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Phil Hogan, CPA, CA, CPA (CO)
Cross-Border Tax and Investment Specialist
I get these questions all the time, does Canada have a wealth, inheritance or estate tax?
The quick answer, at least for now, is no…
Canada doesn’t currently have any type of wealth tax other than a final death tax that calculates and taxes a taxpayer’s final capital gain on accumulated property upon death.
So, how does the current “death tax” work?
Under current Canadian tax law when someone passes away their worldwide assets are “deemed to be disposed” at the time of death. In simple terms, when someone dies they are taxed on their accumulated capital gains as if they actually sold all their assets and property.
Let’s use a simple example to help illustrate this concept:
Assume Jane owns the following assets (assume she does not have a spouse and is at the highest marginal tax rate):
- Principal residence of $500,000 with an original cost of $200,000
- Non-registered investments of $500,000 with a cost of $200,000
- RRIF/RRSP of $300,000
Upon death Jane is “deemed to have disposed” her assets at fair market value. Here’s how each individual asset will be taxed:
- The principal residence will be reported on her final Canadian T1 return, however assuming she qualifies for the years in which she owned the property the capital gain will be exempt and tax free.
- Her gain on the investment account will be $300,000 and her tax on this amount will be 25% (highest capital gains marginal rate)
- The full amount of the RRSP will be included in income at around 50%
Note however that if Jane had a spouse these assets would “roll over” to the spouse tax-free to be deferred until such time that the final spouse died.
Any assets received by beneficiaries would carry a cost basis equal to the fair market value of the assets at the time of death allowing the beneficiaries to “start fresh” for any future capital gains on inherited property.
Do I have to pay tax on inheritances I receive?
This is also a question I get asked a lot. If you receive an inheritance from a family member this inheritance is not taxable to you. The individual that you’re receiving it from has already paid the tax on this amount. Some exceptions to this include US deferred pension accounts such as IRA and ROTH IRA accounts. These assets can “roll” to a non-spouse family member without being taxed upon death.
That being said, any income earned on your inheritance or increase in value of the investments will eventually be taxed in the hands of beneficiaries.
So, what’s “wrong” with current death tax system?
Considering the current government debt levels and the amount of stimulus required to help protect Canadians from the financial impact of Covid many in government are proposing an additional wealth or estate tax to help fund our rising debt levels.
Many argue that the current system of deemed disposition tax upon death is not effective enough at collecting tax on the wealthy. In many ways this argument does make sense.
If someone had accumulated investment and business assets their whole lives and chooses to not realize any of their “gains” on these properties they could easily defer taxes on their assets well into their 90s especially considering the use of the spousal rollover. From the governments perspective this is way too long to wait to get additional tax revenue into the system. Especially considering the level of wealth that will not be fully taxed for many decades.
Canadians think the wealthiest fifth — or top 20% — of Canadians hold more than half of the wealth in the country (55.5%) and that the poorest fifth — or bottom 20% — hold less than 6%. In actuality, the wealthiest hold more than two-thirds (67.4%) of the wealth, while the poorest fifth of Canadians own no share at all. (https://www.broadbentinstitute.ca/the_wealth_gap)
Some also question the current death tax system in Canada because it doesn’t take into consideration how the compounding effect of inter-generational wealth can lead to significant income and asset gaps in the country.
Although wealthy families do pay tax on income at relatively high tax rate levels and their net worth is subject to Canadian deemed disposition tax, the compounding effect of years and years of inherited wealth provided some in Canada with a significant financial head start in life.
Many Canadians cannot imagine what it would be like to be born a millionaire, however for some new Canadians this is a reality.
Graham Purse writes in his recent CTF article:
Inheritances are just as relevant as income and savings with respect to the measurement
of well-being, and both income and savings are generally taxed in Canada.75 Unlike income and savings, however, there is no deferred pleasure (for example, work over leisure)76 or deferred consumption (for example, saving instead of buying a new boat) for inheritances. Inheritances thus represent the obtaining of money at no opportunity cost,77 and are therefore properly subject to taxation on the basis of fairness and economic incentives. 1
What are some alternatives to the current “death tax” system in Canada?
Some are floating the idea of implementing an annual wealth tax or estate tax similar to how the US taxes individuals upon death.
It’s easy to look south to our neighbors for new ideas on tax policy. Heck, where did you think we go the idea for Tax Free Savings Accounts? ROTH IRA accounts have existed for many year and have been popular with a huge percentage of the population.
Given the US already has an established estate tax system it’s relatively easy to imagine how this would be implemented in Canada. To give you some context, the US doesn’t have a “deemed disposition” tax upon death, but rather, a system where they tax you on your worldwide estate upon death (around 40%).
In this case it would be relatively easy to implement a Canadian estate tax given we can use the American systems as a proxy for how to implement and administer the tax.
If a Canadian estate tax was implemented we would also likely also need to consider establishing a congruent gift tax regime to ensure wealthy Canadians could not simply give away their assets to avoid the estate tax.
In its report, the Canadian Centre for Policy Alternatives made the modest recommendation that Canada introduce a maximum 45 percent inheritance tax on fortunes above 5 million Canadian dollars. (washingtonpost.com)
Many are skeptical however that a Canadian estate tax would be an effective way of redistribution Canadian wealth. They argue that it takes decades to collect this tax and given how long Canadians are currently living the collection of estate taxes is too far off into the future.
This is one of the reasons why some are proposing an annual wealth tax. Andrew Jackson and Toby Sanger argue that an annual wealth tax of 1% on net worths above $20,000,000 would help narrow the currently expanding wealth gap. 2
“It is both reasonable and practical to add a wealth tax to Canada’s current arsenal
of fair taxes—one that would be levied at a low but rising rate on very large fortunes.
The aim would not be just to raise extra revenues, but also to compensate for the
lower effective tax rates and the substantial economic rents that many of the wealthy
have been able to achieve, and to limit the concentration of wealth and economic
power among a few.”
A wealth tax of this nature would be a significant change to the current tax environment in Canada greatly impacting filing, planning and compliance requirements for high net worth Canadians.
However given the proposed taxation threshold this potential new tax measure would likely have broad political support among average Canadians.
The challenges presented by this proposal are quite significant however. First, valuing assets such as marketable securities is relatively straight forward, but valuing assets such as real estate or business assets can be quite subjective. Second, the additional cost and time required to maintain these valuations could become prohibitive to some.
Most Canadians understand, appreciate and support individuals that have saved, invested and built wealth over their lifetime. In fact, much of the messaging from banks and investments advisory businesses in Canada resolve around the dreams of retiring early with enough wealth to travel, enjoy time with family and be unburdened by financial challenges.
Inter-generational wealth however is something that continues to compound in the hands of a very few and will only serve to further widen the wealth gap in Canada. Developing a system of wealth, inheritance or estate tax is necessary to ensure this gap does not continue to widen and further concentrate power among a few Canadian families and corporate groups.
What do you think about a Canadian wealth or estate tax? Let me know in the comments below.
- canadian tax journal / revue fiscale canadienne (2020) 68:3, 851 – 62
- Policy Forum: The Case for an Annual Net Wealth Tax Andrew Jackson and Toby Sanger. canadian tax journal / revue fiscale canadienne (2020) 68:3, 835 – 50