture is fully taxable on terminal tax return

Terminal loss is deductible within the final return

Note: Where property transfers to the surviving spouse the transfer occurs at Adjusted Cost Base (Undepreciated Capital Cost for depreciable property) unless Fair Market Value (after 1992 for depreciable property) is elected. This is true for both jointly owned and/or solely owned assets that transfer to the spouse.

Note: Where qualified farm property transfers to a spouse trust or child the transfer rules are more flexible. As with other capital property, qualified farm property transfers to the surviving spouse at Adjusted Cost Base unless Fair Market Value is elected. However, Qualified farm property transfers to the surviving child (minor or adult) or a Spousal trust at Adjusted Cost Base, unless an election is made to have the transfer occur at another point between Adjusted Cost Base and Fair Market Value.

For a further discussion on this topic, obtain Revenue Canada's Guide for Preparing T1 Returns for Deceased Persons. Better yet, use the Tax Manager referral service to arrange for preparation of the deceased's final tax return.

3. What happens to my pension tax credit the year I die?

If you were eligible for the credit had you not died in the year, you get to use it, with respect to the eligible pension income received (January 1 to date of death). For example, if you are going to turn age 65 on June 30, 1996 and you die March 1, 1996 - you would have turned 65 in the year of death, so you could use the pension credit in respect of eligible income received during the January 1 to March 1, 1996 period for which you receive a tax slip in the year of death. The tax slip can be issued following death, so long as it is issued during the year of death.

If you are unable to use all of your eligible pension credit, you can transfer the remaining credit to your surviving spouse so long as you have first reduced your own tax liability to zero. This transfer can occur regardless of the surviving spouse's age.

4. What happens to my personal and other non-refundable tax credits when I die?

See Revenue Canada's "Guide for Preparing T1 Returns for Deceased Persons" T4011(E).

Here are some basic facts to calculate non-refundable tax credits regardless of when you die in the year. Once you know the "amount" on which to determine the credit - the rules are the same (i.e. 17% of the "amount").

Type "Amount" To Determine Credit:
Basic Personal Full personal amount
Age Amount If at least 65 on day of death, claim full amount available (The age credit is reduced by 15% of net income in excess of $25,921)
Married Amount Use Spouse's income for whole year to determine married amount - the credit is reduced by 17% of the spouse's net income in excess of $539
Dependent Children No longer available after 1992, unless over 18 and infirm
Pension Income Amount Use eligible pension income to date of death to determine pension income amount (the maximum credit is $170, based on $1,000 of eligible pension income)
Medical Expenses Expenses can be for any 24 month period that includes the date of death, as long as not previously claimed by deceased
Charitable Amount see Question 8

5. What happens to Alternative Minimum Tax upon my death?

In the year of death, it is not necessary to calculate Alternative Minimum Tax (AMT). Only the normal tax calculation is required. Consequently, any RRSP deductions or other items that would normally be added back to determine AMT are not a problem.Where the deceased had to pay AMT in a previous year, and hoped to recover AMT paid under the seven year carryforward - the last year to recover is the year of death.

6. What happens to my Cumulative Net Investment Loss (CNIL) balance when I die?

It dies when you die. However, if you are hoping to use a capital gains exemption in respect of the deemed disposition of the deceased's property, remember the deemed disposition occurs immediately before death, when CNIL technically stills exists. Unless you can use the farm or spousal rollovers to avoid a deemed disposal at Fair Market Value - the CNIL balance can preclude the use of a capital gains deduction by the deceased.

7. What happens to my capital gains exemption upon my death?

Remember that the February 22, 1994 budget eliminated the $100,000 capital gains exemption, other than for qualified small business corporation shares and qualified farm property and subject to the special one-time election available with the 1994 tax return. For those taxpayers who still may be able to use the super capital gains exemption on qualified small business corporation shares and qualified farm property, the super capital gains exemption dies with the taxpayer. You do not get to give it to someone else. Because your property is deemed to be disposed of "immediately before" death, however, you technically still have any available super capital gains deduction to use "immediately before" death, unless you have a Cumulative Net Investment Loss Balance (CNIL) that would preclude the use of some or all of the otherwise available Super Capital Gains deduction.

If a client is precluded from using or has used up the capital gains exemption, remember that capital losses (which can be carried forward indefinitely) may be able to offset a capital gain. Here's how:

Step One: Capital losses can be carried back 3 years before death. The loss carried back cannot be more than the capital gains in those years.
Step Two: If there are still unused capital losses, the deceased may be able to offset (totally or partially) capital gains in the year of death to the extent that any remaining, unused capital losses exceed the capital gains exemption already claimed by the deceased on capital gains realized in prior years.
Step Three: If there are still unused capital losses available after having worked through Step One and Step Two, 3/4 of the remaining capital losses can be used to reduce other income in the year of death.

Terminal losses in the year of death (associated with depreciable property - see Question 2) can offset "other" income in the year of death.

8. What happens to my charitable tax credit when I die?

The deceased may claim a credit for donations made in the year of death and apply the credit to reduce tax otherwise payable in the final return. Donations made by virtue of a last will and testament are considered to have been made in the year of death.

Where an individual has died in 1996 or a subsequent year, the limit on gifts which may be claimed in the year of death is 100% of the deceased's net income in that year. Any credit which cannot be used in the year of death may be carrried back to the previous year.

9. Am I taxed on jointly-held, non-registered assets?

Regardless of how you jointly own the non-registered asset (joint tenancy or tenants in common) the portion of the property owned by the deceased is deemed to be disposed of on death.

If the surviving joint tenant is the spouse of the deceased, the deemed disposal occurs at adjusted cost base (unless fair market value is elected), so the deceased could defer the capital gain to the surviving spouse. When the deemed disposition occurs at fair market value (elected in the case of spousal transfers or automatic in the case where a non-spouse receives the property), the deceased can offset the gain against capital losses if any.

The point, however, is that assets held as joint tenants avoid probate due to right of survivorship, but joint tenants (and tenants in common) do not avoid deemed dispositions for tax purposes.

10. Am I taxed on registered assets?

It depends. See Section 3 on Beneficiary Designations.

11. May a contribution be made to my RRSP in the year of my death?

Not unless the contribution was made by you prior to your death. However, if you have prior year's earned income or carry forward room, your estate representative can make a contribution to a Spousal RRSP, after your death, where your spouse's age permits. The government has become more lenient about the deadline for making this Spousal RRSP contribution (deductible on the final tax return for the deceased):

The deadline is 60 days following the year in which the taxpayer dies. (It used to be 60 days following death.)

12. Can a $6,000 Spousal RRSP contribution, relating to the receipt of pension benefits, be made in the year of my death?

For the 1989 to 1994 taxation years, the estate representative could, within 60 days following the end of the year of death, based on the periodic, private pension or DPSP income that was received during the period January 1 to the date of death, make the spousal RRSP contribution and deduct same on the deceased's tax return. This 60(j.2) $6,000 annual maximum rollover privilege was only available for tax years from 1989 to 1994.

13. What happens to my retiring allowance payment(s)?

If you are entitled to a retiring allowance but die before retiring, the amount(s) that would have otherwise been paid can be paid to the deceased's estate. The amounts are not however, treated as retiring allowance payments, so are fully taxable to the deceased. (If part of the payment of what would otherwise have been a retiring allowance can be classified as a "death benefit", the first $10,000 would be an employer-paid non-taxable benefit, to the surviving spouse or any other beneficiary).

If you have already retired, and were either expecting your retiring allowance or had already commenced receiving some retiring allowance installments, the amounts received after death qualify as a retiring allowance and the eligible amount can rollover to the RRSP of the surviving dependent or related beneficiary. If the surviving dependent or related beneficiary has not acquired the right to the retiring allowance one year after the date of death or 90 days after the mailing of the notice of assessment in respect of the deceased's year of death (whichever occurs latest) or there are no named or surviving beneficiaries, the remaining payments are treated as rights or things. More on rights or things at question 22.

14. May I transfer assets to my surviving spouse with a deferral of tax?

Yes. Transfers of capital property to a spouse on death occur automatically at adjusted cost base, unless the estate representative elects that the transfer occur at Fair Market Value. If Fair Market Value is elected (no special form to do this, just a notation with the income tax return), capital losses either carried forward from previous years (or the super capital gains deduction if applicable and there is no CNIL balance to worry about) can be used to offset any taxable capital gain.

15. When I die, what happens to the assets in an inter vivos trust that I had established?

The assets of the trust (unless the terms of the trust provide otherwise) remain the trust's. The trust assets therefore avoid probate and and are not deemed to have been disposed of on the death of the settlor. See the Trust section for more. See the rules with respect to the Spousal Trust.

16. Is an employer-paid $10,000 Death Benefit taxable?

No. While the $10,000 Death Benefit cannot be transferred to the RRSP of the surviving spouse or dependent, the $10,000 Death Benefit is tax-free, so long as the employer issues the appropriate tax slip in respect of the Death Benefit.

17. What happens to CPP I was splitting with my spouse?

If a couple is splitting CPP benefits, the surviving spouse would, from the date of death, receive his/her own CPP retirement benefit in full, plus any CPP survivor's pension as it would normally be calculated had the splitting not occurred in the first place. This example assumes both the husband and wife were eligible for CPP in the first instance.

18. Are insurance proceeds taxable?

Insurance proceeds paid to a named beneficiary are not taxable to the named beneficiary or the deceased whose life was insured. If the insurance proceeds were instead payable to the deceased's estate, the estate is not taxed on the proceeds either. However, proceeds paid to the estate are subject to probate fees. See Section 7, Question 5.

19. Do the attribution rules stop when I die?

Yes.

20. What portion of the RRSP may be transferred to my surviving spouse's RRSP?

See Section 3 on Beneficiary Designation.

21. What happens to my pension plan when I die?

If you are survived by a spouse, the spouse will be the beneficiary of your pension plan as required under provincial pension legislation (there is a possible exception in Ontario and British Columbia, where a spouse can waive a pre-retirement death benefit and there may then be a non-spousal beneficiary to a pre-retirement death benefit). If the spouse receives a lump sum cash settlement or other periodic pension payments, the spouse will be taxable on same when received. In many cases, the spouse will be able to transfer a lump sum benefit to a LIRA, LIF, or Life Annuity, and the spouse will be taxed on payments when received from that particular vehicle, based on the rules regarding those products. Check with the pension sources if you need further information on the options available to the spouse, which will depend on the legislation governing the pension plan in question.

If you do not have a spouse when you die, or if you are dealing with a pre-retirement death benefit in Ontario or British Columbia for which the spouse has formally waived the benefit, the tax consequences depend on who is the beneficiary

of the pension plan. If the beneficiary is the estate, the pension assets will form part of the final tax return for the deceased pension plan member and will be taxed accordingly. If the beneficiary is an individual other than the estate, the plan value is taxed in the hands of the recipient. If the beneficiary is a minor child or grandchild who was financially dependent** on the deceased, the child can purchase an annuity with a term not to exceed 18 minus the age of the child at the time of the plan member's death, and have the taxation of the pension benefit spread over the term of the annuity. If the beneficiary is an adult child or grandchild who was financially dependent** on the deceased and who is mentally or physically infirmed, the lump sum settlement proceeds can be rolled over to the child's or grandchild's RRSP. In all other cases, the cash refund received by the beneficiary is taxed in his or her hands in the year of receipt.

**A child or grandchild is assumed to not be financially dependent if the child or grandchild earned more than the basic personal amount in the calendar year prior to death of the pension plan member. For the 1995 taxation year, the basic personal amount is $6,456 (this amount is the basic personal amount on which the non-refundable tax credit is based, at line 300 of the T1 General Tax Return, and it is subject to change from year to year because it is indexed and therefore is affected by the rate of inflation).

22. What type of tax return must the deceased file and when?

The deceased's representative may be able to file up to four different tax returns on behalf of the deceased. The more tax returns that are filed, the more personal credits and the lower overall tax rate that may be available. Here are the four types of tax returns:

Chapter 6 of the Tax Library (Elections to File Separate Tax Returns) gives a lengthy description of when the deceased may be able to use these tax returns. Here is a brief description of when the four tax returns would be available:

Final or Terminal Tax Return

The final return is the same T1 Tax Return a client who lives throughout the year would file, but there is a section to note that the person is filing a final tax return, having died in the year. The specific rules to complete the final return are provided for in part in this section and in the guides* and other materials available from Revenue Canada. Also, Chapter 6 of the Tax Library is dedicated to this subject. Check with your Tax Manager contact person to determine the cost associated with completing a final tax return for the deceased. The final or terminal tax return must be filed by the later of:

The final tax return must be accompanied by a copy of the Will, plus a list of all of the personal and real property (including Cost and Fair Market Value) of the deceased.

*Guide for Preparing T1 Returns for Deceased T4011(E)

Rights or Things Tax Return

If the deceased has earned, but not yet received certain income (listed below), the Rights or Things tax return can be used.

Income earned but not received that qualifies as rights and things:

Not Included as rights and things is income associated with:

Proprietorship or Business Tax Return

If the deceased operated a business that was not incorporated (ie. a proprietorship or a partnership) and the business had a fiscal year end that is not December 31, then there may be an opportunity to file a separate proprietorship or business tax return. Here is when:

Testamentary Income Beneficiary Tax Return

If the deceased is an income beneficiary under a testamentary trust and the trust has a fiscal year end other than December 31, a separate tax return may be filed including only the income from the trust which arose after the end of the taxation year of the trust, up to the date of death.

T3 Trust Return

The deceased's representative is also responsible for reporting the income and capital gains of the estate (generated after the death of the deceased). The return is due 90 days after the year end of the estate and on an annula basis thereafter until the estate is wound up. The income that is distributed or allocated to the beneficiaries is not taxable to the trust but taxed in the hands of the beneficiaries. However, the representative has an opportunity to reduce the income taxes payable in the hands of the beneficiaries by electing to have the income taxed in the estate (an income splitting opportunity). This would be advantageous if the beneficiaries are in a tax bracket higher than the estate (estates are subject to the same graduated marginal tax rates as individuals). However, a trust is not permitted to use the nonrefundable tax credits that individuals have access to, so the electin is not logical where a beneficiary is at the lowest tax level and would remain in there with the income allocations from the estate.

23. What are the main planning ideas in the year of death?

See the attached list of planning ideas. These ideas are also found in the Appendix to Chapter 6 of the Tax Library.