Brian Quinlan / Canadian MoneySaver
This is the third article in a series of four presenting the income tax implications of the death of a taxpayer.
Part 1: The tax implications of death
Part 2: Specific rules that can impact the filing of final personal tax returns
Part 3: Mandatory and optional tax returns for a deceased taxpayer
Part 4: Strategies to adopt while alive to minimize the income tax due on death
As part of the many tasks in dealing with a deceased’s affairs, the executor is responsible for filing the deceased’s tax return(s). To make matters a touch more complicated, in the year of death an individual may file a required personal tax return plus up to three more separate optional personal tax returns. Despite the fact that the extra tax returns sound complicated, the executor should prepare them. They minimize the tax bill of the deceased and increase the value of the estate being passed to the beneficiaries.
Tax returns needed for deceased and the estate
Personal income tax returns that must be prepared for the deceased:
- any unfiled personal tax returns for years that preceded the year of death
- a personal tax return for the year of death, often referred to as the final (or terminal) personal tax return
Optional personal tax returns that may be filed in the year of death:
- a personal tax return for rights and things
- a personal tax return when the deceased was a beneficiary of a testamentary trust (which would include being a beneficiary of an estate)
- a personal tax return where the deceased was self-employed
In addition to the personal tax return requirements, the estate may also need to file an estate tax return for income earned after the death of the taxpayer. As an estate is treated as a trust for income tax purposes, the tax return filed by an estate is actually a “trust income tax and information return.”
The number of yearly estate income tax returns to be filed will depend on how quickly the estate is wound up and the assets distributed to the beneficiaries. Where the deceased indicated in his or her will that the estate is to be carried on for specific purposes, an estate income tax return will be needed for each year the estate remains in existence.
Final personal tax return of the deceased
A final personal tax return must be filed for the deceased. It includes income earned from January 1 of the year of death up to and including the date of death. This income will include the taxable capital gains and recapture caused by the deemed disposition of assets owned on death. It also includes the value of any RRSPs and RRIFs held at the time of death. (This was discussed in Part 1 of this series. As noted in the earlier article, the taxation of these types of income can be deferred where the assets, RRSPs and RRIFs are passed on to a spouse.)
This personal tax return reports all the deceased’s income excluding any income that has been reported on an optional personal tax return.
The final personal tax return and the income tax are due on April 30 of the following year where the deceased dies on or before October 31. Where the death occurred after October 31, the return and tax are due six months after the death.
If the deceased was self-employed, the tax due dates are as noted above. However, if the death was on or before December 15, the final personal tax return is due on June 15 of the following year. Otherwise, the final personal tax return is due six months after death.
Advantage of filing the separate optional personal tax returns
By filing the optional returns, the executor can minimize the total income tax liability for the deceased’s estate. The optional returns serve to tax certain sources of income at lower rates. By shifting the income to separate personal tax returns, the total income reported on the final personal tax return decreases. This allows the executor to take advantage of the graduated tax brackets on the optional returns as well as on the final personal tax return. If all the income were reported on the final return, the overall effective tax rate would be higher.
Also, by filing the optional returns, the executor can claim certain tax credits in full on more than one return — once on the final return and on each of the applicable optional returns. The following tax credits can be claimed in full on each of the returns:
- the basic, age and spouse or common-law tax credit
- the tax credit for an eligible dependent
- the tax credit for an infirm dependent age 18 or older
- the tax credit for children under 18 (eliminated for 2015 and subsequent years)
- the caregiver tax credit
Other tax credits (tuition, education and textbook, disability, pension, charitable donation, medical expense) may be claimed on any of the returns or split between the returns. The total credit cannot exceed the maximum credit that would be available if no optional returns were filed. The medical expense tax credit is still subject to the threshold for the year ($2,208 for 2015) and 3% of the total net income reported on all the personal tax returns filed for the deceased.
Personal tax return for rights or things
The return for rights or things is the most common of the three optional personal tax returns. The return for rights or things can be filed to report income that had been earned and owed to the deceased at the time of death but had not been received prior to death.
Examples of rights and things include the following:
- salary and wages (including vacation pay and declared bonuses) owed for a pay period that ended before death
- Old Age Security (OAS) that was due and payable before death
- uncashed matured bond coupons
- bond interest earned to a payment date before death
- dividends declared where death is after the record date
- inventory of taxpayers using the cash basis of reporting income (farmers and fishermen)
- work-in-progress, where the deceased was a self-employed professional (accountant, dentist, lawyer, medical doctor, veterinarian, chiropractor) that had elected to exclude work-in-progress in calculating professional income
Note that these income sources are items that would not normally be included in an individual’s income until actually received. However, as a result of the taxpayer’s death, they are subject to tax in the year of death. In filing the personal tax return for rights and things, some tax relief is available for these additional income sources.
The filing deadline for a personal tax return for rights and things is the later of:
- 90 days after Canada Revenue Agency (CRA) has issued an assessment for the final personal tax return of the deceased
- one year after the date of death
In practice, assuming the information is available, the personal tax return for rights and things is prepared and filed at the same time as the final personal tax return.
Other optional personal tax returns
Other optional personal tax returns pertain to income the deceased earned from two sources:
- a testamentary trust (which would include an estate) with a non-calendar taxation year-end
- a business with a non-calendar taxation year-end where the deceased was self employed (operating either as a proprietor or through a partnership)
Both optional personal tax returns allow the deceased to avoid including more than 12 months of income earned from the above sources in his or her final personal tax return.
Take the example of a taxpayer that dies on October 31, 2015. Assume the deceased was a beneficiary of a testamentary trust with a taxation year-end of June 30, 2015, or is self-employed with a business having a June 30, 2015, taxation year-end. If it were not for these optional personal tax returns, the deceased’s final personal tax return would include the following:
- income from the testamentary trust or the business for the year ending June 30, 2015, plus
- income earned in the four month stub-period of July 1 to October 31, 2015
That means that the final personal tax return of the deceased would need to include 16 months of income. Here, the executor can decide to exclude the income earned in the four-month stub-period from the final personal tax return and report it on a separate personal tax return. As with the personal tax return for rights and things, this filing allows the deceased to take advantage of lower tax rates and multiply the use of certain tax credits.
The due dates for these optional personal tax returns and the tax liability are the same as noted above for the final personal tax return.
Due to income tax changes in the mid-1990s, most self-employed individuals now report income on a calendar year basis. Consequently, the optional personal tax return for deceased self-employed individuals is seen less frequently than it was 20 years ago.