Death and taxes are two certainties in life, and taxes are also a certainty in death.
But when it comes to estate planning, one common mistake you can make is not having an effective plan on how to manage the taxes after death. Failing to do so might cause a heavy tax burden for your family and beneficiaries, who may end up getting a smaller share once all the taxes are settled.
Tax implications after death
Your estate will primarily incur two types of taxes after your demise: your final income tax return, and probate fees or estate administration taxes.
Final income tax return
Your executor is responsible for paying outstanding liabilities, which includes paying the final tax return with the Canada Revenue Agency (CRA). A final tax return is mandatory for any deceased person and must be filed in the year of death.
On this final tax return, the executor must report the income earned by the deceased person between the first day of the year and the date of death. Any income earned after the death of death must be reported on the Trust Income Tax and Information Return (T3).
Probate fees or administration taxes
If your estate requires probate, the fees associated with probate are often known as administration tax. Probate fees are based on the size of your estate and vary depending on the province you are in.
For example, in Ontario, a new statute called the Estate Administration Tax Act (EATA) requires that you pay estate administration taxes on the value of the assets passing through the estate of the deceased, as part of the process of obtaining the certificate of appointment of estate trustee (the certificate that formally appoints the executor of an estate).
Like your final income tax return, your executor is also responsible for paying probate fees to the court alongside any application costs.
Estate and tax planning strategies to reduce taxes after death
If you want to leave more money in your beneficiaries’ pockets, there are also several ways you can minimize your estate administration taxes in advance through estate planning. Here's quick overview of strategies we'll cover in this section:
- Avoiding probate and court filing fees
- Adding joint owners to assets
- Naming beneficiaries for financial assets and insurance policies
- Registering your estate with the Registry Act System
- Giving gifts while you're alive
- Creating trusts during your lifetime
- Having assets in different jurisdictions
- Making multiple wills
- Leaving gifts for charities in your will
Avoid probate
Not all wills need to be probated in Canada. Your own will may not need to go through probate if you have a small estate, your financial institution(s) agree to waive a grant of probate, you are a First Nations member who is a resident of a reserve, or if you have multiple wills and another one of your wills does not require probate.
Learn more about how to avoid probate and reduce probate fees →
Joint ownership of assets
Placing assets in Joint Tenancy with Rights of Survivorship (JTWROS), where two or more people can hold assets together, can help reduce your estate fees after you pass. This can also help your property avoid capital gains tax.
This is because assets owned jointly pass to the other owner without entering the estate, though, of course, exceptions may exist.
Beneficiary designations
By naming beneficiaries on investments, RRSPs, life insurance policies, and other similar financial assets, you ensure your beneficiaries receive these assets directly, bypassing your estate–and bypassing additional fees.
Registry act system
Registering real estate under the Registry Act system (not Land Titles Act) helps you avoid taxes because it does not require a probated will to be administered.
Inter vivos gifts
Inter vivos means between the living, so inter vivos gifts are gifts of assets you can make while you are alive. While these gifts can help reduce the tax value of your estate when you pass, they are also irrevocable.
Inter vivos trust
Likewise, an inter vivos trust is a trust you establish during your lifetime. Also referred to as a living trust, these allow trustors to set a duration for a trust involving the distribution of assets to the trust’s beneficiary during or after the trustor’s lifetime.
Complex trusts
Alter-ego trusts, joint partner trusts, and other complex trusts can also be issued during your life to avoid estate taxes in the future, though they need legal expertise.
Trusts and estate freezes
An estate freeze is a strategic asset management technique for trusts. It allows you, as the owner of your estate and trust, to transfer future growth of assets to beneficiaries while retaining the current value.
This is typically done by exchanging common shares for preferred shares with a fixed value, effectively "freezing" the owner's stake at its present worth. The future appreciation of estate assets are then redirected to new common shares issued to beneficiaries, often through a family trust.
The primary benefit of an estate freeze is reducing or deferring capital gains taxes. The tax liability of someone's frozen estate is capped at whatever the frozen value was, not the estimated value at the time of death.
This strategy can also enable income splitting among family members, potentially reducing overall tax burdens, and allows for the multiplication of the lifetime capital gains exemption.
Additionally, an estate freeze can help smooth succession planning and asset protection for future generations.
Asset relocation
Another option for reducing taxes after death is to move your assets into a jurisdiction outside your province.
Multiple wills
As mentioned before, having multiple wills which separate your assets based on probate requirements can help you save taxes on assets which are not probated. People also sometimes create separate wills or dual wills for business assets as well.
Charitable bequests
Giving to charities you support when you pass away can also help reduce the tax burden placed on your estate.
Additional benefits to planning for the future
If the unexpected happens and you not longer have the mental capacity to manage your assets yourself, your appointed attorney could also act on your financial wishes and implement these strategies for you. But that's only if they've been officially appointed in a legal power of attorney document.
Powers of attorney documents prove that your appointed person has permission to act your behalf concerning your medical or financial decisions, if you're ever unable to make those decisions yourself. Without these documents, your loved ones may have difficulty managing your assets and reducing taxes for you.
Planning ahead makes all the difference for giving both yourself and your loved ones peace of mind. It gives you control over your future, your assets, and what happens to your loved ones. That's why making a will and POAs are so important for preparing for the future.
Frequently asked questions
When considering estate planning taxes and how to manage them, here are some other questions you may have.
How much can you inherit without paying taxes in Canada?
There is no inheritance tax in Canada, so theoretically, there is no limit to how much you can inherit without paying taxes for it. But final tax income returns and other estate settlement fees shouldn’t be ignored, as monies owing are deducted from the estate before funds are distributed to beneficiaries.
Is estate planning tax-deductible in Canada?
Estate planning is not tax-deductible in Canada, though the benefit of it to you and your loved ones, and the peace of mind it’ll give you, is worth it.
What is the best trust to avoid estate tax?
Any trust that is irrevocable, such as inter vivos trusts and many complex trusts, is shielded from estate taxes as the trust is no longer considered part of your estate.
How to start estate planning
Remember, you don’t need to have a vast estate to start planning because not having a large estate does not exempt you from paying taxes. As mentioned, tax rates may vary between provinces and territories, so check first with the CRA on the prevailing estate laws so you can plan effectively.
Which strategy do you think can benefit you the most? You can speak with your accountant about the best possible tax workaround that applies to your estate. But before that, make sure to prepare the basic documents that you will need in estate planning, starting with writing a will.
