Minimizing or Deferring Taxes Upon Death

18.5 Minimizing or Deferring Taxes Upon Death

Passing away is never an easy topic, for sure. But—believe it or not—a bit of planning can lighten the burden on loved ones from a tax perspective. When someone dies in Canada, a whole flurry of things can happen: from the dreaded “deemed disposition” of assets to potential double taxation if the deceased owned private-company shares. In this section, we’ll explore the key strategies you can use—some big, some small—to minimize or defer taxes at death. We’ll walk through post-mortem planning, pipeline strategies, spousal or common-law partner rollovers, how to manage “rights or things,” and more. I once worked with a family that realized, after digging into the father’s private-company shares, how essential a proper post-mortem strategy was to avoid paying twice on the same economic value. It seemed complicated at first, but once they understood the fundamentals, it felt a lot less intimidating.

Let’s take a closer look at the nuts and bolts of each approach. We’ll also talk about special considerations like non-resident beneficiaries, testamentary trusts, and the concept of a Graduated Rate Estate. We promise to keep it as human as possible, while also giving you enough detail to really get a handle on it.

Key Approaches to Minimizing or Deferring Taxes

There are certain triggers at death that can lead to big tax liabilities—namely, the “deemed disposition” rule. Basically, when someone dies, their assets are generally considered to be sold at fair market value right before death. That could result in capital gains or other forms of income being recognized on their final tax return. But the good news? With a little know-how, you can often reduce or defer those taxes.

Below are some primary approaches to deal with taxes upon death:

• Post-Mortem Planning (including “pipeline planning” for private-company shares)
• Filing a Rights or Things Return
• Spousal or Common-Law Partner Rollovers
• Graduated Rate Estate (GRE) strategies
• Testamentary Trusts
• Non-Resident Beneficiary Considerations

We’re about to dig into each of these in more detail.

Post-Mortem Planning for Private-Company Shares

Let’s say the deceased owned shares in a private company. At the moment of death, there is typically a deemed disposition of those shares at fair market value, which can trigger capital gains tax. Then, when the corporation pays out the underlying corporate assets to the estate or to beneficiaries, there could be a second level of taxation—often taxed as a dividend. This “double dip” of tax is precisely what post-mortem planning tries to solve.

One well-known approach is the “Pipeline” strategy. Imagine it like a pipeline that moves the corporate funds to the estate with minimal or no second layer of taxation. I remember an accountant friend of mine saying, “We’re basically trying to connect that big pot of corporate value directly to the estate or beneficiaries without letting the taxman charge us for the same value twice.” That’s a simplified version, but it captures the essence.

Here’s a (very) high-level look at how a pipeline might work:

1. The estate sets up a new corporation or uses an existing structure to “channel” the private-company shares.
2. The shares get moved (via a transfer or a sale) so that the estate receives a note in return.
3. Over time (often years), the corporation redeems that note using corporate funds, effectively returning the capital to the estate.
4. Because of the way the reorganization is structured, you may avoid the second layer of tax that would normally be triggered upon share redemption.

But it’s not a DIY project—definitely consult a tax lawyer or an experienced tax accountant. The rules can be quite intricate, especially with possible changes to legislation. Also note that post-mortem planning should be carefully timed—sometimes you must execute certain steps before filing final tax returns.

Rights or Things Return

Ever heard of the optional “Rights or Things” return? If the deceased had amounts owed but not received at the time of death (like uncashed employment cheques, declared dividends that weren’t yet paid, or arrears of pension income), you can choose to report them on a separate return instead of lumping them into the final one. By doing so, you might be able to reduce the overall tax load, especially if the deceased was near the top of a tax bracket. Splitting income across multiple returns effectively leverages multiple sets of personal tax credits and brackets. That’s a nifty trick worth exploring.

In practice, I’ve seen estate executors who didn’t realize they could file this extra return. When they found out, they saved thousands in taxes. The extra paper filing is a bit more effort, but the potential tax reduction can be significant. Just remember that the CRA has specific guidelines on what qualifies as “rights or things,” so not everything automatically fits.

Spousal or Common-Law Partner Rollover

One of the biggest ways to defer taxes is through the spousal or common-law partner rollover. If the deceased had certain registered plans, like an RRSP or RRIF, they typically roll over to the surviving spouse or partner on a tax-deferred basis. In plain English, that means the spouse can take over ownership of those funds without triggering a big tax bill right away. (Of course, if there isn’t a spouse, the entire RRSP or RRIF value might be taxed in the deceased’s final return.)

The same goes for capital property. Instead of a deemed disposition at fair market value, you can “elect” to roll over the property at the deceased’s adjusted cost base (ACB). This effectively defers capital gains tax until the spouse eventually sells the property or passes away. A real-world example might be a family cottage that’s been in the family for decades. By rolling it over to the surviving spouse, you don’t pay capital gains tax right away. Later, yes, but you’re buying time—and sometimes, time can translate into better tax planning.

Graduated Rate Estates (GRE)

If you’ve been around estate administration, you’ve probably heard of the concept of a Graduated Rate Estate (GRE). For up to 36 months after death, an estate can qualify as a GRE, which allows the estate income to be taxed at graduated rates rather than having to jump to the top marginal rate. That can be a lifesaver if the estate is generating significant income during its administration period.

Basically, if you do it right, you can split income between the estate and the beneficiaries in a way that optimizes overall tax. The result: less tax paid, more wealth retained. Once the 36-month window ends, the estate typically becomes a “testamentary trust” that might be taxed at the top marginal rate. So the GRE is a short-term advantage that you want to harness while you can.

Testamentary Trusts

Testamentary trusts are trusts set up through your will. People have used them for years to control how and when beneficiaries receive their inheritance. But from a tax perspective, testamentary trusts can also offer certain benefits (like income splitting) depending on how they are structured.

For instance, a spousal trust can defer capital gains tax on property until the spouse’s death. Or a family trust might allow the trustee to allocate income across multiple beneficiaries (like kids or grandkids), just to name a few examples. Note that tax rules for testamentary trusts changed as of 2016, and now most testamentary trusts are taxed at the top marginal rate unless they qualify as a GRE or a Qualified Disability Trust (QDT). So read the fine print or talk to a professional—especially if you are trying to set up multiple testamentary trusts for multiple beneficiaries.

Non-Resident Beneficiaries

If you have beneficiaries living outside Canada, things can get trickier. Non-residents may be subject to withholding taxes or special tax treaties. Also, your estate might have additional reporting burdens. For example, distributing assets to a non-resident successor could trigger a clearance certificate requirement to ensure all Canadian taxes are paid before moving capital overseas.

I was once helping an executor with multiple relatives in different continents—some in the U.S., some in Europe—and we had to juggle various tax treaty provisions. It was a puzzle, but with methodical planning, the estate avoided unnecessary double taxation. In these situations, a cross-border tax specialist is your best friend, even if it costs a bit more in fees. It’s worth preventing a potential avalanche of taxes.

Visualizing Post-Mortem Planning: A Simple Diagram

Sometimes it helps to see how these pieces connect. Here’s a very simplified Mermaid diagram to illustrate the flow of a basic post-mortem pipeline plan. Please note that real scenarios are more complex, but this can give you a big-picture sense of how a pipeline moves funds from the corporation to the estate, minimizing double taxation.

    flowchart LR
	    A["Deceased <br/> Shareholder"] --> B["Estate <br/>(heir of shares)"]
	    B --> C["Reorganization <br/>(Pipeline Strategy)"]
	    C --> D["Note Receivable <br/>from Corporation"]
	    D --> E["Corporation <br/>Redeems Note"]
	    E --> F["Estate Receives <br/>Funds with Reduced Tax"]

In short, the estate inherits the shares. Then there’s a reorganization (often a Section 85 rollover or similar) that swaps shares for a note. The corporation eventually redeems that note, and the estate ends up with cash. Since the capital gain was recognized at death, the pipe prevents taxation again as a dividend. The result: one level of tax instead of two.

Best Practices and Practical Insights

• Get professional advice early. Obviously, we keep saying it, but estate and post-mortem tax laws can be complex, and the difference between good planning and none can be huge.
• Keep beneficiaries in the loop. If you’re an executor, communication with all beneficiaries—especially non-residents—avoids misunderstandings and nasty surprises.
• Utilize the GRE window. The 36-month period is precious for income-splitting and flexibility with timing. Don’t waste it.
• Maintain proper documentation. Keep track of the deceased’s final tax return, carry forward balances, RRSP or RRIF statements, property purchase prices, and other details.
• Revisit your plan regularly. Yes, that means even though we’re talking about death, you want to refresh these strategies as circumstances change—like changes in marital status, introduction of new beneficiaries, or significant changes in net worth.

Case Studies

• Corporate Shareholder Passing Away Without a Plan: A deceased shareholder left behind a private corporation. No post-mortem plan was in place. The estate ended up paying tax on the capital gain (on deemed disposition) and again as a dividend when the corporation’s assets were distributed. The total tax was significantly higher than if they had done a pipeline.
• Rights or Things Return in Action: An individual passed away in April but had a year-end bonus declared in March. The executor filed a Rights or Things return for that bonus, effectively splitting tax liability across two returns. The family saved a notable sum because of separate personal credits.
• Spousal Rollover for the Family Cottage: A cottage that had soared in value over the decades was transferred to the surviving spouse upon death, deferring the capital gains. That spouse later decided to keep the cottage as a legacy property for the grandkids.

Common Pitfalls

• Missing deadlines for filing optional returns (like the Rights or Things return) can cause you to lose a valuable tax break.
• Overlooking non-resident beneficiary rules and ending up with withheld amounts that are irreversible.
• Failing to designate an estate as a GRE leads to higher taxes.
• Not updating wills and trust documents frequently—resulting in outdated instructions that can conflict with new tax rules.
• Underestimating the complexity of private-company share valuations, leading to incorrect capital gain calculations.

Incorporating Official Regulations and Resources

Staying on the right side of the law and maximizing tax breaks means referencing official guides. Take note of:

• CRA T4013 “T3 Trust Guide” — for testamentary trust rules and estate filing requirements.
• “Post-Mortem Tax Planning for Private Company Shares” — look up KPMG Canada or Ernst & Young bulletins for technical guidance and updates.
• Provincial bar association continuing education programs on estate administration — can provide insights into legal and administrative aspects, especially if you’re an executor or trustee.
• CIRO updates on handling the investment accounts of deceased clients. CIRO is now the single self-regulatory body, having replaced the previously separate organizations (the MFDA and IIROC). They offer guidance on how to manage transferring or liquidating assets in a deceased’s trading account.

Practical Table: What Goes Where

Below is a quick reference table (just a broad-stroke guide, keep in mind every estate is different) that shows typical tax treatments upon death:

Conclusion

Minimizing or deferring taxes upon death might feel overwhelming at first, but once you understand the underlying concepts—especially how “deemed dispositions” work and how spousal/common-law partner rollovers, pipeline planning, and testamentary trusts can help—you’ll be in good shape. It’s really about putting the puzzle pieces together so that the estate and beneficiaries don’t overpay the government. Whether you’re an executor, a financial planner, or just someone wanting to make life easier for your heirs, remember that good advice and adequate preparation can go a long way.

At the end of the day, estate planning is kind of like casting a safety net: you’re trying to keep as much of the assets in the family (or other beneficiaries) and ensure as little is lost to taxes and legal fees as possible. Keep that bigger picture in mind, and always re-check your plan as the rules or your family circumstances evolve.

Test Your Knowledge: Minimizing Taxes Upon Death