Nizam Shajani, CPA, CA, MBA
October 26, 2020
While it is a difficult situation when a loved one passes away, this situation may be exasperated with the tax filing requirements for the deceased. Understanding the requirements helps. Planning for this is better, as we are all destined to have this done on our behalf.
There are both mandatory as well as optional returns that need to be filed on behalf of the deceased. The mandatory return includes the final return, whereas optional returns include the rights or things return as well as trust returns.
The final return of the deceased is mandatory and reports all income earned from January 1st to the date of death. The return and any balance owing is due April 30th of the year following the date of death if the death occurred between January 1st and October 31st – or is due six months after the date of death if the death occurred between November 1st and December 31st. Also note if the deceased passes away before the deadline and filing of their previous year return – they may be given a six-month extension on that due date. Late filing penalties are 5% of the balance that was owing on the due date plus 1% of the balance for each full month the return is late (to a maximum of 12 months).
Generally, the final return calculation is similar to the calculation for determining income in previous years. This may include employment income, old age security, CPP or QPP, other pensions or superannuation, employment insurance benefits, investment income, RRSP income, self employment income as well as other types of income.
Additional considerations in calculating the final return include the deemed disposition of property. When a taxpayer passes on, there is a deemed disposition of all their assets. This is as if the deceased had sold their property immediately before their death – regardless of an actual sale occurring. The disposition may be elected at cost if their assets are transferred to their spouse. If they are not transferred to their spouse (of they do not have a living spouse), their assets are deemed to be disposed of at fair market value. This may incur capital gains as well as the recapture of any depreciation deducted on previous tax returns.
A capital gain is when the deemed proceeds are more than the cost of the property that is deemed disposed of. This is calculated as fair market value minus the cost of the property.
Some property may be depreciable. If the taxpayer had deducted capital cost allowance (a form of depreciation) in prior years -they would have paid less tax on those tax years. This is recaptured on any disposition that is higher than the book value of that property. For example, if a rental property is worth $250,000 and was purchase some many years ago for $150,000 and had been depreciated to $100,000 on the taxpayers past tax returns – the taxpayer had received deductions of $50,000 over a period. The deemed disposition would calculate the recapture (cost minus book value) and pay tax at the regular rate on the $50,000. The taxpayer would also pay tax at the capital gains rate on any capital gain, in this example $100,000. The capital gains rate is half the regular tax rate.
Capital losses may also be calculated in the same way where the fair market value of the property is less than the cost.
Other tax deferrals such as RRSPs will also be deemed disposed of – resulting in a tax liability to the estate at the full rate (unless transferred to a spouse).
The final return may be reported on a regular tax return with the box that indicates “is the taxpayer deceased” checked off. This return may be either e-filed or paper filed.
Rights or Things Return
Rights or things are amounts that had not been paid to the deceased at the time of their death, however were due to the deceased. This income is typically included on a tax return when received. This may include employment rights such as salary, commissions and vacation pay that was owed to the deceased before the date of death for a pay period that ended before the date of death. This may also include items such as OAS benefits, uncashed bonds, bond interest earned to the date of death, unpaid dividends, and other receivables.
The rights or things return may be filed using the general tax return (T1 General) and writing “70(2)” on the top right corner of the first page. The rights or things return is due the later of ninety days after the notice of assessment is receive for the final return or one year after the date of death. However, the due date of any amounts owing is the same as the final return due dates.
It should be noted that some amounts may be income for the estate and may be reported on a T3 Trust return.
T3 Trust Return
Assets of the deceased may be held in trust by a trustee for the benefit of beneficiaries. These assets may earn income while held in trust. The trust return reports income from the trust each tax year. As such, income from a trust would be reported on the beneficiary’s tax return and not the deceased persons return. This may be important as the year of death may be the highest income year for an individual, considering the deemed disposition of all assets. Canada has a tiered tax system, increasing the tax rate as the taxpayer moved into higher tax brackets. Utilizing a trust may allow the use of lower tax brackets of the beneficiaries. Note recent tax changes have varies the way trusts are used and access to lower tax brackets, however opportunities still exist.
Being aware of the filing requirements as well as optional filings should help navigate this heartrending time. This may also be an opportunity to complete an estate plan with the goal of minimizing tax on your own death, allowing you to write this final chapter for yourself – rather than have someone do this on your behalf.
This information is for discussion purposes only and should not be considered professional advice. There is no guarantee or warrant of information on this site and it should be noted that rules and laws change regularly. You should consult a professional before considering implementing or taking any action based on information on this site. Call our team for a consultation before taking any action. © 2020 Shajani LLP