Canada does not have an estate tax. However, capital gains and income taxes are generally triggered by death.
A legal representative must file the deceased’s final income tax return for the year in which they died and pay any tax owed up until the point of death (including taxes on any deemed disposition of assets, see below). This final return is called a “terminal return”. Once all taxes have been paid, the Canada Revenue Agency (CRA) will issue a “clearance certificate”, certifying anything distributed from the estate has been taxed.
In addition, some provinces and territories also have additional taxes in the form of probate fees, sometimes referred to as Estate Administration Tax, Probate Tax, or Probate Charges.
Is a clearance certificate required from CRA?
It is important that the executor for the estate pays any final tax owed prior to distributing anything from the estate. An executor can be held personally liable for any outstanding taxes on assets of the estate if a clearance certificate is not obtained prior to distribution of the assets. Accordingly, it is generally prudent to seek a clearance certificate from the CRA (though it should be noted that processing times for the clearance certificate can be quite long).
In some cases, executors may make interim distributions when:
- The assets are sufficient to do so;
- There is enough certainty with respect to the potential tax; and
- The executor has obtained indemnities or releases from the beneficiaries.
What is a “deemed disposition” and why does it matter?
When someone dies, CRA treats any property or items owned at the time of death as though they were sold on the day before the person died. For example, if the deceased owns stock, it would be presumed for income tax purposes that the stock was sold the day before the person died. Any gains (or losses) would be taxed accordingly.
Deemed dispositions of property may trigger additional capital gains tax to be included in the terminal tax return.
What is a Qualifying Spousal Trust?
Capital gains tax may be deferred by using a Qualifying Spousal Trust (QST). For spouses, creation of a QST allows the payment of capital gains tax to be deferred until both spouses are deceased, or the assets held within the trust are disposed of to anyone other than the spouse. Detailed estate taxation planning including setting up trusts should be undertaken with the assistance of a TEP.
A QST allows spouses to provide for the surviving spouse during their lifetime, and then have any remaining assets revert back to their own chosen beneficiaries. The surviving spouse will be able to use the assets of the QST to their benefit for their lifetime.
Why use individual trusts for my children?
If gifts are made to an adult child using a trust instead of being made directly, the adult child may be given the option of splitting the income of the trust with their own children. Depending on the number of grandchildren and their age, and the amount of income being produced in the trust, this could offer significant tax savings. For more information on the benefits of individual trusts, speak with a TEP.
What happens if the assets continue to increase in value while the executor is distributing them?
Special rules apply for assets being distributed in the year following death. For up to 36 months, the estate of a deceased individual may qualify as a graduated rate estate, which typically has significant tax advantages.
What is a Graduated Rate Estate (GRE)?
Since 2016, testamentary trusts have been subjected to the highest federal tax rate, with the exception of Graduated Rate Estates (GREs) and Qualified Disability Trusts (QDTs). Qualification as a GRE may have significant tax advantages, including the ability to access graduated rates, certain exemptions, and allocations to beneficiaries.
An estate will qualify as a GRE for up to 36 months from the date of death if:
- The estate meets the definition of a “testamentary trust”
- The estate designates itself as a GRE
- No other estate of the individual designates itself as a GRE
- The SIN number of the deceased is provided
What is a testamentary trust, and how is it taxed?
Generally, a testamentary trust is any trust that arises on death due to the operation of a Will. A testamentary trust creates a legal relationship between the deceased person who created the Will, the trustee, and the beneficiaries of the trust. The trustee is often the executor of the Will, but can also be a separate individual named in the Will. The beneficiaries are the family members or other individual beneficiaries specified in the Will of the deceased. The trustee is responsible for payment to the beneficiaries on the terms of the trust. Beneficiaries can have fixed interests set in the Will, or discretion may be given to the trustee to allocate income and/or capital to the beneficiaries.
A testamentary trust is treated as a separate taxpayer under the Income Tax Act, and must file a tax return at the end of each calendar year. As noted above, with limited exceptions, income generated in testamentary trusts which is not allocated to a beneficiary will be taxed at the highest marginal rate.
Does this mean beneficiaries pay no tax for inheritances?
In most cases, inheritances are received after-tax. For instance, if the testator has left real property to a beneficiary, the beneficiary will pay no tax on receiving that property. Once the property is transferred, the beneficiary will be liable for standard taxes on it such as property tax and potentially capital gains tax on sale.
Note that some jurisdictions outside Canada tax estates in the hands of the beneficiary. As such, it is possible that a foreign beneficiary will be subject an inheritance tax while the Canadian estate is subject to capital gains tax on the deemed disposition of the deceased’s assets. A TEP should be consulted for advice on how different tax systems will impact estate planning for foreign beneficiaries.
It may also be possible to defer capital gains tax by using trusts. Detailed estate taxation planning including setting up trusts should be undertaken with the assistance of a licensed professional.
What are Probate Fees / Estate Administration Tax?
Probate fees (known in some provinces as probate tax, probate charges, or estate administration tax) are fees or taxes charged in relation to obtaining a grant of probate (or Certificate of Appointment in Ontario). The name of the fee/tax and amount of tax charged varies from province to province and territory to territory.
Are there any exemptions from Probate Fees?
The list of items and estates eligible for exclusion from probate fees varies from province to province. Estate planning can be undertaken to minimize probate fees through the use of Multiple Wills. For more information on probate exclusions and rates, please refer to the “What is Probate?” and “Probate in Canada” sections of this website.
For further information or assistance in administering an estate, please consult a TEP.