The loss of a loved one is an emotionally overwhelming experience. Amid the grief, the person named as the executor is tasked with the significant responsibility of managing the deceased’s financial affairs. This process, often called estate administration, involves a complex web of legal and tax obligations that can be daunting to navigate. Understanding these duties is crucial for any executor to ensure the estate is settled correctly and efficiently, minimizing potential tax burdens and family disputes.
This guide will demystify the key financial steps and tax implications that arise after a person passes away in Canada, providing clarity on everything from probate fees to the final tax return.
The Executor’s Primary Role: Marshal and Manage
At its core, an executor’s duty is to step into the financial shoes of the person who has passed away. This involves a comprehensive process of:
- Identifying and gathering all assets: This includes real estate (houses, cottages), bank accounts, investment portfolios, registered plans (RSPs, RRIFs, TFSAs), pensions, and personal property.
- Identifying and paying all liabilities: This includes mortgages, loans, credit card debts, and, most importantly, taxes.
- Distributing the remaining assets to the beneficiaries as outlined in the will.
A crucial piece of advice for any executor is to convert assets to cash as quickly as is feasible. Once sentimental items have been distributed, liquidating assets like vehicles, investments, or property into a single estate bank account simplifies the process of paying debts and distributing the inheritance. Holding onto assets that can fluctuate in value can complicate the tax filings and distributions later on.
The Two Major Tax Hurdles: Probate and Income Tax
When settling an estate, executors will encounter two primary forms of taxation. It’s important to understand that they are separate and distinct.
1. Probate Tax (Estate Administration Tax)
Probate is the legal process where a court validates a will and officially appoints the executor. To receive this authority, the estate must often pay a probate tax, known in Ontario as the Estate Administration Tax. This tax is calculated on the total fair market value of the estate’s assets.
In Ontario, for example, the rate is approximately 1.5% on the value of the estate over $50,000. This applies to almost everything the deceased owned, including:
- Real estate
- Bank and investment accounts
- Vehicles and other personal property
For a $2 million estate, the probate tax alone could be close to $30,000.
2. The Final Income Tax Return (Terminal Return)
Separate from probate, the executor must file a final income tax return for the deceased, covering the period from January 1st to the date of death. The most significant and often surprising element of this return is the “deemed disposition” rule.
Under Canadian tax law, a person is considered to have sold all of their capital property at fair market value immediately before death. This means any unrealized capital gains on assets like rental properties, cottages, non-registered investment portfolios, and corporate shares are triggered and become taxable on the terminal return.
For example, if an individual bought a cottage for $100,000 decades ago and it’s worth $900,000 upon their death, there is an $800,000 capital gain. Half of that gain ($400,000) is included as taxable income on their final return, potentially resulting in a tax bill of over $200,000. This can create a significant cash flow problem if the value is tied up in an asset like real estate.
A Closer Look at How Different Assets Are Taxed
The tax treatment of assets varies significantly. Here’s a breakdown of the most common types:
- Registered Retirement Savings Plans (RSPs) and RRIFs: If there is no surviving spouse or qualified beneficiary named, the entire fair market value of the RSP or RRIF is included as 100% taxable income on the terminal return. A $500,000 RRIF could easily result in a tax liability of over $250,000.
- Tax-Free Savings Accounts (TFSAs): A TFSA remains tax-free up to the date of death. However, any growth or income earned within the TFSA after the date of death is taxable. This is why it’s crucial for the executor to liquidate these accounts promptly.
- Principal Residence: Generally, the capital gain on a principal residence is exempt from tax. However, careful records are needed, and complexities can arise if the individual owned more than one property.
- Secondary Properties (Cottages, Rentals): As mentioned, these are subject to the deemed disposition rule, and the capital gains are taxed on the terminal return.
- Corporate Shares: Shares in a private corporation are extremely complex. They are subject to deemed disposition on the terminal return, but the value is also still inside the corporation. This can lead to a significant double taxation problem if not handled with expert tax planning. Strategies exist to mitigate this, but they require professional advice.
Strategic Planning to Minimize the Tax Burden
While taxes at death are unavoidable, proactive planning can significantly reduce the burden on an estate.
- Designate Beneficiaries: Naming beneficiaries directly on registered plans (RSPs, RRIFs, TFSAs) and life insurance policies allows these assets to bypass the will and, therefore, avoid probate tax.
- Spousal Rollovers: The Income Tax Act allows most assets, including RSPs/RRIFs and capital property, to be transferred (or “rolled over”) to a surviving spouse on a tax-deferred basis. This doesn’t eliminate the tax but pushes the liability to the future when the surviving spouse passes away.
- Strategic Gifting: Gifting assets to children or others during your lifetime can reduce the value of your estate for probate purposes. However, gifting capital property can trigger immediate capital gains tax for the person giving the gift, so it must be done carefully.
- Donating Shares In-Kind: For those with charitable intentions, donating publicly traded shares (either during life or through the will) is a powerful strategy. It not only provides a donation tax credit but also eliminates the capital gains tax on those shares.
- Dual Wills: For business owners, a dual will structure can be highly effective. A primary will deals with personal assets that require probate, while a secondary will deals with the corporate shares, which can often be transferred without needing probate, saving the estate 1.5% of the company’s value.
- The Peril of Joint Ownership: A common but risky strategy is adding a child as a joint owner on a house or bank account. While the intent is often to avoid probate, this can create serious unintended consequences. The CRA may view it as a disposition, potentially triggering a capital gain. Furthermore, the asset is now exposed to the child’s creditors or any marital property claims in a divorce. This strategy can also create conflict if there are other siblings who are not on title.
Final Steps for the Executor
Once taxes are calculated and paid, the executor should obtain a Clearance Certificate from the Canada Revenue Agency before distributing the final assets. This certificate confirms that all tax liabilities of the estate have been settled. Distributing assets without one can make the executor personally liable for any unpaid taxes the CRA later discovers.
The journey of an executor is complex and fraught with potential pitfalls. Given the significant financial and legal responsibilities, it is always recommended to seek professional advice from lawyers and accountants who specialize in estate administration. Their guidance can save the estate thousands of dollars and ensure the final wishes of your loved one are carried out smoothly and correctly.
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Article courtesy of Jeff Brown, Chartered Professional Accountant, Partner, Bouris Wilson LLP
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