Article

Death of a Taxpayer

Let us look at a hypothetical example of the death of Mr. Jones on October 5, 1998, leaving an estate consisting of his one half share of the family residence worth $130,000, a Registered Retirement Savings Plan (RRSP) with a value of $80,000 and some shares in Bell Canada having a fair market value of $15,000 to his wife of twenty-eight years and his three unmarried children.

Fortunately, Mr. and Mrs. Jones had the good sense to prepare updated wills before the untimely passing of Mr. Jones. This allowed each of them to prepare for the orderly distribution of their assets in a manner that they could control. In this case, the document was quite basic. It provided for each of the spouses to leave all of his or her assets to the other until such time as the death of the last surviving spouse. At that time, all remaining assets will pass to the children equally.

The main provisions of the Income Tax Act that are applicable in the year of death can be divided into two parts. The first contains the rules for the computation of income earned to the date of death while the second consists of deemed disposition rules that are applicable to the taxpayer for property owned as at the date of death.

Income Earned to the Date of Death

Mr. Jones passed away in October. Completed returns signed by he executor or other legal representative of his estate must be filed prior to April 30, 1999.

In some cases, it is possible for more than one income tax return to be prepared for the deceased taxpayer in the year of death. The executor of Mr. Jones’ estate (Mrs. Jones) will have some flexibility as to how certain income may be declared in these special circumstances.

Income of a deceased person is computed in the same manner as for other taxpayers, except that only income earned to the date of death is recognized. Therefore, such items as earnings from employment interest, rents, royalties and annuities that are due to Mr. Jones for the period through October 5 must be reported. However, in some cases, some of the items listed above, called rights or things in the Income Tax Act, that are due to a taxpayer may not have been paid to him during his lifetime. These may include matured but uncashed bond coupons, dividends declared but unpaid as at the date of death and salaries, commissions or vacation pay owing for a pay period that ended prior to the date of death.

The executor has three options:

1. Where rights or things which would ordinarily be included in the income of the deceased are transferred to beneficiaries within one year of death, or within ninety days of the Notice of Assessment of the deceased’s final return, whichever is later, the resulting income belongs to he beneficiary when it is realized and is not considered to be income of the deceased; or

2. The rights or things may be included along with the deceased’s other income and reported on the final return; or

3. The executor, perhaps relying on the provisions of the will, may choose to maintain the deceased’s assets as a separate entity. In this case, the assets are not transferred to the beneficiaries but are maintained as The Estate of Mr. Jones. Under these circumstances, the executor may decide to report the income arising from these rights on a separate income tax return claiming another set of full personal exemptions and certain other deductions for the period from the date of death through December 31. The time frame for making this decision is identical to that of (a) above.

1. transfer the shares into her name and declare the third quarter dividend as her income;
2. declare the dividends as part of Mr. Jones’ income prior to his death because they were owing him as at that date; or
3. set up a separate estate and have these shares form part of its capital, thereby allowing this dividend income to be reported on a separate income tax return to Revenue Canada.

Disposition of Assets Owned at the Date of Death

In our example, the Bell Canada shares that Mr. Jones held at the time of his death consisted of common shares that traded on the Toronto Stock Exchange for $60 apiece on October 5. He had purchased them for $35 each some years earlier. In the regular course of events, Mr. Jones would realize a capital gain of $25 per share on each of his 250 shares, and declare an income inclusion of 75% of that amount on his final return.

An important exception to the general rule outlined above pertains to this example. Where non-depreciable capital property of a deceased passes to a Canadian resident spouse or to a special trust for a spouse that was created in the deceased’s will, the property is considered to have been transferred at the original cost incurred by the deceased.

Thus, if the provisions of the will had expressly left the shares to Mrs. Jones personally or to her via a trust that she controlled, no capital gain would he calculated as part of Mr. Jones’ income on his final return. The capital gain would he deferred until such time as Mrs. Jones sold the shares or died and these shares formed a part of her estate. In either case, she would report a cost of $35 per share as that is the value of the shares that had been transferred to her from her husband.

If the will dictated that Mrs. Jones was not to inherit the shares directly but they were to form a part of a separate estate, then the taxable portion of the capital gain would be included on Mr. Jones’ final return and the shares would be valued at $60 a piece within the Estate.

In the case of the Registered Retirement Savings Plan, we did not determine whether Mr. Jones passed away prior to or after the plan had commenced to pay retirement income to its annuitant.

In the case where the plan had already matured, and the terms of the plan expressed that the surviving spouse was to become the successor annuitant, there are no income tax repercussions for the deceased and the surviving spouse is taxed on the retirement income as it is received. In this case, Mrs. Jones would typically commute the plan and roll over its proceeds to her own RRSP, Registered Retirement Income fund (RRIF) or guaranteed annuity.

Should Mr. Jones have designated his estate to be the beneficiary of his RRSP, the executor of the estate (Mrs. Jones) could elect to treat the surviving spouse as the annuitant, and the above results would be achieved.

The last of Mr. Jones’ assets at his date of death was his 50% ownership of the family residence. The income tax status of this capital property is identical to the Bell Canada shares discussed above.

Under the circumstances described above, Mr. Jones has effectively deferred the income taxes owing on the disposition of this asset to such time as his wife passes away. At that time, the executors of her estate will he responsible to prepare a tax return in her name.

There will be a deemed disposition of the family residence, but since we have assumed all along that this has been principal residence of the Jones for many years, there will be no income tax repercussions on any gains that may have accrued during her lifetime.

If we can assume that Mrs. Jones inherited the Bell Canada shares personally upon the death of her husband, she will be considered to have sold them immediately before she passed away. The capital gain will be calculated as the difference between the fair market value of the shares on that day and the original price that Mr. Jones paid for them of $35 apiece.

At this point, the children will inherit the family home and the Bell Canada shares. Should they decide to liquidate the family assets shortly thereafter, both the home and the shares will be sold and all proceeds received will be distributed to them on an equal basis free of any income.

Article ©1998 The Quarterly Dividend
Reprinted with permission