The death of a family member or a close friend, can be a difficult time. Our office is committed to making it as easy as possibly for you during this trying time by providing estate planning prior to death and setting out some tax tips for tax return filing on death.
Does an income tax return need to be filed for a person who has passed away?
Yes. A return must be filed for the year of death of the deceased person. This is known as a person’s terminal return. For the most part, the usual income tax rules apply to prepare the terminal return. However, there are a few exceptions including when the return is required to be filed with the Canada Revenue Agency, and how income is calculated.
Who is responsible for filing the terminal return on behalf of the deceased person?
A deceased person’s legal representative such as their executor/executrix or administrator/administratrix is responsible for filing the terminal tax return. An executor/executrix is the individual(s) appointed by the deceased’s will to administer the person’s estate. In contrast, an administrator/administratrix is an individual(s) appointed by a court to administer a deceased person’s estate when they die without a will (intestate).
When must the terminal return be filed?
Generally, the terminal return is due on April 30 of the year following a person’s death. However, there are certain exceptions. If a person dies after October 1, their legal representative has 6 months from the date of death to file their terminal return. There are also certain situations involving spousal trusts when a legal representative may have up to 18 months to file the terminal return. We suggest that you contact us to seek legal advice if you intend on settling a spousal trust in your will, or if you are administering a will with a spousal trust.
What must be included in a deceased person’s income for the terminal return?
In the terminal return, any income that has been earned and paid up until the date of death must be included in income. This may include income from employment, business, investments, royalties, pensions and employment insurance, to name a few. However, there are certain provisions in the Income Tax Act which have the effect of bringing other amounts into income that would not typically be included in a person’s income. Some of the more common income inclusions in the terminal return are discussed below.
On death, the full market value of the deceased’s RRSPs must be included in their income. However, if the deceased has a spouse, the RRSP may be rolled over into the spouse’s RRSP to achieve tax deferral until the spouse passes away.
Employee Stock Options
If the deceased has unused employee stock options at the time of their death, the full market value must be included in the terminal return.
Immediately before death, the Income Tax Act deems a person to dispose of all of their capital property. This means that for tax purposes, the deceased person is considered to have sold all of their capital property. Capital property may include shares, investments and real property. The advantage of a disposition being classified as capital gain from capital property, is that only ½ of a capital gain is included in income.
Additionally, some capital property is called depreciable capital property, and is treated differently for tax purposes than capital property because it depreciates in value over time. This might include (for example) a photocopier or a piece of farming equipment.
There are several different tax consequences that are possible as a result of the deceased being deemed to have disposed of all of their capital property and depreciable capital property. They may have a capital gain or loss, and they may have recapture (an amount to be included in their income) or a terminal loss(an amount to be deducted from their income) on their depreciable capital property.
If you are unsure of whether an asset is capital property or depreciable capital property, and the consequences of disposing of it, consult your tax expert. Our office would be happy to assist you in making this determination. Additionally, there are certain tax free rollovers for spouses and limited rollovers for children for farm or fishing properties that achieve tax deferral on the disposition of capital property and depreciable capital property of the deceased. Our office can help you determine if you are able to take advantage of these tax savings strategies.
Accrued Income Payments Periodically
There are several situations in which a person may have earned income prior to their death, that they will not receive until after their death. For example, they may receive payments periodically, such as rent, royalties, interest or employment income that is not payable until after death. Payments that are received periodically after the death of a taxpayer are included in their terminal return. Consider the situation when an individual passes away, but will not receive their pay cheque for another 10 days. In this case, their pay cheque is not payable at the time of the person’s death. However, it is still included in income even though it will not be paid until after the person’s death, because it is a periodical payment made to the deceased person.
Rights or Things
The deceased may have certain ‘rights’ or ‘things’ that must be included in income for their terminal return. The benefit of something being classified as a ‘right’ or a ‘thing’, is that the legal representative can elect to file a separate income tax return for the rights and things. Filing a separate return for rights or things provides an opportunity for the deceased taxpayer to have separate deductions and be subject to separate marginal tax rates from the first terminal return. In addition, there are circumstance in which the tax liability of a ‘right’ or ‘thing’ can transferred to the beneficiary rather than the deceased.
The Income Tax Act does not define what a right or a thing is, however, it specifically excludes certain types of property and income. A right or a thing typically catches amounts that are payable before death but have not yet been received such as a declared but unpaid dividend, a retroactive salary payment, or a Professional’s work in progress. In their interpretation bulletin IT-212R3, the Canada Revenue Agency has listed a number of other examples of rights and things. If you are unsure whether something qualifies as a right or a thing and should be included in a person’s terminal return, do not hesitate to consult us.