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February 2008 Article

Income Tax Considerations upon the
Death of a Loved One

Article by Barbara Bell

When there is a death of your spouse or a good friend, as the executor (or legal representative), it is easy to feel overwhelmed by making the arrangements for the funeral, securing and valuing the deceased person’s assets, cancelling credit cards and identifying all of the debts, and still allowing for the grief. Then, to make matters worse, it is the executor’s responsibility to file all of the necessary tax returns for the deceased.

There are a number of things that the executor should consider when they attend to this responsibility, including:

Have all previous tax returns been filed?

The executor of the estate is responsible to file all of the personal tax returns for the deceased on a timely basis.  If the loved one passed away in January, February or March there is a good chance that the return or the previous year was not filed and therefore it is due to be filed within 6 months of the date of death.  For example if your spouse passed away on March 1st 2007, the 2006 return was due by Sept. 1st, 2007.  And in some cases if the deceased was a good friend who had been sick for a year or more, it is very possible that there are one or two years of tax returns outstanding. 

The executor can contact Canada Revenue Agency (CRA), by sending them a copy of the death certificate, the deceased’s social insurance number and a complete copy of the will, asking them what personal tax returns are outstanding.  Delaying these filings could cost the estate considerably more dollars in interest and penalties.  This extra interest and penalty cost may be reduced by completing a taxpayer relief request.

What are the filing deadlines?

If your loved one passed away during the months of January 1 and October 31, the final return is not due until April 30th of the following year.  If the death occurred during the period from November 1st through December 31st then the return is due six months after the date of death.  As mentioned above if the previous year’s tax return has not been filed, it is due 6 months from date of death.

What is taxable for the deceased on the final return?

All income earned from the period January 1st to the date of death must be reported on the final (terminal) personal tax return for the deceased (unless reported on optional returns – see below).  This would include any employment income, investment income such as interest and dividends to date of death, all of the person’s RRSP or RRIF, any capital gains on securities, etc. 

In the year of death the Income Tax Act treats all capital property owned by the deceased as if it was sold immediately prior to death.  So assets like stocks and bonds, buildings or land would be treated as disposed of at fair market value as of the date of death.  Capital gains must be calculated on these assets and included on the deceased’s final tax return.  There are certain assets that can be transferred at cost to a spouse or in some cases to a child or grandchild, there by deferring the reporting of any capital gain. CRA’s pamphlet, Preparing Returns for Deceased Persons, is a good source of information to assist the legal representative in determining all of the taxable income for the final return.

How much will the taxes be and can I make any istribution to the beneficiaries?

It is best to file all of the outstanding tax returns before the legal representative makes any distribution to beneficiaries.  However if there is a pressing need for the beneficiaries, you may wish to estimate the taxes by reviewing previous year’s assessment notices to ensure all taxes to date have been paid and to get an idea of the usual annual tax cost. 

Calculate the capital gains on all of the deceased’s assets and then take 25% of that as a tax cost. Then take 50% of all RRSP or RRIF assets as another tax estimate cost. Then add all of these tax estimates together (usual annual tax cost prorated + capital gain tax estimate + RRSP or RRIF tax estimate) plus another 10% of the balance should give you a good estimate.  However, the executor is legally responsible for taxes payable by the estate and if there had been a distribution, any short fall of monies for taxes, may end up as the executor’s liability.

How can I pay as little taxes as possible?

As many as four separate tax returns may be filed by the legal representative for a deceased person.  The final or “date of death” personal tax return must be filed and it includes taxable income from January 1st to date of death, unless reported on one of the optional returns.  The optional returns include the “rights or things” return for amounts owing to the deceased but not paid as of the date of death; the “business” return for business income; and, a testamentary trust return for trust income. 

There are very specific conditions for each of these optional returns, but under the correct circumstances the filing of these returns will reduce taxes in the year of death because each return is subject to tax at the marginal rates and allows for full personal tax credits.  It is best to seek professional advice to see if the deceased qualifies for these filings.

The executor may also consider what assets to transfer at cost to a spouse, if available, to defer the reporting of capital gains where appropriate.  Also, if the deceased’s assets are not all distributed to the beneficiaries very close to the date of death, a T3 trust return for the estate may have to be filed and this can provide other tax saving opportunities. 

There are many tax planning opportunities that arise on death, so if you have taken on the role of executor, it may be best to consult a professional to assist you or at least visit the Canada Revenue Agency web site: www.cra-arc.gc.ca/

DISCLAIMER: This newsletter is for information and educational purposes only. The information contained in this report has been compiled from sources I believe to be reliable.

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