Death of a Loved One: Filing the Final Tax Return

Death of a Loved One: Filing the Final Tax Return

020317_Thinkstock_491359394_lores_KWDealing with the death of loved ones is difficult, and that may be compounded by having to figure out how to handle their taxes after they’re gone.

Canada doesn’t have an inheritance tax. Instead, Canada Revenue Agency (CRA) treats the estate as a sale, unless the estate is inherited by the surviving spouse or common-law partner, where certain exceptions are possible. This means that the estate pays the taxes owed to the government, rather than the beneficiaries paying. By the time the estate is settled, the beneficiaries shouldn’t have to worry about taxes.

Legal Representation

When someone passes away, that person’s legal representative (executor or estate administrator) has to file a final income tax return and take care of many other tasks. This article can help you understand what to expect during the process.

The representative:

1. Advises the CRA, Revenu Québec (if appropriate) and Service Canada of the date of death.

2. Arranges transfers to a survivor, if applicable, of any of the following benefit and credit payments:

  • Goods and services tax/harmonized sales tax (GST/HST) credit,
  • Working income tax benefit advance payments, or
  • Canada child benefit

If the death occurred between January 1 and October 3, 2016, the deadline for filing the final return and paying any tax owing is May 1 this year, as the usual April 30 falls on a Sunday. If the death occurred between November 1 and December 31, 2016, the deadline is six months after the date of the death.

Determining Total Income

The representative must determine the deceased person’s income from all sources from January 1 of the year of death up to, and including, the date of death. The representative will probably need previous tax returns and may have to contact employers, banks, trust companies, stock brokers and pension plan managers. The final return can’t be submitted through NETFILE.

Tax returns must be filed for any years that the person didn’t file before the year of death. If an individual who pays tax by installments dies during the year, payments due on or after the date of death don’t have to be paid.

In some cases, cheques may arrive for the deceased person. You may have to return certain cheques, but payment will definitely have to be stopped for the Canada Child Benefit, the GST/HST/QST credit and other benefit cheques if applicable. Employee vacation pay is considered income for the deceased and unused sick leave is considered income for the estate or the beneficiary.

Taxes and Debts First

Like all other debts, income tax has to be paid by the estate first before beneficiaries can inherit. This is part of settling the estate. The notice of assessment for the deceased individual’s tax return is one of the documents the legal representative needs in order to get a clearance certificate and distribute property from the estate.

A clearance certificate officially states that all amounts for which the deceased is liable to the CRA have been paid — or that the CRA accepted security for the payment. If the representative doesn’t get a clearance certificate, he or she can be liable for any amount owed.

The certificate covers all tax years to the date of death. It isn’t a clearance for any amounts a trust owes. If there’s a trust, a separate clearance certificate is needed.

Account and Asset Transfers

In terms of transfers, any non-registered capital property may be transferred to the deceased taxpayer’s spouse or common-law partner.

If there are registered assets such as Registered Retirement Savings Plans (RRSP) or Registered Retirement Income Funds (RRIF), the deceased person is deemed to have received the fair market value of the plan’s assets immediately prior to death. This amount must be included in the income of the deceased unless the spouse or common-law partner or a dependent child or grandchild is entitled to the funds.

If an individual or individuals are designated as beneficiaries, the proceeds from the plan will be taxable in their hands in the year they receive the money unless it’s transferred into their own tax-deferred plans. If no one is a designated beneficiary, the plan’s value may still be taxable in the hands of family members or others if they’re beneficiaries of the estate. In addition, proceeds in the RRSP may also be able to be rolled over to a Registered Disability Savings Plans for the benefit of a financially dependent infirm child or grandchild.

Other rules apply if death occurred after the plans matured and began paying out annuities.

If the value of investments in a registered plan declines between the date of death and the time of final distribution to the beneficiaries, that decrease may be carried back and deducted against any income from the registered plans that was included on the final return. For this to happen, the plan:

1. Must be wound up by the end of the year following the year of death, and

2. Must have held no investments other than qualifying investments during the post-death period.

If the deceased individual had a Tax-Free Savings Account (TFSA), tax implications may vary. The account holder can name a spouse or common-law partner as the successor holder. In that case, the spouse or partner becomes the new holder, keeping the account’s tax-exempt status. This won’t affect the TFSA contribution room of the spouse.

If some other person is named as beneficiary, the account will no longer be a TFSA. Whether or not a beneficiary can be named in a TFSA contract depends on provincial legislation. The legal representative will determine what applies in your case.

Assets with named beneficiaries such as life insurance policies or RRSPs are usually excluded in determining the value of an estate for purposes of probate. It’s likely that a TFSA with a named beneficiary would also be excluded from probate. Again, this depends on provincial legislation.

If no successor holder is named for the TFSA, the proceeds of the account become part of the estate. Any proceeds from the account that a surviving spouse or common-law partner receives can be used to make an exempt contribution to the survivor’s TFSA without affecting the contribution room of the survivor, provided:

  • It’s done before the end of the first calendar year after death, and
  • It’s designated as an exempt contribution in the survivor’s income tax return for the year of the contribution.

If there’s no spouse or common-law partner named as successor holder, the TFSA won’t lose its tax-exempt status until the earlier of:

1. The time it’s completely paid out to beneficiaries and no longer exists, or

2. The end of the first calendar year after death.

Any payments to beneficiaries, including during this exempt period, will be taxable to them to the extent that the payments include income or capital gains earned after the death of the holder.

Final Word

Representatives may also use optional tax returns to declare certain types of income. Also, by claiming certain amounts more than once, splitting them between returns or claiming them against certain kinds of income, representatives may be able to reduce or eliminate the deceased’s tax payable. Contact your tax advisor for more information in your situation.

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