Here are all the things you should know about filing a loved one’s final tax return.
August 12, 2022
Losing a loved one is a difficult time, with lots of considerations. One that might not come to mind is that when someone passes on, one final tax return must be completed. We’ve written about the preparation needed to make sure affairs are in order, and below are some of the special considerations to think about when you’re doing that final return.
All income accrued from January 1st up to the date of death is reported in what’s called the “final” or sometimes the “terminal” return. For this purpose, income that is paid periodically, such as interest, rent, royalties, annuities or salary and wages is deemed to accrue in equal daily amounts in the period it was payable, so it may not actually have been received at the time of death.
This means, if the deceased person had a salary that was paid once per month on the 1st of the month at $4,000, but the person died on the 23rd day of the month, then although they would have received the full $4,000 payment for work that month, their income would be considered $2,968 for those 23 days (if the month had 31 days total). When their employer issues their last T4 slip, it’s going to provide an amount paid for the whole year, so it’ll be your responsibility to do the math and figure out exactly how much income counts on their final return.
How is their property accounted for?
Also reported on the final return is the value of any capital property owned by the deceased person at the time of their death, such as real estate, shares, mutual funds or other securities. That’s so the government can determine what their capital gain is since the deceased person purchased it. So, if they bought a house for $200,000 many years ago and it’s now worth $700,000, the capital gain on that property is $500,000. That might seem significant when the estate has to file taxes on such a large capital gain, but the ‘deemed disposition rule’ will help if the deceased has a common law partner or surviving spouse. This rule means that the property goes to the spouse/partner at cost, and essentially defers the capital gain payment until that person dies. In the case of real estate, the capital gain will also be exempt if the property can be designated as the deceased person’s principal residence for all the years they owned it.
Similarly, any Registered Retirement Savings Plans (RRSP) and Registered Retirement Income Funds (RRIF) held by the deceased person can be transferred to the surviving spouse/partner’s plan. Now, a financially dependent child or grandchild can also have the funds transferred to them, however, unless the child is infirm (technical term the CRA uses to mean sick or disabled), it can only be transferred into an annuity with a term date no later than the child’s 18th birthday. If there’s no one to transfer to, the issuer is required to report the full market value of fund the at the time of death which has the effect of including the entire amount in income.
What doesn’t go on the final return?
If the deceased person ever worked in Canada, they'll have contributed to the Canada (CPP) or Quebec Pension Plans (QPP) which will entitle the estate to a $2,500 death benefit when they die. Executors often make the mistake of including this on the final return, but it should actually go on the estate return. If the estate doesn’t have any other income and a T3 return wouldn’t be required, the CRA will allow it to be reported directly on the beneficiary’s return as a special administrative concession.
One thing executors should always look out for is whether or not the deceased had unapplied net capital losses from prior years. Did they ever lose money on a property or mutual fund which they were unable to claim because they didn't have any offsetting capital gains? If so, reporting it will help reduce the income inclusion resulting from the deemed disposition of capital property we talked about earlier. If the deceased didn’t have any capital gains in the year they died, there is also a special rule which allows you to deduct any unapplied net capital losses against other income, either on the final return or the return of the immediately preceding year. If you have authorization from the CRA to act on behalf of the deceased taxpayer, you'll have access to this information.
What about other money coming in or out?
The deceased might’ve made wishes to donate to charities in their will. These will qualify for the charitable donations tax credit just as if they were made while alive. There’s also considerable flexibility as to how to claim them. The executor has the choice of not only claiming them on the final return or the return of the preceding year but also on the estate return for the year the distribution was made to the charity or any other taxation year of the estate for up to five years. The rule allowing you to claim it in the year prior to death is especially beneficial if the deceased died early in the year and therefore did not have enough income on the final return for the gift to be fully utilized.
Flexibility is also extended to claims for medical expenses. Normally, you can only claim medical expenses paid for in a 12-month period ending in the taxation year. However, in the year of death, they can be claimed for any 24-month period which includes the date of death. This is especially beneficial in situations where the deceased died late in the year and some of their medical expenses weren’t paid until the next year. Unfortunately, funeral expenses are not considered to be medical expenses and can’t be claimed.
Ready to file? H&R Block can help you navigate filing the taxes of a loved one. Choose from one of four convenient ways to file: File in an Office, Drop-off at an Office, Remote Tax Expert, or Do It Yourself Tax Software. And if you’re looking to create your Last Will and Testament, or arrange your Online Estate Planning, H&R Block can help with that too.