Getting an inheritance from a loved one may be bittersweet but it can also be awkward if a tax bill is attached. Kim Parlee speaks with Georgia Swan, a Tax and Estate Planner with TD Wealth, about some options around inheritances and why the CRA can sometimes wish to claw funds back.
Originally published May 19, 2021
Well, that's a question I get quite often, Kim. And actually, unlike the United States, Canada doesn't have inheritance tax, or doesn't really tax beneficiaries. But that doesn't mean that the deceased person and their estate are not taxed.
So I think a good way of looking at this as maybe getting a little bit of understanding of what happens when somebody passes away from a taxation perspective. So let's take a very typical will. I leave everything fully to my kids. Usually, what happens in that case is that the executor has to determine what the person's assets were, what their liabilities were. Then basically, usually the executor will just sort of sell everything off, pay off all the taxes and liabilities, reduce everything to a pot of money, which is called the residue, and then divide the residue amongst the beneficiaries.
So the taxation happens of the deceased. So any accrued capital gains, any income they made any way in that last year of their life, the full value of any RSPs or RRIFs, all of that lands on the deceased's tax return. And so that tax has to be paid.
And then if, during the course of the administration, the estate makes any additional income, before it liquidates things-- maybe they increase in value-- in that case, then the estate has to pay tax. So once all those taxes are paid, as I said, the net money is the residue that's distributed to the beneficiaries. So in those cases, all of the tax is pretty much paid up front, and whatever the beneficiaries receive is theirs.
- Let me ask you about some specifics, because that all makes sense to me. But what about RSPs? You mentioned them briefly. But how does that work?
Yeah, RSPs, unfortunately, are kind of the little things that could create a problem. So as I said, when you die with money in an RSP or a RRIF, and it doesn't go to a spouse-- so we're looking at sort of the next generation distribution-- you can designate a beneficiary of the RSP or the RRIF. And that's good. Because if you're in a province that has probate taxes or probate fees, that will avoid those probate fees. Because that money will go outside the estate, to the designated beneficiaries.
But as I said, the full value of that RSP or RRIF is brought into income in the deceased's tax return. And that tax bill goes to the estate. So what happens if there isn't enough other assets in the estate that goes through the will to pay that tax bill? Do you really think the CRA says, oh, that's OK. We don't need our money?
No they don't. This is one time when even though those assets don't go through the will, don't go through the estate, and actually go directly to the beneficiaries, the CRA can actually come after the beneficiaries to the extent of what they received from the RSP, to get that tax money. And that can actually also be something that can happen if-- let's say the deceased person owed tax from previous years.
There was a recent case where basically because the deceased owed money from previous years, and as well, the RSP, or in this case, the RRIF was taxable. The CRA did go after the beneficiaries. So it is important that if you're a beneficiary of something like an RSP or a RRIF, don't spend the money until you know for a fact from the executor that there's no tax liability that the CRA may indirectly come after you for.
- OK. Point of clarification, just to make sure. So if I'm a beneficiary of an asset coming from someone who has a tax bill, the CRA could come after the asset that was received. But they can't come after the beneficiary beyond that, just so we're clear, right?
Yes, absolutely. You're not responsible for their tax bill. So if, for example, the RSP or the RRIF only has $1,000 in it, and the tax bill is for $10,000, they can only take the $1,000. They can't take anything more than that. But that-- there's only a few assets that can be what's called clawed back into the estate. Doesn't happen for insurance proceeds-- so life insurance policies. But it can happen for RSPs and RRIFs. That's the thing to think.
- I was just going to say, inheriting a tax bill from somebody would be the worst inheritance ever. But anyway, so-- OK, last thing I wanted to ask you about is property, so something like a cottage. How would that work, from a inheritance standpoint?
Yeah, so maintaining the cottage, and keeping the cottage to the next generation, is something a lot of people want to do. But as I said, if there is accrued capital gains to that cottage, that tax has to be paid from somewhere. So in many cases, other assets are brought to bear. So non-registered investments, or whatever else you might have that can be sold, is sold in order to be able to maintain that cottage in kind.
The thing is, though, if there aren't enough other assets, then in that particular case, if it ends up being a discussion between the executors and the beneficiaries as to whether they're willing to chip in some money, in order to retain that cottage. Otherwise, the cottage may have to be sold to pay that tax liability.
- Final thoughts, Georgia, things to keep in mind?
Well, things to keep in mind is just because you're left something under-- in will doesn't mean that's exactly what you're going to get. It's important to look at the will. Because sometimes, even the might say, I leave my account 1234 to my daughter Georgia. But the tax consequences of that account are to come from that account.
So you need to understand what it means to have the net money come to you or actually have the bequest. And you need to make sure that the executor is getting really good advice, and you're getting good advice, about what the outcome is going to be. Is there a tax liability? Might you end up becoming responsible for it? Or otherwise, are you getting something that's after tax, and off you can go and spend that inheritance.
- Always great talking to you, George. Thanks so much.
Thank you. Good to see you again.
- That's Georgia Swan. And if you have few questions you'd like to ask MoneyTalk, to send it to firstname.lastname@example.org with Ask MoneyTalk in the subject line. You ask this question. We'll find the right person to answer for you. And you can find those answers on MoneyTalkGo.com. Dotcom.