Tax Consequences When a Person Passes Away in Canada
There are certain practical matters to be aware of when a person passes away, a critical one being the income tax implications that arise upon the death of an individual in Canada. Understanding these implications is crucial for the deceased person’s estate and their beneficiaries.
Deemed Disposition of Assets
When an individual passes away in Canada, they are deemed to dispose of all their assets at fair market value. The deceased person’s estate is subject to, and becomes liable for, income tax on any accrued capital gains, net of capital losses, resulting from the deemed disposition. As this tax burden may be significant for a deceased person’s estate, and may create financial hardship, it is important to plan for the funding of this income tax while the person is alive.
There is tax planning available to minimize the value of a person’s estate on death and, therefore, the resulting income tax from the deemed disposition. It is critical, however, this planning be undertaken early in the lifecycle of a person’s estate plan.
Spousal Rollover
The deemed disposition of assets on the death of an individual can be deferred by leaving property to a surviving spouse or to a testamentary spousal trust. Any reference to a spouse for the purpose of this blog post includes a common-law partner. A testamentary spousal trust is trust created by the deceased’s will, under which the surviving spouse is entitled to receive all the income of the trust arising before their passing, and while the surviving spouse is alive, no other person may receive or obtain the use of any of the trust’s income or capital.
Provided the property vests indefeasibly in the surviving spouse or the spousal trust within 36 months of the deceased person’s passing, the property can “roll” to the surviving spouse or spousal trust without triggering immediate income tax (i.e., transferred on a tax-deferred basis). The surviving spouse or spousal trust is deemed to receive the property at a cost equal to the cost of the property to the deceased person immediately before their passing. The capital gain from the deemed disposition on death is then triggered on the death of the surviving spouse.
The term “vest indefeasibly” generally refers to the surviving spouse or spousal trust obtaining absolute and unconditional ownership in the property as a consequence of death of the deceased person.
It is important to note the spousal rollover only applies to property transferred to a surviving spouse or to a testamentary spousal trust. Any property transferred to other beneficiaries (i.e., directly to the children of the deceased) would not qualify for this rollover treatment.
Probate Fees
Probate is a legal process whereby a deceased person’s will is validated and an executor’s ability to manage the estate is confirmed. Probate fees in British Columbia are generally applied on the total value of a deceased person’s estate and the cost is typically 1.4% of the value, plus a filing fee. Probate fees are in addition to the income tax triggered on the deemed disposition of assets.
There are certain mechanisms available to minimize probate on certain assets. The common mechanisms are described on a general basis as follows:
- Utilizing beneficiary designations – designating beneficiaries on assets such as life insurance policies and registered accounts (i.e., RRSPs and TFSAs) allows assets to pass outside of a deceased’s will directly to beneficiaries.
- Multiple wills – certain provinces (including BC) allow the creation of multiple wills. Certain assets that are not required to be probated (i.e., shares and debt of a corporation) can be governed by a “restricted will” that is not subject to probate, while assets that are required to be probated (i.e., bank accounts and land) can be governed by a separate “general will” that is subject to probate.
- Gifting assets prior to death – gifting assets to beneficiaries prior to death can reduce the value of a person’s estate. However, any transfers of property prior to death should be planned with the advice of professional advisors as there are certain legal and income tax implications to consider.
- Use of trusts – transferring assets to a trust effectively removes the assets from a person’s estate however, professional advice should be sought to avoid inadvertently triggering income tax on a transfer of property. The use of an alter-ego trust or a joint spousal trust as a “will substitute” can be effective for those over the age of 65, while tax planning can also be undertaken to minimize the value of an estate with the use of trusts when a person is under age 65.
- Joint tenancy – holding assets in joint tenancy with another individual may avoid probate as the asset passes automatically to the other individual upon death. This type of planning requires the beneficial interest (i.e., not only the legal title) in the asset to be held by both parties. There are certain implications to be considered with this type of planning, such as the loss of control of the asset, exposure to creditors of the other individual, and tax implications when wholly owned assets are converted to joint tenancy.
Careful planning should be undertaken with the assistance of professional advisors to implement any mechanism to minimize probate fees, as tax and legal implications will need to be considered.
Reach out to one of Smythe’s estate planning experts today to discuss how you can minimize the income tax resulting from the deemed disposition of assets on death, as well as how to minimize any probate fees.
