Is my inheritance taxable?
Your relative passed away at age 80 in early 2016. They never married and had no children. You are the sole beneficiary in their will. Is your inheritance taxable?
It is basically the executor’s choice whether or not to make the estate pay all the income tax before distributing your inheritance to you. We will look at the tax arising on each type of property they owned.
They had a Registered Retirement Income Fund (RRIF). The full $201,000 market value becomes taxable income on their final T1 tax return. The tax bill can be up to $96,000 if there is enough other income to push the RRIF into the top Ontario tax bracket of 48 per cent.
The financial institution holding the RRIF will issue a cheque for the entire $201,000 with no tax deducted at source.
What if they had designated you as RRIF beneficiary to reduce probate costs? You would receive the full $201,000, but that leaves the onus on the executor to find cash to pay the big tax bill.
The Canada Pension Plan death benefit (up to $2,500) is reported on an estate T3 tax return, which is for reporting income earned after death. Since the estate T3 return has graduated tax brackets (for 36 months after death), the executor can take advantage of the lowest 26 per cent bracket rate.
When they retired, they chose a 10-year guarantee for their employer Registered Pension Plan (RPP) benefits. With three years remaining in their pension guarantee period when they died, there is a $31,000 commuted value payable to the estate. However, unlike the way their RRIF is reported on the final T1 return, the $31,000 RPP lump sum value must be reported on the estate T3 return, where it can be taxed at a rate as low as 26 per cent.
What if they had designated you as RPP beneficiary to reduce probate costs? That means you would receive the T4A tax slip for the $30,000 income and the executor would have no option to report this income on the estate T3 return for you.
Because their $301,000 condo had been their principal residence, the condo capital gain is tax-exempt. If the executor transfers title to you as estate beneficiary, you pay no tax on the condo value.
If you keep the condo and rent it out, the rent is your taxable income.
They had $48,000 in a Tax Free Savings Account (TFSA). The $2,500 accumulated growth in his TFSA is tax-free when paid out on death. But investment income earned after death becomes taxable to the estate, if the estate was the TFSA beneficiary; or else to you if you were the TFSA beneficiary.
If they also owned stocks with capital gains in a non-registered investment account. The executor must include half the accrued gains as income on their final T1 tax return even if the executor transfers those stocks to you, without selling them. The market value at their death is your adjusted cost base (ACB).
Closing up an estate typically takes a year or two. When RRIFs keep growing and estate investments earn income after death, the executor can choose for the estate to pay all the tax on the estate T3 return or allocate income to you using a T3 slip.
In summary, if the estate pays all the tax, you would inherit tax-paid dollars or the executor can choose to allocate estate income to you which would make you responsible for paying the taxes.
For help with estate planning you can download my “Personal Affairs Organizer” and read Canada Revenue Agency’s guides called “Preparing Returns for Deceased Persons” (T4011) and the “T3 Trust Guide” (T4013).