Estate Related Taxes in Canada
Estate planning is done to ensure a proper transfer of one’s assets upon death. However, another important consideration is minimizing taxes that arise on death. Below is a brief overview of estate-related taxes and how those taxes can be minimized through an effective estate plan.
Estate Taxes in Canada
Canada does not have an estate tax, unlike the United States which has a unified gift and estate tax regime (US estate taxes). There are however a number of different taxes that can arise on death:
- Probate fees – Most provinces levy some form of tax on the value of the assets in an estate (for example, in Ontario the fee can be as high as 1.5% of estate values). Probate tax can be in most cases be planned around and minimized.
- Capital gains tax – resulting from what is known as the “deemed disposition” of one’s capital property (for example shares in a private corporation) at the time of death.
- Registered plan income – inclusion in income of the full value of the deceased’s RRSP, RRIF and DC Plan.
These taxes and related planning opportunities are discussed below.
Probate fees (known as the estate administration tax in Ontario) are levied in most provinces based on the value of assets being distributed under your will. At the time of death, there are some legal formalities that must be satisfied before your executor can assume control of assets under your will. Namely, your will must be legally approved by the courts in your province (this is known a probating a will) before certain assets (such as bank accounts and real estate) can be transferred into the name of your executor and ultimately pass to the beneficiaries of your estate.
This probate process verifies that your will is legitimate and that the named beneficiaries are entitled to your assets. It also confirms the appointment of your executor. This process comes with fees (essentially a tax) based on a percentage of the assets in your estate. The probate fee (estate administration tax) in Ontario is 1.5% of assets exceeding $50,000. For example, if the assets passing under the will have a value of $1 million, the estate administration tax in Ontario would be approximately $15,000.
There are a variety of planning techniques, best implemented with the advice of your lawyer, which can minimize or plan around this fee. Some typical techniques include using a primary Will (probated) and Secondary Will (not probated), naming a beneficiary of your RRSP, RRIF, and insurance policies, and transferring assets into joint ownership with your spouse or children. The income tax considerations of these various techniques should be reviewed with a tax specialist before proceeding.
Capital Gains Tax
The Income Tax Act provides that on death you will be deemed to have disposed (i.e. sold) all your capital property (such as shares of a private company) at current fair market value. This deemed disposition takes place even when the property is retained in the estate for distribution to beneficiaries. An important exception is that the transfer of property on death to your spouse or a spousal trust can take place on a rollover basis, deferring any taxes until the property is actually sold.
If the value of the capital property owned at death is greater than its original cost (known as its “adjusted cost base”) then a capital gain will be realized and 50% of that gain is subject to tax. Similarly, if any capital property has declined in value, 50% of the loss is an allowable capital loss that can be used to offset taxable capital gains. Any taxable gains in excess of allowable capital losses must be included in the last tax return of the deceased person, known as their terminal tax return. It is possible to utilize the deceased’s principal residence exemption to offset gains arising from the deemed disposition of the deceased person’s home. And, as previously noted, there is no capital gain (or loss) arising on property that is transferred to a spouse or a spousal trust. For more information, see Capitals Gains.
Therefore, if a person has shares in a private (or public) company and at time of death they have a value of $10 million and their adjusted cost base (what was paid for them) was $1 million a $9 million capital gain will arise from the deemed disposition rules on death. A taxable capital gain of $4.5 million will be included in the deceased’s terminal tax return and, based on a top marginal tax rate of approximately 50%, there will be a tax liability of $2.25mm. As part of the estate planning process, consideration as to how this tax will be funded (such as through insurance or liquidation of other assets) should be addressed.
Registered Plan Income Inclusion
While funds are invested in a person’s Registered Retirement Savings Plan (“RRSP”) or Registered Retirement Income Fund (“RRIF”), the income earned on those funds will accumulate tax-free. The same is true for someone who is a member of a Defined Contribution Pension Plan (“DC Plan”). However, if funds are withdrawn from an RRSP, RRIF or DC Plan, those funds are included in plan member’s income.
At time of death, all the remaining funds in these plans are included in the person’s terminal tax return. It is possible to avoid this income inclusion by naming the surviving spouse as the beneficiary of the RRSP, RRIF or DC Plan. In this case the registered proceeds will be taxable to the spouse. However, the spouse can transfer those funds into an RRSP or RRIF or DC Plan and avoid immediate taxation. Similar rules apply where the registered funds are transferred to a dependent child or grandchild. The value of the registered plan will be included in the income of the dependent child/grandchild, but there is a more limited ability for the child/grandchild to transfer those funds into an RRSP to defer taxation.