What tax returns should be completed when someone passes away? Why do these returns need to be filed?
Benjamin Franklin once wrote that “nothing is certain, except death and taxes.” Death is inevitable; however, how much tax we pay is unique to each Canadian. Not everyone “pays tax,” as it depends on income level. So, for the sake of this column, let’s tweak it to read: “Nothing is certain, except death and tax returns!”
Also, taxes are not just for the living. When a person passes away, there are several tax returns to know about. And tax returns can be a complicated process on the best of days. For example, when someone passes away, navigating their taxes becomes an even more perplexing process as the taxpayer essentially files their taxes two times—more on that later. But first, four things to know when filing a tax return for someone who has passed away in the previous year.
4 changes for filing tax returns when someone passes away
There are items to be mindful of when preparing the final return for someone. To keep things simple, I will cover a few of the points most will encounter. If you find you’re dealing with a more complex tax return, consider working with an accountant.
- The type of tax return used when someone dies
The tax return prepared for the year someone passes away is called a “Final T1 General Tax Return,” and it is commonly referenced by accountants as the “Terminal Return.” It works like a regular annual return but with a few differences you should be aware of.
- The deadline for a final tax return
Every Canadian is required to file a tax return for income earned in the preceding year by April 30. This year, that date falls on a Sunday, so May 1, 2023, is when the T1 General Tax Return for 2022 is due (unless you or your spouse are a business owner, then the deadline is June 15, 2023). The same is true when someone passes away, except the ending period of the tax return would be the date of death instead of December 31. And the deadline to file and pay taxes for someone who has died, if they passed between November 1 and December 31, 2022, is six months after the date of death. Otherwise, the May 1, 2023, deadline is still to be followed.
- The name of the deceased as it appears on the return
Typically, your tax return lists your legal name, like Jane Doe. However, on the final return for a deceased person, the naming convention would be: The Estate of Jane Doe.
- The disposition of assets
The last main difference—and quite possibly the most intricate—would be the disposition of assets and property. Canadians hold different types of assets throughout our lifetimes that we do not have to report on an annual tax return. That is until these are sold or disposed of, and we claim a capital gain or loss. Claiming a loss is trickier (see in this video), but capital gains tax is applied to 50% of the income earned, based on your tax bracket.
For example, if you bought a stock for $10,000 and then sold it 10 years later for $25,000, you have a capital gain of $15,000, and you would include a $7,500 taxable capital gain (50%) on your tax return.
The same holds true in the year of death. However, we cannot take our assets and possessions with us upon death, which means that death is a large tax event as everything we own is deemed to be disposed of and reported on this final tax return based on the market value on the date of death.
Next, what is an estate tax return? Does your estate report income after your death?
Remember how I mentioned earlier that when someone dies, taxes are filed twice? On the final return, as noted above, income up to death is reported. However, the tax filing process does not stop there, as income may continue to accrue on assets after the date of death. This is when an estate is created, and it carries on until the executor wraps everything up. Therefore, starting the taxes for the “second time,” the estate (not the executor) assumes the responsibility of claiming any income earned from the date of death onwards.
It is no secret that wrapping up an estate is a lengthy and time-consuming process. This is because many steps are taken to finalize the paperwork for someone’s death. Common delays include identifying assets that the deceased owned, all their debt, applying for probate, selling off assets like property and investments, and ensuring the estate is liquidated if applicable.
Since all these tasks take time, it is pretty typical for assets to earn income while held in their original date of death form. Dividends and interest may continue to be deposited to an investment account after the account holder dies. Their rental properties will still earn monthly income. And other assets may continue to rise or fall in value after death until these are sold.
All these extra earnings are reported on the estate’s tax return, also known as a T3 Trust Income Tax and Information Return. There are also less common optional returns like a Return for Rights or Things or a Return for Partner or Proprietor that may be filed to report income earned but not paid as of the date of death.
The trust return is filed for each year that the estate is active until all distributions are made to the beneficiaries, and the estate no longer holds anything and can be closed.
Also, an estate can report the Canada Pension Plan (CPP) death benefit payment—which can be up to $2,500—on the T3 return.
- The deadline for a T3 return depends on the tax year-end for the estate, which is based on when the estate is created. A prudent executor should hire a tax professional to ensure that all tax points are covered and any tax elections that can be explicitly made based on the estate’s situation are appropriately done. Income taxes can be more complicated upon the death of a taxpayer. However, with planning and professional guidance, executors can take it one step at a time, one tax return at a time.
Planning for the unplannable
While taxes are predictable, someone’s passing isn’t always something we can be ready for. By working with a Certified Financial Planner and a tax accountant, you can do some tax prep, learn about the optional tax returns available for your specific situation and, perhaps, save some tax along the way. And figuring out your estate planning, you are reducing the tax burden for our estate and our loved ones.