Whether you’re preparing your will or amid an estate dispute, you might be wondering about the financial implications of inheritance or estate disputes-for example, are estate settlements taxable? Or, what taxes do I need to pay before distributing estate assets? This article will provide some general information about how inheritance and settlements are treated for tax purposes. In reading this article, however, remember that tax law is a complicated area, and you should never make any serious tax-related decisions without consulting your lawyer or accountant first.
Are inheritances taxable in Ontario?
According to the Canada Revenue Agency (CRA), most gifts and inheritances are not taxable as income. So, if you’re a beneficiary of an estate in Ontario, you will generally not be expected to pay taxes on any money you receive from the estate.
Additionally, most amounts received from a life insurance policy are not taxable.
Does the estate need to pay taxes?
When a will-maker dies, their executor is responsible for filing a final tax return to the CRA. The executor will file a final return that reports all of the deceased’s income from January 1 of the year of death to the date of death. To that end, there may be tax owing on the estate, but any taxes owed should be paid before estate assets are distributed to the beneficiaries.
Beyond the final return, the executor has the option to also file three optional returns:
- Return for rights or things:
This tax return addresses (if applicable) amounts that were owing to the deceased at their time of death and that, had the person not died, would have been included in their income (such as salary, old age security benefits, unpaid dividends, etc.)
- Return for a partner or proprietor:
This tax return addresses situations where a deceased person was a partner in or owned a business with a fiscal year that did not start or end on the same dates as the calendar year. If the will-maker died after the end of their business’s fiscal period but before the end of the calendar year in which the fiscal period ended, they can either report the business income on their final return or file a return for a partner or proprietor in addition to their final return.
- Return for income from a graduated rate estate:
A graduated rate estate is a testamentary trust that arises from the death of a person on or after December 31, 2015, and no more than 36 months after the person’s death. Graduated rate estates must meet certain requirements and, if those requirements are met, benefit from graduated tax rates for the first 36 months after the person’s death and flexibility in claiming donation tax credits.
How much tax will the estate need to pay?
The estate will need to pay any income tax owing after filing the final return.
In addition, the estate will need to pay estate administration tax (EAT). The estate administration tax taxes the value of the assets the estate holds on the date of the will-maker’s death (as opposed to income earned by the will-maker) if the executor is applying for probate. The estate administration tax is paid as a deposit when applying for probate and, once a probate certificate is issued, the deposit is paid towards the estate administration tax.
You do not need to pay estate administration tax if the estate is valued at $50,000 or less. Above the $50,000 threshold, the estate administration tax is calculated at $15.00 for every $1,000 (or part thereof) of the estate’s value.
The value of an estate for the purposes of the estate administration tax is based on the value of real estate, bank accounts, investments, vehicles, and all other property (including goods, intangible property, business interests, and insurance).
So, for example, if you have an estate worth $500,000, the estate administration tax is calculated as follows:
- First $50,000: $0.00
- Remaining $450,000: 450×15= $6,750.00
Note that this calculation only applies if you applied for probate after January 1, 2020; different calculations apply for probate applications before that date.
For more information about the estate administration tax, review this guide from the Government of Ontario.
Are settlements and judgments taxable in Ontario?
Settlements (where the parties agree to a particular amount of damages without going through a formal trial) and court judgments (where the court awards damages to a party) are treated the same for tax purposes. However, payments to an individual for a settlement or a court judgment may or may not be taxable, depending on the circumstances.
The taxability of a settlement or court judgment is governed by the “surrogatum principle”. The surrogatum principle stands for the idea that a settlement or court judgment is meant to replace or compensate for something and, as such, is taxed the same way as the thing that it is meant to replace. So, for example, if you were to sue for loss of employment income due to wrongful dismissal, the settlement amount would replace the lost income and would be taxable. On the other hand, if you were to sue for injuries sustained in a motor vehicle accident, the damages you received as compensation for your injuries would not be taxable.
Are estate settlements taxable in Ontario?
Applying the “surrogatum” principle, estate settlements and court judgments will typically be non-taxable, as gifts and inheritances are not taxable. However, remember that income earned on gifts and inheritance is taxable. If you, for example, invest your inheritance money, any income earned as a result would be taxable.
Further considerations for inheritance, estate settlements, and taxability
While we have provided a high-level outline of tax considerations for estates and estate settlements above, it’s important to always consult with your lawyer and, when appropriate, an accountant for comprehensive information on estate tax liabilities and their implications. Whether you are preparing a will, acting as executor, or contesting an estate in court, be sure to consult with the appropriate specialists to ensure you have a full understanding of any potential tax liability you might face.
Contact the Estate Litigation Lawyers at Derfel Estate Law for Advice on Probate and Estate Administration Matters
At Derfel Estate Law, our experienced estate litigation lawyers are here to guide you through every step of the estate litigation process. Our practice focuses on all aspects of estate disputes, as well as estate administration and probate. Call us at 416-847-3580 or contact us online to speak with one of our knowledgeable estate lawyers.