No inheritance taxes
There are no inheritance taxes or gift taxes in Ontario payable by the recipient of funds.
When you are alive you can give money at any time to an adult child. The child will not have to pay any gift taxes. You, however, should be careful about a) capital gains taxes that might be payable on the disposition of the ‘asset’ (for instance, if you give a cottage rather than cash), and b) the attribution rules if the cash you give is invested.
Estate Administration Tax is an Ontario tax that must be paid on probate. Learn more here.
The deceased’s income taxes
The estate must pay all income taxes owed by the deceased. This includes for years prior to death, and, for the year of death. These taxes should be paid before any estate assets are distributed to beneficiaries.
The income of the deceased in the year of death often includes income from the deemed disposition on death of assets such as real estate (cottages, rental properties) and RRSPs.
Note that all assets owned by the deceased are deemed disposed of when the deceased dies, even if they are not actually sold by the estate until much later. Taxes are payable first, by the deceased with respect to the deemed disposition on death, and second, by the estate, for any gains during the period the asset was held by the estate.
The principal residence exemption
Capital gains on the principal residence of the deceased may be exempt from taxation. Some key points to consider:
- An individual can only have one principal residence at a time,
- It must, truly, be their principal residence,
- For the exemption to be claimed, it must be declared on the tax return of the year of disposition,
- The exemption only applies to share of the gain proportionate to that individuals ownership of the property (if they owned one half, they can only shelter one-half the gain). Accordingly, individuals who are co-owners but not co-residents may not benefit from the exemption on ‘their share of the gains’.
The taxation of RRSPs and RRIFs
The full value of an RRSP or RRIF must be included in the income of the deceased in the year of death unless the the RRSP or RRIF is ‘rolled-over’ to the spouse of the deceased. This rule applies regardless of whether there is a named beneficiary of the RRSP/RRIF.
As a result, it is very possible that 100% of an RRSP/RRIF can pass directly outside the estate to a named beneficiary, while the estate must pay taxes on the full value of the RRSP/RRIF as if it were income of the estate (which tax rate can be 50%).
There is no roll-over available for RRSPs or RRIFs that pass to a named beneficiary who is an adult child who is not disabled.
The taxation of TFSAs
There are no taxes payable on funds held in a TFSA.
If a TFSA is rolled over to a spouse as ‘successor annuitant’, then, the funds in the TFSA remain ‘in a TFSA’ regardless of whether the surviving spouse also has contributed to a TFSA. Income on funds rolled over to a successor annuitant remains tax free.
TFSA funds that pass to a named beneficiary (who is not a spouse named as a successor annuitant) pass outside the estate directly to the beneficiary and are tax free, but do not retain their character as TFSA funds – income in the future will be taxable.
The estate trustee must prepare (or have prepared) all outstanding income tax returns and file them. They must also pay all taxes as assessed, in a timely manner and minimize penalties and interest charges.
It is common practice for the estate trustee to request a ‘clearance certificate’ from Canada Revenue Agency. Once one is received, the estate trustee can then distribute the balance of the estate without personal risk for future tax liabilities.
Clearance certificates often take 4-6 months to receive, after the request is filed.
Nothing says that the estate trustee must wait for a clearance certificate before distributing some, or even all of the estate. As a general rule, ‘sooner is better than later’ for distributions to beneficiaries, so prudent but effective estate trustees weigh the benefits of early distribution against the risk of potential future tax liabilities, and often make substantial interim distributions and only retain a modest holdback until the final clearance certificate is received.