Death of Taxpayer: A Terminal Tax Return

While one might assume that death brings an end to everything, this is not true for taxes. The passing away of a person can trigger additional tax liabilities that were not present while the person was alive. These liabilities can create serious additional difficulties for surviving families as if the death of a loved one itself wasn’t a life-shattering event.

In this article, we will briefly discuss the tax filing requirement at the death of a taxpayer, various tax consequences of death, and options that surviving families may have. 

Filing Requirement for the Deceased Taxpayer

A final return must be filed for the deceased person, known as a terminal return. Legal representatives must file the final tax return for the deceased person’s estate. An estate is what the person who died owned (assets) and what they owed (liabilities). Any dues and liabilities, including any balances due to the CRA, are paid out of the estate’s assets. After settling taxes and other liabilities, the rest is distributed to beneficiaries.

Who is Responsible for Filing the Terminal Return

A legal representative of a deceased person, such as their executor or estate administrator, is responsible for filing the terminal tax return and other returns. The legal representative must inform the Canada Revenue Agency (CRA) and Service Canada of that person’s death and provide the official death certificate to stop payment of benefits, credits, etc.

What Income is Reported in the Terminal Return

To some extent, a terminal return is the same as a regular tax return in the sense that you will report all income of the deceased, such as salary, business, investment, rental, and pension, from January 1^st to the date of death. Additionally, there are unique income inclusions specific to the deceased person’s return, as discussed below.

Death-triggered Events and Income Inclusion in the Terminal Return

Under Canadian tax laws, taxpayers are deemed to have disposed of all their properties at their fair market value immediately before their death. This provision results in additional income inclusions in the final return, which would not have been added had the taxpayer been alive. Any capital gain or loss from such deemed disposition will be included in the deceased’s terminal return. This income inclusion can create a severe tax and cash flow burden for the executor or administrator.

Examples of properties include homes, investment properties, stocks, jewelry, shares in partnership or any corporation, etc.

As an exception to above income inclusion, under the tax laws, where a spouse or common-law partner is the beneficiary of these assets, these are transferred to the spouse on a “tax basis”, meaning this transfer will have no tax consequences or tax liability for the deceased or the surviving spouse. This tax-free transfer is called section ITA 70(6) automatic rollover. The spouse may “elect out,” and this election can be made on an asset-to-asset basis.

Let’s assume John passed away and had an investment property that he bought at CAD500,000 a couple of years back. At his death, the property’s fair market value was CAD900,000. Following will be the tax consequences at his death.

a) If the property is transferred to the spouse, Sarah: There is no tax implication for John or his spouse, Sarah. Until Sarah remains alive, she has no tax liability. At her death, let’s say the property has a market value of CAD1,200,000. A capital gain of CAD750,000 will be included in Sarah’s terminal return.

b) If the property is transferred to any other beneficiary: A capital gain of CAD400,000 will be included in John’s final tax return, and his estate will have to pay tax on this gain before the property may be transferred to the beneficiary.  Here, John’s estate will have to pay the tax bill resulting from the “deemed” capital gain before the assets are transferred to the beneficiary. This creates an immediate cash flow problem for the legal representative or beneficiary.

Timeline for Filing of the Return

• January 1st to October 31st of the year: April 30th of the following year
• November 1st to December 31st of the year: 6 months after the date of death

What is the Importance of Filing a Final Return?

The estate needs to pay income tax first and then other liabilities before heirs and beneficiaries can get balance money in their hands. For this, the legal representative of the deceased needs a clearance certificate. To obtain this certificate, a notice of assessment (NOA) from the CRA is essential, which shows that the deceased or his estate has no tax obligations outstanding.

Rights or Things Return

A taxpayer might die owning some “rights” or “things.” For example, dividends declared before death but not yet received or salaries, bonuses, and commissions for work done but not yet paid at the date of death. Such “things” may be included: –

1) In the terminal return, or

2) An election may be made to include rights or things in a separate return, called right or things return. Benefits of filing a separate return include the possibility of a lower tax rate and claiming certain credits in both returns in full. 

3) Also, there are situations in which ‘right’ or ‘thing’ can transfer from the deceased to the beneficiary in a lower income bracket, resulting in lower tax rates.

Special Rules (relaxation) for Deceased Returns.

• Credits: Certain credits may be claimed in full in both terminal and things return without the need for prorating based on the time length, i.e., January 1^st to date of the taxpayer’s death. These include basic personal credits, age amount, spouse or equivalent to a spouse or eligible dependent, caregiver amount, family caregiver amount, etc.
• Split Credits: Other credits must be split into two returns and cannot exceed what could have been claimed if only one return had been filed. Canada Pension, Employment Insurance, and Canada employment credit may be claimed in the return in which income is reported.
• Capital losses: In the year of death, capital losses, left after setting off the capital gains, may be used to offset any other income in terminal return or the preceding return. This is an exception to the normal rule, where capital losses can only offset capital gains.
• Charitable Donation: In the year of death and the year preceding, the 75% net income limitation on charitable Donation does not apply.
• Medical Expense: In the year of death, medical expenses paid in the last 24 months may be claimed instead of the current year’s expenses.

Tax Tips:

1. While a person is alive, having a will in place and an estate plan is highly recommended. A will ensures that the transfer of assets can be easy and quicker. If there is no will, the court will appoint an administrator to manage the estate, which is usually a close family member. However, this increases the time and cost of the transfer.
2. Engage an estate lawyer from the outset to oversee the execution of the estate and asset transfer, thus avoiding legal liability and responsibility for the appointed representative.

If you need advice on your personal and business taxes, a Source Accounting Professional Corporation tax professional can assist you. Book a consultation call by calling at 647-930-8130.

Whether you’re an individual, a business, or a corporation owner seeking tax planning assistance or in need of a tax accountant, we invite you to visit our website or call us at 647-830-8130 to schedule a consultation. Source Accounting Professional Corporation, CPA is Mississauga’s trusted provider of tax filing, payroll management, bookkeeping, and more.. 

Disclaimer: The above contents are provided for general guidance only, based on information believed to be accurate and complete, but we cannot guarantee its accuracy or completeness. It does not provide legal advice, nor can it or should it be relied upon. Please contact/consult a qualified tax professional specific to your case.