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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.

Probate Taxes

Estate Administration Tax is an Ontario tax that must be paid on probate.  In very rough terms it is 1.5% of the value of the probated estate.  Learn more at Probate Taxes.

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 capital assets such as real estate (cottages, rental properties).  This will result in capital gains tax (very roughly 25% of the increase in value).  In addition, unless they are ‘rolled over’ to the spouse of the deceased, the full value of RRSPs and RRIFs must be included in the taxable income of the deceased in the year of their death – even if the RRSP/RRIF passes outside the estate to a designated beneficiary.

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 a 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 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’s income taxes

The income earned by an estate (as distinct from the income earned by the deceased) is also taxable.  For instance, if the estate is invested in GICs, then the interest received will be taxable income of the estate.

If the CPP death benefit is received by the estate (which is the most common outcome) it is taxable income of the estate.

The taxation of an estate in the first three years is ‘graduated’.  This means that, like a person, the tax rate is lowest on the first income and then the ‘marginal tax rate’ increases at certain levels of income, such that high incomes (over $200,000 per year, are taxed at over 50%).

Starting 36 months after death, the estate will no longer be able to apply the graduated tax rates to its income – all income will be ‘taxed at the top marginal rate’.  This is a very strong incentive to cease earning income in the estate and to finalize distribution, if at all possible, within 36 months of death.

It is common to hold estate assets that are being held for distribution in the near future in non-interest bearing trusts.  This ensures that the trustee does not get into a never ending cycle of ‘receiving small amounts of income, having to report it and pay tax on it, then being unable to get a clearance certificate and finalize the estate’.

Personal liability for taxes

It is the estate trustee’s obligation to ensure that all taxes of the deceased and the estate are paid in full before the estate is fully distributed.  Note that this does not mean that none of the estate should be distributed before a clearance certificate is received.  It just means that before the estate trustee makes a distribution to beneficiaries that they should be certain that they have retained sufficient funds (a ‘holdback’) to pay any tax liabilities that are reasonably foreseeable – see below for more.

In certain circumstances, a beneficiary who receives funds from an estate can be personally liable to the extent of the funds received for any unpaid income taxes related to what they received.  For instance, if an individual receives proceeds from an RRSP directly by way of beneficiary designation, and the estate fails to pay the income taxes of the deceased that arise from the termination of the RRSP , then CRA seek to recover the unpaid taxes directly from the beneficiary.

Filing Income Tax Returns

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.

Clearance Certificates

A clearance certificate is a certificate from the tax authority (in this case, usually Canada Revenue Agency) certifying that no income taxes are due by the estate.

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 to the estate trustee or the beneficiaries for tax liabilities of the deceased or the estate.

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.

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