Taxes After Someone Dies

The final tax return

When someone dies, the executor files a final tax return for them (sometimes called the terminal return). It covers January 1 of the year they died up to the date of death, and includes all of their income for that period plus a few special items explained below.

Different filing dates can apply if the person, or their spouse or common-law partner, was self-employed. Check with an accountant or the CRA's guide T4011, Preparing Returns for Deceased Persons.

Any earlier years that weren't filed must be filed too. Tax instalments that would have come due after the date of death don't have to be paid.

Why the final return can be big

Two things often surprise families:

1. The "deemed disposition." At death, the CRA treats the person as if they sold most of what they owned at fair market value right before they died. Any increase in value, such as on a cottage, a rental property or investments held outside an RRSP or TFSA, becomes a capital gain on the final return. Currently, half of a capital gain is taxable.

2. RRSPs and RRIFs. The full value of an RRSP or RRIF is generally added to income on the final return, all in one year. On a large account, much of it can be taxed at the top rate. We call it the ticking tax bomb.

The big exceptions

• A spouse or common-law partner. Assets left to a spouse or common-law partner, or to a qualifying spousal trust, can usually "roll over" with no tax until the surviving spouse sells them or dies. RRSPs and RRIFs can roll over to the surviving spouse's own RRSP or RRIF.
• Financially dependent children or grandchildren. Special rules may let an RRSP or RRIF pass to them with less tax, for example into a registered disability savings plan for a dependant with a disability, or into an annuity for a minor child.
• The family home. The principal residence exemption can shelter some or all of the gain on a home that was the person's principal residence. The executor still reports it on the final return.
• Life insurance. The death benefit is generally received tax-free.

TFSAs

A TFSA stays tax-free up to the date of death.

• If a spouse or common-law partner was named as successor holder, the TFSA simply becomes theirs and stays tax-free.
• If someone else was named as beneficiary, they receive the value at the date of death tax-free, but growth after the date of death is generally taxable to them.
• If no one was named, the TFSA goes to the estate.

The CPP death benefit and other income

The CPP death benefit is taxable. It's usually reported on the estate's T3 return, or by the person who receives it. Pension income, final pay and investment income up to the date of death go on the final return.

Optional returns that can save tax

In some situations the executor can file up to three extra "optional" returns, which let certain income be taxed separately with its own set of personal credits. One example is income that was owed to the person but not yet paid when they died, which the CRA calls "rights or things", such as unpaid salary or vacation pay. An accountant can tell you whether they're worth filing.

Credits worth claiming

• Charitable donations. Donations made through the will or by the estate can often be claimed on the final return, the return for the year before, or the estate's return. That gives the executor flexibility to use them where they save the most tax.
• Medical expenses. On the final return, you can claim medical expenses paid in any 24-month period that includes the date of death.

The estate's own tax return (T3)

After the date of death, the estate becomes its own taxpayer. Interest, dividends, rent or gains earned after the date of death are reported on a T3 Trust Income Tax and Information Return.

An estate can usually be a "graduated rate estate" for up to 36 months after the death. That means it pays tax at the same graduated rates as a person, rather than the top rate. It's one more reason not to let an estate drag on.

The clearance certificate

Before the final distribution, the executor should ask the CRA for a clearance certificate using form TX19. It confirms that all taxes owed by the person and the estate have been paid or secured.

Here's why it matters: if you distribute everything without one and the CRA later assesses more tax, you can be personally responsible, up to the amount you distributed. The CRA usually needs all the returns assessed first, and processing can take several months, so build it into your timeline.

Telling the CRA

• Call 1-800-959-8281, or send in the form on the back of RC4111, What to Do Following a Death.
• To act as the legal representative, you'll usually send the CRA a copy of the death certificate and a copy of the will or the probate certificate.
• Ask the CRA to stop payments like the GST/HST credit and the Canada child benefit, and to transfer them to a survivor where that applies.

If they had US assets or US citizenship

US real estate, US stocks or US citizenship can bring US estate tax rules and filing obligations into play, even for Canadians. Get cross-border tax advice early.