Estate and Inheritance Tax in Canada

You’ve put a lot of time and effort into your will. You’ve spent the time having those difficult discussions and dwelling on something you’d rather not. The last thing you want is for the taxman to come in and wreak havoc on your carefully considered plan.

It’s essential to consider all angles when you’re planning your will. Unfortunately, taxes and tax planning need to be a part of that plan.

Estate tax and inheritance tax in Canada

The good news is: there is no inheritance tax in Canada. 

This means beneficiaries don’t have to worry about taxes on any of their inheritance because the estate pays all the tax before it is received by the beneficiaries. However, this doesn’t mean death is tax-free. Instead of taxing inheritance, the Canadian Revenue Agency (CRA) levies an estate tax. 

Estate tax vs. Inheritance tax

Though both estate and inheritance tax are levied after death, there are important distinctions between the two which are important to take into account when estate planning.

The main difference between the two is who pays.

• Estate Tax is paid by the estate before it’s given to the beneficiaries.

• Inheritance Tax is paid by the beneficiaries after receiving their inheritance.

How does Canada’s Estate Tax work?

After death, the executor must file a final tax return as of the date of death. This tax return must include all income received since the beginning of the calendar year. This could include salary income,  CPP (Canada Pension Plan), OAS (Old Age Security), RIF (Retirement Income Fund) income, etc. 

All assets owned by the deceased are deemed to be ‘sold’ at fair market value. The income from this ‘sale’ must be included as income on the final tax return.

This can potentially trigger a large tax bill.

While inheritors won’t have to deal with the estate tax, the executor will have to take a few steps before carrying out the instructions in the will.

1. The executor of the estate must file a final tax return for the deceased which includes all income for the year. Along with the deemed disposition or “sale” of the assets in the estate.

2. Once the taxes are paid, the executor must obtain a clearance certificate from the CRA or they can be held personally liable for any taxes owed by the deceased.

3. Finally, the already-taxed assets can be distributed as per the will.

What is the final tax rate?

Calculating the tax bill depends on the assets and income the deceased retained until their death. However, there are a few things to take into account that will affect that final tax bill.

• All income is taxed at the applicable personal income tax bracket for the deceased.

• Non-registered capital assets, which could include rental property, are considered sold at fair market value. Half of any capital gains over the purchase price are taxable.

• The fair market value of registered assets, like a Registered Retirement Savings Plan (RRSP), a Registered Retirement Income Fund (RRIF). a Locked-In Retirement Account (LIRA) or a Lifetime Income Fund (LIF) is taxed at the deceased’s personal income tax rate, which can sometimes reach over 50% with all assets being deemed to be sold on death.

*If a spouse is named as the beneficiary, there are some rollover provisions available, where the tax can be deferred.

Estate tax exemptions

There are some exemptions available for some assets depending on a variety of factors. These include the Principal Residence Exemption and the Lifetime Capital Gains Exemption. Furthermore, if you leave properties to a spouse/common-law partner, the taxes may be deferred

What the estate tax looks like in action

Jack and Sally recently passed, leaving an array of assets in their estates.

• Jack still has $100,000 left in his RRSP along with an investment condo. When Jack died, the CRA taxed all $100,000 dollars of his RRSP as income, The condo, which he bought for $200,000 was valued at $300,000 when he passed on. That’s a capital gain of $100,000. The CRA taxed half of that, $50,000, at his personal tax rate.

• Sally had $1000,000 in her RRIF, gaining her an income of $5250 for the year up until her death, as well as a cottage her parents passed down to her. The CRA taxed both the income from the investment and the $100,000 principle itself at her personal income rate. The cottage was valued at $500,000 at Sally’s time of passing, but because it was valued at $300,000 when she received it, only $200,000 of it is considered as capital gains. Fifty per cent of that capital gain (or $100,000) was taxed at her personal income tax rate.

Probate fees

The estate will also have to pay probate fees in addition to estate tax. Because probate fees are provincially dictated, the amount depends on the deceased’s province of residency.

 In Manitoba, where the value of the property devolving (i.e. passing through the estate) is more than $10,000, probate fees total $70 plus $7 for every additional $1,000 of value or fraction thereof. An estate with a date-of-death value equal to $1 million, for example, would incur probate fees equal to $7,000.

How you can lower estate taxes

While fairly straight forward at first glance, there are a variety of ways you can lower the estate’s tax bill, and optimize the amount that goes to beneficiaries. 

To make sure your transfer of wealth goes as smoothly as possible, with the lowest possible tax bill, it’s important to create a robust estate plan as early as possible and keep it updated as much as possible. 

By meeting this challenge head-on, and with the help of financial advisors, you can make sure your estate goes where you want it to, and not to the government coffers.