Does Inheritance Tax Exist in Canada?

Good news! In Canada, there is no inheritance tax. Before you turn your next funeral into a party, however, there’s some bad news too: that money still gets taxed. The Canada Revenue Agency (CRA) treats the deceased’s estate as a sale and — unless the estate is inherited by the surviving spouse or common-law partner, in which cases exceptions apply — taxes it accordingly. That means you, the recipient, will not pay taxes on the amount you inherit, but because the estate is taxed before it’s distributed, you will not inherit as much.

Also important to note, in case you’re responsible for it: whatever amount the deceased owed in taxes upon death should be settled with what’s called the deceased tax return. Once that’s complete, whatever’s left over can be distributed.

How Canadian estates are settled

Here’s an overview of what happens when someone dies (at least in terms of their estate; for bigger questions, you’re on your own):

1. Their legal representative, the executor, files a deceased tax return to the CRA. The due date of this return depends on the date the person died. Any taxes owing from this tax return are taken from the estate before it can be settled (dispersed).

2. Once the executor has settled the estate, they must ask the CRA for a clearance certificate. This confirms that all income taxes have been paid or that the CRA has accepted security for the payment. As a legal representative, it is important to get this clearance certificate before distributing any property.

3. If you do not get a certificate, you can be held personally liable for any amount the deceased owes.

Canada’s inheritance tax rates

All income earned by the deceased is taxed on a final return.

Non-registered capital assets are considered to have been sold for fair market value immediately prior to death. Any resulting capital gains are 50% taxable and added to all other income of the deceased on their final return where income tax will be calculated at the applicable personal income tax rates. Capital gains tax rates also apply.

The fair market value of a Registered Retirement Savings Plan (RRSP) or a Registered Retirement Income Fund (RRIF) is included in the deceased person’s income and taxed at the regular applicable personal income tax rates with no special treatment for any capital gains earned within the RRSP or RRIF.

Inheritance tax exemptions

Certain exemptions are available for tax liability incurred for deemed disposition (which applies when, for tax purposes, a deceased person’s assets are considered disposed of even though no sale took place). These include the Principal Residence Exemption and the Lifetime Capital Gains Exemption.

Probate fees and estate tax

An estate tax is imposed by a province or the federal government based on the right to transfer a person’s assets to their heirs after death. An estate tax is based on the overall value of the deceased person’s estate. The estate is liable for paying the estate tax.

In Canada, the CRA does not tax the assets of an estate but they do require that all of the tax owing on income up to the date of death be paid. When the executor files the final tax return, it should include any income the deceased received since the beginning of the calendar year.

Some examples of income include:

• Canada Pension Plan (CPP)

• Old Age Security (OAS)

• Retirement pensions

• Employment income

• Dividend income

It’s important to understand that all of your assets are deemed to have been “sold” just prior to death for tax purposes. This would include real estate, land, businesses, investments and your RRSPs. This is referred to as deemed disposition.

The deemed disposition can potentially trigger considerable taxation. If a spouse is a beneficiary, there could be some rollover provisions where the tax may not be triggered now but deferred until later.

In addition to income tax, provinces institute probate fees. Probate fees vary from province to province and are based on the total assets of the estate.

Let’s use Bob’s estate as an example:

1. Personal residence = $590,000

2. Bank account = $22,000

3. Cottage = $225,000

4. Non-Registered Investments = $85,000

5. RRSPs = $90,000

6. Tax-Free Savings Account (TFSA) = $48,000

7. Life insurance death benefit = $150,000

For probate purposes, assets with a named beneficiary like life insurance, RRSPs, and the Tax-Free Savings Account (TFSA) are not included. These assets can bypass probate with the direct beneficiary designation unless the designation is the estate. In addition to these direct beneficiary-designated assets, joint assets are typically not included for probate because the surviving joint owner becomes the owner of the asset.

So, in Bob’s example, his total estate would be worth $922,000 (1+2+3+4).

In Canada, every province and territory has different probate fees. These can be illustrated as follows:

• If Bob lived in Alberta, the total probate fees would be $525.

• If Bob lived in BC, his total probate fee would be about 1.4% of the total value of the estate, which would mean $12,900.

• If Bob lived in Ontario, his total probate fee would be about 1.5%, which would mean $13,800.

• If Bob lived in Halifax, his total probate fee would be about $15,000.

Inheriting tax-advantaged accounts (when the account holder is still living)

In general, if you transfer RRSPs or RRIFs to your spouse during your lifetime, you’ll pay tax on the full amount at the time of transfer. A more preferable option is to hang on to the money and to split the income taken from RRSPs\RRIFs with your spouse at age 65.

It is possible to transfer your TFSA to your spouse’s TFSA during your lifetime, too, but only up to your spouse’s TFSA contribution room. That’s generally not preferable either, as you’ll each want to maximize your own TFSA room, which is a lifetime balance of $75,500 for every resident adult, for the tax year 2021.

Capital assets held in a non-registered account may be transferred to your spouse during your lifetime at your choice of adjusted cost base (ACB) or fair market value (FMV). Both will have tax consequences.

Transfers of assets to children—minor or adult—occur at FMV, but accrued gains at the time of transfer are taxed in the hands of the transferee. In the case of minor children, dividends and interest income will be attributed back and taxed in the hands of the transferor.

There are several elective tax returns that can be filed on death, which will allow certain personal amounts to be claimed again on these additional returns. This can result in a substantial tax benefit.

You can make transfers to the spouse at either the asset’s ACB or FMV, or Undepreciated Capital Cost (UCC), in the case of depreciable assets. If ACB or UCC is chosen, there is a “tax-free rollover.” That is, the tax consequences are completely postponed until the surviving spouse dies.

Inheriting tax advantaged accounts (when the account holder is deceased)

When you leave untaxed accumulations in your RRSP or RRIF, you are deemed to have received the FMV of all assets in your RRSP or RRIF immediately prior to death.

If there is a surviving spouse, the assets may be transferred tax-free to that person’s registered plan. If there is no surviving spouse, unless another beneficiary is specified the RRSP assets are transferred to the estate. Any decrease in value of RRSP assets while held in the estate may be used to decrease the income reported on the deceased’s final return.

Earnings in your TFSA are tax-free during your lifetime, but not after death; however, assets may be rolled over to the TFSA of a surviving spouse or common-law partner.

Inheritance taxes outside of Canada

The inheritance tax is not present in all countries. Some forms of inheritance tax exist in Belgium, Denmark, France, Germany, Italy, Japan, the United Kingdom, and the United States.

Note that in the U.S., the federal government doesn’t have an inheritance tax, and only six states collect one: Iowa, Kentucky, Maryland, Nebraska, New Jersey, and Pennsylvania.

Some countries, such as Australia, Israel, New Zealand, and Russia no longer impose this tax. Instead of the tax, many countries impose capital gains tax on the asset’s sale or ownership transfer in case of the death of the owner.

In many countries inheritance tax is collected from the beneficiaries of the estate of a deceased person. The tax is payable upon the transfer of the estate to the beneficiaries. In most cases, each heir is responsible for paying their own inheritance tax based on the portion of the estate inherited.

The relationship between the deceased person and the beneficiary may impact the necessity to pay the inheritance tax. For instance, spouses are generally excluded from paying the tax. In addition, the entities and organizations that receive the estate as a charitable donation from the deceased person are not required to pay the tax.

Lineal descendants and ancestors, including parents, children, siblings, and grandparents, as well as remote relatives and non-relatives, typically must pay inheritance tax. Remote relatives and non-relatives generally face a much higher tax rate compared to the close relatives.

Generally, the tax imposed is based on the value of the estate. In certain scenarios, if the value of the estate is below a predetermined benchmark, it will not be imposed.