Did you receive inheritance and are wondering about declaring inheritance on a tax return? Or are you planning for the future and want to ensure that your heirs get the most benefit from your estate?
With a death in the family or as you consider who will inherit your estate, you have a lot of financial questions. Is there an inheritance tax in Canada? What about the estate tax? How do life insurance and funeral insurance work?
Find out what you need to know about the estate tax and inheritance tax in Canada.
What's the Difference Between Inheritance Tax and Estate Tax?
People sometimes use the terms inheritance tax and estate tax interchangeably. You may also hear them called a "death tax." In fact, inheritance tax and estate tax differ based on who pays them.
An inheritance tax is a tax on the assets inherited from the estate of a deceased person. The amount of the tax usually depends on the value of the estate. In countries with an inheritance tax, the beneficiaries of the deceased person's estate pay the tax on the portion of the estate they inherited.
An estate tax is based on the right to transfer someone's assets to their heirs when they die. The value of the estate determines the amount of the tax. Unlike an inheritance tax, however, the estate pays the estate tax.
Is There an Inheritance Tax in Canada?
Canada doesn't have an inheritance tax. Someone who receives inheritance doesn't need to declare it on their income tax return.
The estate pays the taxes to the government instead of the beneficiaries paying. When someone receives money or other assets from an estate, the estate has paid the taxes already.
Is There Estate Tax in Canada?
Canada doesn't have an estate tax. The Canada Revenue Agency (CRA) doesn't tax the assets of an estate. The CRA does require the payment of all income taxes due up to the date of death. Sources of income could include employment, Canada Pension Plan, Old Age Security, dividends, RRSP, or RRIF.
Taxes and Settling the Estate
When someone dies, their legal representative must file a final tax return to the CRA. The CRA will take any taxes owed from the estate. This process must be complete before the estate can be given to the inheritors.
The final tax return will include federal and provincial taxes.
After the legal representative has filed the tax return and paid any taxes, they should ask the CRA for a clearance certificate. The clearance certificate certifies that all income taxes have been paid or that the CRA has accepted security for the payment.
The legal representative can begin distributing the inheritance after obtaining the clearance certificate.
How Do Canadian Inheritance Tax Laws Work?
If a surviving spouse or common-law partner doesn't inherit the estate, Canadian law considers the deceased to have sold all of their capital property for fair market value immediately prior to death. This is called deemed disposition.
If any of these assets have increased in value since the deceased acquired them, the estate will owe capital gains tax. Half of the capital gain is taxable. Capital gains taxes apply to all non-registered assets like real estate, cars, personal belongings, or investments.
Take for example someone who died with a portfolio worth $1,000,000. If the original value (the adjusted cost base) was $400,000, that person would have a capital gain of $600,000 at their death. Half of the capital gain is taxable, which leaves taxes owed on $300,000.
You may qualify for an exemption from capital gains in certain circumstances. For example, the principal residence exemption may apply to the deemed disposition of the deceased person's primary residence. Shares of qualifying Canadian private corporations may be eligible for the lifetime capital gains exemption.
The deceased's spouse or common-law partner can receive any non-registered capital property as a transfer. This delays having to pay any taxes.
For registered assets like RRSPs and RRIFs, the CRA considers the deceased to have received the fair market value of the plan assets immediately prior to death. This amount is included in the deceased person's income tax return.
Registered assets will go on the deceased person's income tax return.
However, the income tax is deferred if an eligible person is a designated beneficiary of the RRSP or RRIF. Eligible people include a spouse or common-law partner, a financially-dependent child or grandchild younger than 18, or a financially dependent infirm child or grandchild of any age.
When the eligible beneficiary sells the investments or dies, the beneficiary pays taxes on the registered assets as ordinary income. One way to avoid leaving your descendants with taxes to pay is to have a life insurance policy in an amount that will cover the expected tax balance.
Avoiding Canadian Capital Gains Tax on Inherited Property
Deemed disposition can leave a substantial tax burden. One of the best ways to defer the taxes owed from a deemed disposition is to transfer the property to the deceased person's spouse or partner. Any associated tax liability is deferred until the spouse or partner sells the property or dies.
Another strategy is to leave marketable securities to a registered charity in your will. If you donate publicly-listed shares, mutual funds, or segregated funds in-kind to a charity, you eliminate the capital gains tax. You could also get tax savings on your final tax return with the charitable donation receipt.
Financial and Tax Planning
A certified financial planner and a tax professional can help you maximize the value of what you leave for your heirs. Although there is no inheritance tax in Canada, there is a potential tax burden for your estate.
One way to reduce taxes for your beneficiaries is with a life insurance policy. Insurdinary can help you compare rates, save money, and find the right policy for your situation. Get more information and a free quote today.