Planning for the future means addressing two certainties—death and taxes. While losing a loved one is emotionally difficult, the tax impact and administrative burden that follow can be mitigated through proactive estate planning. Proper preparation ensures that assets are transferred efficiently, minimizing tax liabilities and legal costs.
In Canada, unique tax rules apply upon death, including the “deemed disposition” of assets, where the government treats everything as if it was sold just before death, potentially triggering significant tax consequences. Additionally, probate fees—varying by province—can reduce the final value of an estate. Understanding these rules is essential to safeguarding wealth for beneficiaries rather than seeing a large portion lost to taxation and administrative expenses.
Starting the estate planning process early provides more flexibility and control over tax-efficient strategies. A well-structured plan ensures that your financial legacy is preserved and distributed according to your wishes, rather than being dictated by government regulations.
Tax Considerations Upon Death
Deemed Disposition
Upon the death of an individual resident in Canada, the Canada Revenue Agency (CRA) deems all of the individual’s assets to be disposed of – such as investments, RRSP/RRIFs, real estate and business assets – at fair market value. This may result in a significant tax liability, particularly for individuals with large investment portfolios, registered investments or properties that have appreciated in value.
Tax Impact of Various Assets
- Investments – taxed on the net gain, the difference between fair market value at the date of death and the original cost base of the asset. The gain is included in income at the capital gains inclusion rate, which is currently 50%.
- RRSP/RRIF – fully included in income at the fair market value at the date of death. Because the registered investments have been used to reduce tax over time as they were contributed to the registered plans, they are fully included in income at the date of death.
- Real Estate – is also taxed on the net gain and included in income at the capital gains inclusion rate of 50%.
- Business Assets – if there is a sole proprietorship, the assets of that business are considered to be disposed of at fair market value as well. For depreciable property, this could result in recapture being fully included in income.
Spousal Rollover
An exception to the deemed disposition on death rules is if the assets of the deceased are left to the surviving spouse. The assets can transfer to the spouse on a rollover basis to avoid triggering any immediate tax consequences. The assets maintain their original cost base, deferring tax until the surviving spouse either sells them or passes away.
Proper planning is essential to maximize the tax deferral:
- Ensure beneficiary designations on registered accounts and insurance policies are up to date.
- Clearly outline asset transfers in a will to avoid complications.
- Consider spousal trusts to provide further control over how assets are managed.
If there is no surviving spouse or assets are left in the will or designated to a beneficiary other than the spouse, the deemed disposition rules apply.
Tax Filing Obligations of a Deceased Taxpayer
Final Tax Return
An executor must file a final T1 return, reporting all income and expenses from January 1 to the date of death. This return includes any income earned prior to the deceased’s passing and also any income resulting from the deemed dispositions of assets. If the taxpayer passes away in November or December, their return is due 6 months after the date of death, otherwise the final T1 return is due to be filed on April 30th of the year following the death.
Optional Tax Returns
- Rights or Things Return – can include income that was earned but not received before the individual died such as wages, dividends and pension benefits. The benefit of the rights or things return is the access to additional tax credits to help reduce the overall tax burden of the deceased individual and their estate. A rights or things return is due to be filed by the later of one year after the date of death and 90 days after the notice of assessment for the final return.
- Graduated Rate Estate Return – includes income earned on the assets after the date of death until the assets are transferred to the beneficiaries or are sold. The graduated rate estate benefits from lower marginal tax brackets for up to 36 months following the date of death. An estate return is due to be filed 90 days after the year end of the estate.
Probate Fees
Probate is the legal process that confirms a will’s validity and grants the executor authority to distribute the assets of the estate. Probate fees vary widely by province. For example, Saskatchewan and British Columbia impose probate fees based on a percentage of the value of the estate whereas Alberta charges a modest flat fee.
Strategies to minimize probate fees include:
- Joint ownership with rights of survivorship, which allow assets to transfer directly to a co-owner and would not form part of the estate.
- Naming beneficiaries on registered accounts (e.g. RRSPs, RRIFs and TFSAs) and insurance policies.
- Setting up trusts to transfer wealth outside of probate.
Steps taken to minimize probate fees may cause additional tax and legal implications immediately or upon death and should not be undertaken without first consulting your accountant and lawyer.
Estate Planning Considerations
- Updated will: Ensures assets are distributed according to your wishes and consideration can be made to incorporate asset distributions in a tax efficient manner.
- Life insurance: Helps cover estate taxes and provides liquidity.
- Gradual withdrawal of RRSPs/RRIFs prior to death: May lower overall taxes by spreading the income inclusion over many years and utilizing tax brackets efficiently.
- Trusts: Can provide asset protection and tax benefits.
Conclusion
Estate planning is a crucial step in preserving wealth and ensuring a seamless transition of assets. You can protect your estate from unnecessary taxation by understanding deemed disposition rules, probate fees and tax-minimization strategies.
Given the complexities of tax law and estate planning, consulting a CPA or estate lawyer is highly recommended. Regularly updating your estate plan in response to life changes will help secure your legacy and provide peace of mind for your loved ones.
