Tax Filings at Death (Part 1) - The Final Tax Return
It is always difficult when a loved one passes away and every situation will be different. In this article we will cover a few preparation points through the final personal tax return. Estate filings that follow will be covered in a future article.
The value of planning before death cannot be emphasized enough. These discussions may feel awkward, but it will significantly reduce later challenges, like locating contact information or identifying the assets held. These circumstances will also usually require collaborative efforts between the executor, beneficiaries, lawyer and accountant.
Before we get into the specifics of due dates and relevant tax items, we have a few tips and references that may be helpful to you.
Advance Planning:
Ensure your will, health care directives and power of attorney are up to date
Ensure your executor knows where to locate this documentation and has the contact information for their professional advisors.
Review banking authorizations etc to ensure that your executor can access the necessary funds until the Estate begins to disburse assets. (i.e. to cover funeral costs or clear any outstanding bills)
Consider whether your assets are liquid and if insurance may be beneficial to assist with future tax obligations.
If possible, prepare a summary of your assets/liabilities with the contact information of the advisors (i.e. investment account, insurance policies, financing); this can be as simple or as detailed as you like.
If time permits, meet with the VR team to discuss any tax planning opportunities that should be considered or implemented prior to death.
After Death:
Notify the lawyer, accountant, CRA, Service Canada, bank, investment and insurance advisors, etc.; they will guide the next steps
Prepare a listing of the cost and fair market value of assets/liabilities or obtain one from the advisors above if possible.
Gather tax slips and other information required for tax filings as it becomes available
The Practical Logistics
All bank/investment accounts are owned by the individual up to the date of death. At the date of death, the TFSA, RRSP/RRIF and non-registered accounts will essentially be closed. The balances in these accounts will move to one non-registered account in the name of the Estate. The funds will now remain here or be moved to a lawyer’s trust account until it is time for distribution.
You can choose to leave the funds in the investment account and generate some additional income while you wait (i.e. probate). You will also need funds to pay any outstanding bills, personal and estate taxes. Any questions about probate should be covered with your lawyer.
Once probate is done, all tax filings are complete, and CRA has issued a Clearance Certificate, the funds can be distributed to the beneficiaries. Some executors will choose to do partial distributions during the waiting period but enough funds for taxes or any issues should always be held back.
This process can be as time consuming as it can be complex. Depending on the details of the Estate, it can take several years from the time of death to the conclusion of the duties of the executor. Looking at the above items as early as possible can help to streamline the process, and reduce the stress of those dealing with your Estate.
Tax Return Filings Required With Due Dates
The deceased will need to file at least one final tax return (T1) that includes items from January 1 until the date of death.
If there are significant assets, or assets subject to probate, an estate/trust return (T3) may also be required (more on this will be covered in Part 2 of the series). This return includes income after death but until the assets are distributed. This can occasionally be several years of returns if the distribution is a lengthy process.
Final tax return filing due dates (T1):
Date of Death - January 1 through October 31 inclusive
Filing Due Date - April 30 of the following year
Date of Death - November 1 through December 31 inclusive
Filing Due Date - 6 months after the date of death
Unexpected Tax Implications
Deemed disposition at death
What often comes us a surprise to the individuals responsible for the final tax filings is that the final tax return also includes a “deemed disposition” of all the assets held by the deceased. It helps to think about this as a sale to the Estate.
A deemed disposition means that the assets are reported as sold, even though they are still held by the Estate, usually at the current fair market value. Sometimes this can result in gains/losses that may have a tax advantage. There are tax planning opportunities that could exist at this stage, so it’s always good to consider the options.
Note that when there is a surviving spouse, the assets can roll over to the spouse at cost but you may not want to always do this at cost.
Examples of assets to be considered:
Non-registered investment accounts
Principal residence
Secondary properties such as cottages
Shares of private companies (can be difficult to appropriately value and may have its’ own double-tax exposure if careful planning is not done)
Once all the deemed dispositions are reported at the elected values on the final tax return, these assets and the elected value will basically move into the Estate. The new elected values will form the cost base of the assets in the Estate.
RRIF/Registered account taxation
If you are stilling holding funds in a RRIF or RRSP account at death, and have no surviving spouse, the entire fair market value balance will be taxed. This can often result in losing 48% of the balance to income tax.
If you do have a surviving spouse, the balance in the RRIF account will move to the spouse (no tax implications on the deceased’s return) and future withdrawals from the RRIF by the spouse will be increased.
Once taxed on the final return, the account will become a non-registered of the Estate. Any income or gains/losses after death will be reported on the Estate return.
CPP death benefit
When an individual passes away, the beneficiaries will receive a $2,500 payment through a CPP application noted as a “death benefit.” The benefit is taxable to whoever received the funds. It is not included on the deceased’s final tax return. Often we will see this benefit reported in the Estate or split on the beneficiary tax returns. This item is not well known and can be a surprise to those who received the funds.
Unexpected Tax Benefits
Donation credits
Usually donation amounts are limited to 75% of net income. But in the year of death (and the immediately prior year), the limit is increased to 100% of net income. This will be something to watch for in the final tax return preparation.
Medical credits
Medical expenses must normally relate to a 12-month period however, this is extended to the prior 24 months as long as the amounts have not been claimed previously. The limit for attendant care is also expanded to $20,000.
Unused net capital losses
Typically net capital losses can only be used against taxable capital gains. In the year of death, if there are any losses carrying forward from prior years, these may be used against ANY type of income. This will also be impacted by the prior use of any Capital Gains Exemption.
Stay tuned for Part 2 of the series where we will cover the estate/trust (T3) returns required for the period of time until the assets can be distributed to the beneficiaries.