When both parents have passed away, tax becomes an issue

Most of the time, estate planners are able to structure assets between a husband and a wife to take advantage of tax rules and estate laws that provide for ease of transfer within that marital unit. To do so, assets may be held in joint names, and spouses may be named as beneficiaries of registered assets.  The end result is usually favourable for tax purposes in that taxes are kept to a minimum so that family assets are not depleted.

However, once the husband and wife have both passed away, many of those protections are not available (such as rollover of registered assets). At this point, an estate ends up being liable for taxes when the assets pass to the children.

A reader recently wrote to me about this kind of situation. Her letter and my answer appear below.

"My husband passed away and I inherited a substantial sum of money due to his insurance policies  and  his pension. We own two properties, one being a house as main residence and the other a condo that we are renting out. The money portion of the estate is now invested in GICs as RRSP. What I need to know is if I was to die, how much tax would my kids have to pay on the estate?"

Your kids are not going to have to pay any tax. Inheritances in Canada are not taxable. Your estate, however, is going to have to pay tax.

Obviously I don't know how much the tax will be, since I don't know what any of the assets are worth, and even if I did know, I'm not an accountant. However, I can describe to you the ways in which assets of an estate such as yours are taxed once they leave the protection of the husband-wife unit and pass to the children.

First, let's talk about those two properties. You've said "we" own two properties, by which I understand that the properties are being held in joint names. Now that your husband is deceased, you must remove his name from the titles. This will leave them in your name alone.

When you pass away, the property that you have designated as your principal residence will pass to your estate with no tax consequences. The condo, however, will be subject to capital gains tax. If you want to know the details about how much that tax is likely to be, I suggest you consult an accountant.

Next, the RRSP. If your husband owned an RRSP that named you as the beneficiary, this RRSP most likely rolled over to you on his death. No tax would have been payable on that transaction at the time, because tax rules allow RRSPs to "roll over" to the spouse. This rollover, or deferral, is not available when you pass away and the RRSP funds go to your children. The law says that your RRSP, which now includes your husband's RRSP, is deemed to be cashed in when you die. As you know, any money that you take out of an RRSP is taxable, so if the whole thing is cashed in, the whole thing is taxable.

You may have other taxable assets that you haven't mentioned here. However, based on what you've told me, your estate will be liable for at least capital gains tax on the condo and income tax on the combined RRSP. This tax is not payable by your children; it's payable by your estate. This means that the tax must be paid in full before your kids receive anything.

I encourage anyone who is concerned about taxation of his or her estate to sit down with an estate planning lawyer and/or an accountant.