Canada is currently one of the countries without an inheritance tax. This, however, does not mean that Canadians can forward their wealth tax-free. When a person passes on, their lawyer must file their final tax return to the Canada Revenue Agency (CRA) and also pay any outstanding tax they owe until the point of death. The taxes can be from some assets you owe like a car, cottage, investments, etc.
Since there is no inheritance tax in Canada, the CRA treats your principal residence as sales until it is inherited by a surviving spouse or common-law partner where applicable. You’d be taxed by the government as if you sold all your assets at market value before dying.
In the case where the value of the assets has increased since you bought them, you’d be taxed on 50% of the increased value, known as a capital gain.
What is an Inheritance Tax?
An inheritance tax is a charge on assets inherited from a deceased person’s principal residence, which means that the taxes owed are paid by the estates rather than the beneficiaries.
The value of the assets and the relationship between you and the deceased will determine of you will pay inheritance tax or not. Once the CRA settles the estate, the deceased’s beneficiary would not need to bother about taxes. Thus, whatever amount the deceased owed in taxes before dying would be paid in what is known as a deceased tax return.
An inheritance tax is retrieved from the heirs or beneficiaries of the estate of a deceased person. Once the transfer of the estate is made, the tax becomes payable. In some scenarios, every beneficiary is responsible for paying their inheritance tax according to the part/portion of the estate inherited.
The relationship between the deceased person and the beneficiary plays a significant role in determining an inheritance tax. Generally, spouses are excluded from paying inheritance tax. The inheritance tax law does not apply to entities and organizations that get an estate as a charitable donation from a deceased person.
The following set of people must pay inheritance tax: Lineal descendants and ancestors, including parents, children, siblings, and grandparents. Remote relatives and non-relatives encounter a much higher tax rate compared to close relatives. Inheritance taxes are imposed on the estate’s value, and when it is beneath the set limit, it will not be charged.
How Canadian Inheritance Tax Laws Works
In Canada, when a person dies, their legal representative or executor has to file a deceased tax return to the CRA. The deadline for sending filing this return depends on the date the person died. Any outstanding taxes owing from this tax return are automatically withdrawn from the estate before it can be settled.
Once the executor has settled the estate, they must request a Clearance Certificate from the CRA. This certificate confirms that all income taxes have been paid or that the CRA has accepted the payment security. Note that as an executor, it is crucial to get this document before sharing any property. Without a certificate, you can be held liable for any charges the deceased owes.
Inheritance Tax Rates in Canada
As mentioned above, there is no inheritance tax in Canada. All income earned during the lifetime of the deceased is taxed on a final return. Unregistered capital assets are deemed to have been sold for a reasonable market value immediately before death.
However, any subsequent capital gains are 50% taxable. Also, they are added to all other income of the deceased on their final return. Wherein the CRA will calculate the revenue at the applicable personal income tax rates.
The CRA tax these incomes at the applicable capital gains tax rates. A capital gain is a difference between the items’ reasonable market value when bought and the fair market value item of the same thing at the date of death.
Note that a reasonable market value of a Registered Retirement Savings Plan (RRSP) or a Registered Retirement Income Fund (RRIF) is added to the deceased person’s income. It is then taxed at the regular applicable personal income tax rates with no preferential treatment for any capital gains earned with the RRSP or RRIF.
Inheritance Tax Exemption in Canada
There are certain exemptions made available by the Canadian government for tax liability incurred for estimated disposition. Some of the exemptions include:
- The Principal Residence Exemption
- The Lifetime Capital Gains Exemption.
Inheritance Probate Fees and Estate tax
The state or the federal government imposes an estate tax based on the right to transfer. That is a person’s right to transfer their assets to their beneficiaries after death. An estate tax is calculated based on the total value of the deceased person’s estate. An estate is liable for paying the estate tax after the passing on of the owner.
All assets belonging to an estate is not taxable by the CRA, but you are expected to pay all taxes owed on income up to death. This means that the Canadian government taxes your income, not your assets.
When you file your annual tax income, both the federal and provincial government is owed tax. So when a person dies, the executed must file the final tax return as of the date of death. The final tax return would include any income they have received since the beginning of the year.
Some of the income that can be included in a final tax return include:
- Canada Pension Plan (CPP)
- Old Age Security (OAS)
- Retirement Pensions
- Employment income
- Dividend income
Bear in mind that all assets are considered to have been sold (disposition) before death for tax purposes. These assets include lands, businesses, RRSPs, real estate, investments, etc.
The considered sale of the assets can lead to several taxes. If a deceased used their spouse as a beneficiary. It could buy them some time as they could roll over provisions that are not taxable but deferred until later.
Although there is no tax on the assets, there is a possible disposition of the assets for tax purposes. In addition to income tax used generally, on the provincial level, a probate fee is applicable.
A probate fee varies per province in Canada, and it is based on the estate’s overall assets. Assets with a named beneficiary such as life insurance, RRSPs, and the Tax-Free Savings Account (TFSA) are not included when filing probate. Also, joint assets are not added for probate as the surviving joint owner automatically becomes the asset owner.
Inheriting tax-advantaged accounts
Generally, if you transfer RRSPs or RRIFs to your spouse during your lifetime, you are liable to pay tax on the total amount at the time of transfer. Alternatively, you can hold on to the money and share the income received from RRSPs\RRIFs with your spouse at age 65. You can also transfer your TFSA to your spouse’s TFSA during your lifetime. With this option, you can only transfer up to your spouse’s TFSA contribution limit, which means you will each want to maximize your TFSA limit.
Capital assets in a non-registered account are transferrable to your spouse. You can transfer these assets during your lifetime at your choice of Adjusted Cose Base (ACB) or Fair Market Value (FMV). Whatever choice you make, both are liable to tax deductions.
The Fair Market Value (FMV) is used in reviewing assets willed to children, either minor or adult. However, accrued gains at the time of the transfers are taxed in the transferee’s hand. In a minors’ case, dividends and interest income will be credited back and taxed in the transferor’s hand.
There are currently several elective tax returns that can be filed on death. These tax returns allow some personal funds to be claimed again on other returns. In some cases, it can lead to a substantial tax benefit.
RRSPs and RRIF
On death, either or both of your pension plans are deregistered. That is your Registered Retirement Savings Plans (RRSPs) and Registered Retirement Income Funds (RRIFs). However, if your plan’s beneficiary is your spouse or common law-partner, the CRA will add each plan’s total value to the income filed on your final tax return.
On average, most RRSPs and RRIFs provides instant access to cash to fund the tax liability. This is done by having the plan liquidate the holdings, while the remaining value to be forwarded to the deceased person’s beneficiary can reduce considerably.
You are considered to have received the FMV of all assets in your RRSP or RRIF before death if you leave untaxed accumulation in your RRSP or RRIF. The assets of a deceased person can be transferred tax-free to their surviving spouse’s RRSP or RRIF.
In the case of no surviving spouse, the CRA will transfer the RRSP assets to the estate unless a beneficiary is stated. Any reduction in RRSP assets’ value held in the estate can be used to lessen the income filed on the deceased’s final tax return.
Purchase Life Insurance
Life insurance is one useful tool you can use to fund a tax liability on death. With life insurance, the estate does not have to be liquidated to pay tax. It can come in handy when an estate can not be easily converted to cash. This can be because a larger part of the estate consists of cottages or other real estate holdings.