The Death of a Taxpayer
Benjamin Franklin's observation that the only
certainties in this world are death and taxes is only half the truth; the whole truth is
that we continue to pay taxes even when we're dead.
What will be taxed and what will be paid depends
on a wide range of factors such as the deceased's portfolio, employment and marital status
as well as a host of other factors. The following are the most common areas worth talking
over with your chartered accountant.
Principal Residence
The deceased's house is usually considered the
principal residence and thus the increase in its fair market value from the date of
purchase to the date of death is exempt from tax. It may be transferred to the surviving
spouse or other beneficiary without creating an income tax liability. This generalization
is premised, however, on the assumption that no other house such as a vacation property
has been designated the principal residence.
Personal Items
Personal possessions are usually not taxable at
the time of death. Items such as motorcycles, boats, household furniture, etc. will not be
considered taxable unless they have increased in value. Care must be taken while planning
the estate to ensure that the tax on personal property of high value, such as art,
jewelry, coins, stamps and rare books is minimized.
RRSPs
If the deceased has a Registered Retirement
Savings Plan (RRSP), contributions have been providing personal income tax deductions
since the year the plan was created and all capital gains, dividends and interest income
generated within the plan have been sheltered from tax. The federal government has
refrained from taxing these funds in order to allow the taxpayer to provide for his or her
own retirement. If, however, the taxpayer dies before these funds have been deregistered
and thus become taxable, the fair market value of the whole amount remaining in the RRSP
at the time of death becomes taxable as income in the year of death. For most taxpayers
this means taxation at the highest personal rate. If the deceased has chosen during his or
her lifetime to use part of the allowable annual contribution to create an RRSP registered
in the name of the spouse, that RRSP will not be subject to tax at the contributor's
death.
When the surviving spouse or common-law partner
has been designated sole beneficiary, the entire fair market value of the deceased's
unmatured RRSP, i.e. not yet paying a retirement income, can be rolled over tax free into
the spouse's or partner's RRSP. If the RRSP is mature and thus already paying an annuity,
it remains in place but the annuity now goes to the surviving spouse or partner who
receives it as taxable income.
RRSP amounts paid to financially dependent
children or grandchildren will be included in their incomes and taxed accordingly. Unless
the contrary can be established, a child is assumed not to be financially dependent if his
or her income exceeded $9,600 for the prior year. Children can transfer the RRSP amounts
received into an annuity. The term of the annuity may not exceed 18 years minus the age of
the child when the annuity is established. Such a transfer could be compared to a spousal
transfer with a few notable exceptions.
•
The transfer is
allowed only for children under the age of 18.
• The
annuity ends when the child reaches the age of 18.
• Annuity
income is taxable in the hands of the child.
• All funds
within the annuity must be distributed to the child before the child's 19th birthday.
If there are financially dependent children or
grandchildren with physical or mental infirmities, the rollover provision provides that
the fair market value of the RRSP may be transferred to an RRSP, a life or term-to-90
annuity. The absence of the age restrictions that affect other financially dependent
children or grandchildren permits long-term financial considerations to be addressed.
Investments
Investment assets are deemed to have been
disposed of at fair market value at the date of death. The taxable amount is one-half of
the difference between the fair market value at that date and the adjusted cost base, i.e.
the purchase price adjusted for brokerage and other costs. Since no brokerage is paid on
the deemed sale, the fair market value is considered to be the sale price.
• Interest
Income
Interest income accrued to the date of death
must be included in the deceased's income. For instance, if the deceased taxpayer had
$100,000 in a 5% Government of Canada bond that paid interest on June 1 and December 1 and
died October 31, the $2,500 interest payment received must be included in income plus the
interest accruing from June 2 to October 31 of $2,077 for a total income of $4,577.
If the bond is not liquidated in the distribution
of the estate, interest earned from the date of death becomes income in the hands of the
beneficiary. Care should be exercised to not include amounts in income twice. The $2,077
in the above example should be deducted from the next $2,500 payment before it is included
in the income of the beneficiary or the estate.
•
Equity Investments
Taxable capital gains, if any, are calculated by
netting out the gains and losses of the equity portfolio as at the date of death. This is
done by subtracting the original cost of the investment plus brokerage fees etc. from the
fair market value of the investment at the date of death. Only half the capital gain is
subject to tax. The best way to ensure payment of only the correct minimum level of tax is
to keep an accurate record of all investment transactions including the date of purchase,
number of shares, price paid and brokerage fees. Other investment tax considerations may
come into play that will require the expert advice of a chartered accountant.
If the deceased has named the surviving spouse as
the beneficiary, investments are transferred to the spouse at the deceased's adjusted cost
base. Alternately, the executor could elect out of this rollover, on a
security-by-security basis, to pay tax on the capital gain in the deceased's final return.
There are two choices:
1. Have
the gain included in the deceased's income and transfer the assets with an adjusted cost
base equal to the fair market value of the securities at the date of death.
2. Transfer
the assets at the adjusted cost base attributable to the deceased at the time of death.
There is no capital gain or loss in this case.
The consequences of these alternatives are
best explained by an example.
Assume the following:
•
Many years ago the deceased
purchased 100 shares at $10 per share for a total investment cost of $1,000; and
•
At the time of death,
the 100 shares have a fair market value of $200 per share for a total of $20,000
Scenario 1
At the time of death, the executor elects to
report a capital gain of $19,000 for the deceased and $9,500 is included in the deceased's
income for the year of death. The surviving spouse inherits the shares at an adjusted cost
base of $20,000 since the deceased has already paid the tax on the capital gain. If the
surviving spouse disposes of the shares at a later date, a capital gain will be calculated
as the difference between $20,000 and the disposal price less brokerage.
Scenario 2
The surviving spouse inherits the investment at
the adjusted cost base of $1,000 even though the investment is worth $20,000 at the date
of death. The spouse pays no tax until he or she sells the shares. If the shares are sold
for $20,000 shortly after the date of death, the spouse records a $19,000 capital gain and
pays income tax on $9,500. If the shares are sold for, say, $25,000, some years later, the
spouse will realize a $24,000 capital gain and take $12,000 into taxable income.
Capital losses occur when the deemed or actual
disposal price is below the adjusted cost base. Tax treatment of losses will vary
depending on the marginal tax rates and other factors of both the deceased and the
surviving spouse.
The Bottom Line: Be Prepared
People of all ages find it hard to contemplate
their own death and its consequences. As a result, when death occurs, survivors are often
left unprepared for the effects of taxes on themselves or on the deceased. Reviewing your
personal financial position, planning your estate and discussing your options with your
chartered accountant is a positive step toward eliminating unpleasant surprises for your
loved ones as they face one of the most distressing events of their lives - your death. |
