First things first, there is no estate tax or inheritance tax in Canada. You won’t have to deal with any complicated tax consequences during a difficult time such as the death of a loved one.
However, some taxes apply to the inheritance received. After a person dies, a final tax return has to be filed on the income that the person earned until his death. The deceased’s income and assets are all clubbed together to make an estate and it is handled by their legal representative. After this is settled, the remaining money is distributed among the beneficiaries, if any.
In case you are a beneficiary who is to inherit property or are aiding someone legally, you might have a ton of questions about the inheritance tax process.
To answer those and to help you deal with the Canadian inheritance tax laws easily, let’s go over the basics of the laws.
A. What is an estate?
An estate refers to an individual’s holdings, capital property, or assets at the time of death. It is the total monetary value of the deceased person’s financial activities, including assets and investments. These assets are then distributed according to the individual’s will. In case a will doesn’t exist, then the law determines the distribution and dealings of the deceased person’s estate.
Is there an estate tax?
Canada does not have an estate or inheritance tax Canada. Following an individual’s death, the CRA taxes any income that has been earned up to the date of death. This is called the deceased tax return, which some might confusingly call “estate tax”.
CRA refers to the Canada Revenue Agency, the revenue service of the federal and territorial governments. The CRA collects taxes, administers tax laws and policies, and delivers tax-related services, benefits, and credits.
B. How is the tax return filed?
After the individual’s death, his legal representative will have to file a deceased tax return on his client’s behalf. The due date for this depends on the date the person died.
Once the representative has settled the dues, they must make sure to ask the CRA for a clearance certificate. The clearance certificate confirms that all income taxes have been paid to the CRA. As a legal representative, it is important to get this certificate before the distribution of the estate. Otherwise, the representative can be personally held accountable for any tax owed by the deceased person.
If you need help as a legal executive, look into this guide provided by the CRA.
C. How is the estate taxed?
Since there is no estate tax or inheritance tax in Canada, the deceased’s estate is taxed mainly through capital gains tax and personal income tax.
Capital assets like stocks, mutual funds, and investment properties are considered non-registered investments. The CRA considers them sold at fair market value at the time of death. This is called the deemed disposition of property. For this, the estate has to pay capital gains tax. The CRA defines fair market value or FMV as “Usually the highest dollar value you can get for your property in an open and unrestricted market, between a willing buyer and a willing seller who are acting independently of each other.”
What is the capital gains tax?
Capital gains are the increase in the fair market value of the asset at the time sold from the fair market value at the time of purchase.
Example: Andy had bought stocks worth $70 a share, and after a year, the stocks are worth $78. Then, the $8 increase is the capital gain. This is taxed by the CRA at 50%. This means after his death, Andy’s lawyer will have to report $4 as income on those stocks (50% of $8).
What about registered assets?
Registered assets include RRSPs and RRIFs. These are counted amongst the deceased person’s income and are exempted from capital gains deduction. They are subject to their personal income tax rate.
Example: Andy has $25000 in RRSPs. After his death, the full amount will be included in his final tax return.
D. What if there is a surviving spouse or common-law partner?
In case there is a surviving spouse or common-law partner, then any estates in non-registered accounts (physical assets and investment properties) or registered accounts (RRSPs, RRIFs) are directly transferred to the spouse or common-law partner.
The capital gains tax is not applied in this case and the surviving spouse or common-law partner is deferred from paying taxes. This means that the capital assets and properties will trigger a deemed disposition only when the spouse or common-law partner dies.
It is important to remember that you still have to be eligible in the eyes of CRA to claim the capital gains deduction.
Who else can be an eligible beneficiary?
Apart from surviving spouses or common-law partners, others can claim to be eligible beneficiaries for this inheritance tax. This includes a financially dependent child or grandchild (under 18 years of age), or a mentally or physically disabled child or grandchild of any age. In these cases, the beneficiary is regarded as a “qualified survivor” and receives the estate assets while the income tax is deferred.
What if there is NO surviving spouse or common-law partner, or any other eligible and designated beneficiary?
In the case that there is no family member or eligible beneficiary, then all the estate properties would be deemed to have been sold at the time of death. Capital gains taxes and other income tax would have to be reported in the final tax return at 50%, and the final tax return would include all of the estate held by the deceased person as well as the deceased’s income generated by investments or a registered account(RRSPs and RRIFs).
E. Are there any inheritance tax exemptions?
There are two kinds of inheritance tax exemptions that can be availed:
1) When you make a profit from selling a small business, farm property, or fishing property, the lifetime capital gains exemption (LCGE) spares you from paying taxes on all or part of the profit you’ve earned, inheritance tax is exempted in such cases.
2) In another case of inheritance tax exemption when you sell your principal residence, the principal residence exemption (PRE) spares you from paying taxes on the capital gain realized by the sale and on each year that property was listed as your principal residence.
How do the lifetime capital gains exemption and the principal residence exemption work?
1) LCGE: let’s look again at what Andy did. A year before his death, Andy sold some shares of his small business company. He made a profit of $500,000. This profit is called capital gain. Without the LCGE, Andy would have to pay tax according to the capital gains tax rule and file a personal tax return on half of this amount which would be $250,000 or the 50% of his total capital gain.
Thus, this serves as a great safety net for small business owners when they have to pay taxes as their taxable income is protected.
However, the LCGE has a limit. As of 2022, it is $913,630. This means you can apply for the exemption multiple times until you reach the limit. So, all of Andy’s $500,000 get protected by the LCGE but once he’s past that limit, he’ll have to pay taxes according to the Capital gains taxes rule.
2) PRE: Andy owned and lived in a home for 20 years until his death. It was his principal residence for 14 years. After his death, the capital gain before the tax exemption is $100,000. Now, the principal residence amount is calculated through a formula which is:
(# of years home is principal residence + 1) x capital gain
# of years home is owned
The amount = (14 + 1)/20 x 100,000 = $75,000. The remaining is a capital gain of $25,000 and a taxable capital gain (50%) of $12,500. In this way, Andy’s taxable gain is highly reduced.
Remember, if PRE is planned strategically, then you can ENTIRELY exempt your capital gains.
What happens when you inherit money?
Again, since there is no inheritance tax in Canada, if you receive an inheritance, you do not need to report for additional tax returns.
However, if you inherit a business or capital property, make note of the market value at that time. If you ever sell these inherited assets in the future, you will have to pay capital gains taxes.
F. What is probate?
Probate refers to the legal process that the estate goes through. This includes the determination of the will’s authenticity in court, and also the handling of the will.
If there is no will, then probate refers to the handling and legal management of the whole estate. Provinces charge probate fees for the final steps and the completion of the procedure as well.
How do probate fees work?
Probate fees differ from province to province. In most cases, the probate is decided based on the final amount of the estate. However, Quebec is different in this scenario as they have a flat probate fee of $65.
Final Notes
The Canadian estate tax laws might feel overwhelming at first but as you can see, they aren’t as complicated and can be dealt with, easily. Hopefully, our article on inheritance tax cleared some of your doubts.
As a legal executive, you must make sure to file the last tax return and get a clearance before distributing the properties, to ensure there aren’t any taxes owed. If you’re on the receiving end, do not worry since no shady government policy named “inheritance tax Canada” would come to bother you in a grieving period. You’ve received a tax-free inheritance, you DON’T have any tax owing; now, it is yours to own.
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