Death and Taxes

by MSO

"In this world nothing can be said to be certain, except death and taxes." Benjamin Franklin

True as it is, that life has no certainties except for death and taxes – but very few understand that often, the two coincide.

While Canada has no official death, estate or inheritance taxes, an estate may be faced with large and unexpected tax liabilities and can become overwhelming very easily – especially during a time of grieving with three potential taxes that may be incurred at death.

Income tax due to deemed disposition:

During the year of death, the estate’s executor/liquidator is required to file a final (terminal) tax return which includes all income earned by the deceased up to the date of death, which also includes net capital gain (profits from investments).

When a person dies, according to the deemed disposition rules of the Income Tax Act, all capital property owned by the deceased is treated as if it had been sold immediately prior to death, so even though the person did not actually receive that amount, deemed proceeds of disposition is an expression that considers an amount received after death.

However, if the deceased’s will leaves all assets to a surviving spouse or to a special trust for a spouse (spousal trust), the Income Tax Act does contain a provision to defer the tax owing under the deemed disposition rules. This means that no tax is payable until either the spouse or the spousal trust sells the asset(s) or until the surviving spouse dies.

Provincial Probate Taxes:

Upon death, it is the responsibility of the executor of the estate to file for probate (the legal process of administering the estate of a deceased person by resolving all claims and distributing the deceased’s property) with the provincial court. The executor must submit the original will and an inventory of the deceased’s assets to the court, where upon acceptance of these documents, the court issues letters of probate. This verifies that the submitted will is a valid document and confirms the appointed executor.

Once the executor submits the information to the court, a probate tax, based on the total value of assets described in the will, must be paid. Depending on the province, the rate charged will vary, with the exceptions of Alberta and Quebec, where significant probate taxes are levied.

In certain situations where the estate is extremely simple, the probation may not apply or can be reduced by using strategies such as naming of beneficiaries, Joint Tenancy with Right of Survivorship agreements and the use of living trusts.

U.S. Estate Tax:

While an estate may have to pay taxes in Canada, an estate may also be subject to a tax bill from the U.S. Government if the deceased owned U.S.-sourced assets, such as real estate, corporate stocks and certain bonds. These kind of ownerships require the estate to pay U.S. Estate Tax based on the market value of their U.S. assets at death.

Assets considered “U.S. situs” property will be subjected to this tax and may cause a significant tax burden to their estate.

To alleviate the burden of the U.S. Estate Tax, there are a some methods one can due to reduce the total cost:

* To allow the total estate value to be maintained, life insurance can be used to cover the U.S. Estate Tax bill;

* While timing is everything, the simplest method of avoiding the tax would be to sell U.S. assets prior to death;

* For someone who has substantial U.S. holdings, another option is the use of a Canadian holding corporation (a firm that owns other companies outstanding stock);

* Reduce the value of the estate below the current threshold and dispose of the real estate. This can be done by gifting assets;

* Hold the asset in joint ownership;

* Hold Canadian mutual funds that invest in the U.S. market in order to make the asset a Canadian asset, preventing it from being subjected to U.S. Estate Tax.

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