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It all depends. Was the estate plan designed wisely? Were many of its elements left to chance?
While it is possible for a married couple to “roll over” the estate following the first death — sparing the second spouse from immediately paying taxes — the same formula does not apply when the second spouse dies. In fact, the property that belonged to last living spouse cannot be “rolled over” to future beneficiaries (children or other members of the direct family).
As a rule, the tax authorities consider that all property under the name of the second deceased spouse is sold on the day of his or her death. This is called the deemed disposition. The theoretical income or capital gains that would result are subject to tax rates in the year of death. An estate analysis established during one’s lifetime allows you to fully understand what will happen to your estate (RRST, TFSA, secondary property, etc.) and to plan accordingly. In other words, it determines the tax impact on the estate. The goal is to reduce or at least delay the payment of taxes.
Helping beneficiaries escape hasty decisions
If the individual has an RRSP, the law will assume that it is redeemed in full on the day of his or her death. The deemed income collected could be taxed at the maximum marginal rate, especially if other income is added to that amount.
Furthermore, imagine that the estate includes real estate (other than the primary place of residence since it is tax exempt). For example, let’s assume a real estate property was purchased for $100,000 40 years ago. Furthermore, let’s assume that, on the day of death, it has an estimated value of $1.1 million. Its capital gain would be calculated as follows:
$1,100,000(current value) – $100,000 (cost base) = $1,000,000 (Capital Gain)
In other words, the original purchase price is subtracted from the current market value. In general, you should also deduct expenses related to the initial transaction (commissions, fees, etc.). For the sake of simplification, we are assuming they are negligible. Since only half of a capital gain is taxable, and assuming a marginal tax rate of 50%, the taxes owed would be calculated in the following manner:
$1,000,000 (capital gain) x 50% (inclusion rate) x 50% (marginal tax rate) = $250,000 (taxes owed)
Many such situations result in a heavy tax burden upon second death. A lack of liquidity in the estate plan could cause further losses as it may precipitate the sale of the property below its fair market value.
Wills and testaments, estate freezes, gifts during a lifetime, transfers to a financially dependent minor, insurance policies… Whatever the planned arrangements, they should all be aimed towards reducing the tax (and mental) burden on the heirs.
To avoid upsetting surprises, planning ahead is always recommended. Seeking the help of a third party to evaluate an estate plan remains a wise and prudent decision. For these reasons, do not hesitate to consult our estate advice.
