In early March, you were preparing your client list with respect to the personal tax return preparation season. When you came across Mr. Ricky's name you realized that Mrs. Ricky had called you regarding her husband's death. Mr. Ricky had passed away March 1, 2012, at age 62.
Mr. Ricky owned and operated a Canadian-controlled private corporation, Shining Ltd., involved in reconditioning cars. Mr. Ricky's 100 shares had an adjusted cost base and paid-up capital of $55,000. The fair market value of the shares at the date of death was $750,000. Seventy-five per cent of the shares were left to his wife and the rest of the shares were left to his 25-year-old son.
Mr. Ricky earned $15,000 per month in salary. A non-periodic bonus of $35,000 had been declared on February 15, 2012, but had not yet been paid at the time of his death. His accumulated vacation pay of $10,000 and his February salary was due on the last day of the month, but was paid on March 10, 2012.
In addition to his shares, Mr. Ricky owned bonds which earned $5,500 of interest income in 2011 and accrued $917 of interest in 2012 to the date of his death. He owned another bond on which there was $500 in uncashed bond interest due on January 4, 2012, the anniversary date of that bond. Further, Mr. Ricky had owned two rental properties. Net rental income after capital cost allowance from January 1, 2011 to December 31, 2011 was $45,000 and net rental income before capital allowance was $4,000 for each of the months of January and February 2012.
Other Information:
(1) All assets of Shining Ltd. have been used in the active business of the corporation.
(2) The shares of Shining Ltd. have been owned by Mr. Ricky since 1995.
(3) Mr. Ricky had earned income in 2010 and 2011 of $95,000. He contributed to his RRSP the maximum amount allowed as a deduction in 2011. His RRSP was worth $295,000 at the time of his death. Mrs. Ricky is the designated beneficiary of his RRSP.
(4) Mr. Ricky had a savings/chequing account which earned $2,500 interest in 2011 and $150 during January and February 2012.
(5) Mr. Ricky had utilized $350,000 of his capital gains exemption.
(6) All of Mr. Ricky's other assets have been left to his wife, except for the two rental properties which are bequeathed to his 20-year-old daughter.
(7) The rental properties had a fair market value of $100,000 each. Both properties had the following details:
REQUIRED
Prepare a letter, in draft form for partner review, to Mrs. Ricky explaining the tax implications and the filing requirements in respect of Mr. Ricky's death. Calculate taxable income for 2012.
SOLUTION
Mrs. Ricky
123 Anywhere Place Anywhere Canada
Dear Mrs. Ricky
Re: Mr. Ricky’s Tax Returns
As requested, we have prepared this letter explaining the tax implications and filing requirements for Mr. Ricky as a result of his death.
Filing Requirements
Mr. Ricky’s executor must file a regular personal income tax return for the 2009 taxation year six months from the date of death, i.e., September 1, 2010. Mr. Ricky’s 2010 terminal tax return for the period January 1, 2010 to March 1, 2010, must be filed by April 30, 2011 [par. 150(1)(b) and (d)].
The executor may elect to defer payment of taxes, related to rights or things and deemed dispositions, in the form of ten annual installments plus interest at prescribed rates. The Minister will require security.
Generally, all income earned on a periodic basis must be accrued on a daily basis and included as income in Mr. Ricky’s terminal return [par. 70(1)(a)]. Mr. Ricky’s capital property is deemed to be disposed of at the fair market value at the time of death, except when such property is left to the spouse [ssec. 70(5)], in which case, a tax-free rollover at adjusted capital cost is available.
Shares of Shining Ltd
It is our understanding that 25% of the shares of Shining Ltd. are to be left to your son and the remaining 75% to you. As a result, a tax-free rollover is not available on the 25% left to your son. Therefore, these shares are deemed to be disposed of at their fair market value on the date of death. The taxable portion of the capital gain is calculated as follows:
| Proceeds of disposition (25% × $750,000)................ | $ 187,500 |
|---|
| ACB (25% × $55,000).................................... | (13,750) |
| Capital gain….............................................. | $ 173,750 |
| Taxable capital gain (1/2).................................. | $ 86,875 |
The $86,875 may be tax-free if these shares are eligible for the remainder of the capital gains deduction of $200,000 (i.e., ($750,000 – $350,000) × 1/2)
The shares of Shining Ltd. would qualify for the enhanced capital gains deduction if they are considered qualifying small business corporation (QSBC) shares. Generally, the shares must meet the following tests:
(a) The shares must be shares of a small business corporation at the time of Mr. Ricky’s death. Based on the information available, it would appear that the shares meet this test.
(b) The assets held by the corporation (with a fair market value in excess of 50% of the total assets) were used principally in an active business carried on primarily in Canada throughout the 24 months that Mr. Ricky held the shares. It would appear that the shares meet this test.
(c) The shares were not owned by anyone other than Mr. Ricky, yourself or your son throughout the preceding 24 months.
Therefore, on filing, the executor should apply $86,875 of the potential capital gains deduction of $200,000 against these shares. Your son will have an adjusted cost base of $187,500.
If nothing further is done, then your adjusted cost base will be $41,250 (75% of your husband’s adjusted cost base of $55,000). However, if the executor elects, your husband’s shares can be deemed to be disposed of at their fair market value on a share-by-share basis [ssec. 70(6.2)]. This procedure will enable the executor to use up the remaining QSBC share deduction of $113,125 (i.e., $200,000 – $86,575) and will step up your adjusted cost base accordingly to reduce future capital gains on the disposition of these shares. We would recommend this procedure and would advise that the executor elect this option on 32 shares. The taxable capital gain on a share- by-share basis would be $3,475 (i.e., [1/2 × ($750,000 – $55,000) – 100]). Therefore, the executor should elect on 32 shares (i.e., $113,125 – $3,475). The remaining 43 shares will be transferred to you at your husband’s ACB. In determining the ACB of all shares inherited by you, a weighted average cost is computed as follows:
| Number of shares | Cost |
|---|
| 32 (($750,000 / 100) × 32)........................... | $ 240,000 |
| 43 (($55,000 / 100) × 43)............................ | 23,650 |
| 75..................................................... | $ 263,650 |
| Per share: $263,650 / 75 = $ 3515.33 | |
Rental Property
As indicated earlier, the tax-free rollover will not apply as these properties are being left to your daughter. As a result, Mr. Ricky’s terminal return will need to reflect a capital gain of:
| Unit #1 | Unit #2 |
|---|
| P of D.................................................... | $ 100,000 | $ 100,000 |
| Capital cost.............................................. | 72,000 | 83,000 |
| Capital gain.............................................. | $ 28,000 | $ 17,000 |
| Taxable capital gain (1/2)…............................. | $ 14,000 | $ 8,500 |
In addition, recapture of $22,000 for Unit #1 and $31,000 for Unit #2 would need to be included in Mr. Ricky’s return.
Other Assets
Upon Mr. Ricky’s death, his RRSP is cancelled and the proceeds will be treated as income (refund of premiums) in your return, since you are the designated beneficiary of Mr. Ricky’s RRSP. However, you may defer tax on this income if the funds are transferred into another RRSP within 60 days of the end of the year in which the funds are received [par. 60(l)]. Mr. Ricky’s contribution of $17,100 made before his death can be deducted on the 2009 tax return.
Income
The salary of $20,000 per month is fully taxed in the year received. The January and February salary of $20,000 per month will be taxed in 2010.
The rental income is also taxable in the year in which it accrues. The bond and savings account interest earned must be included in Mr. Ricky’s tax return.
Non-refundable Tax Credits
A claim for the full personal tax credit can be made in 2010 even though Mr. Ricky died in March. A personal tax credit can also be claimed for yourself, as a spouse, but all of your income for 2010 would be used in reducing this credit.
Taxable Income for 2010
Before consideration of a “rights or things” return, Mr. Ricky’s 2010 taxable income will be:
| Salary (2 months)...................................................................................... | Salary (2 months)...................................................................................... | Salary (2 months)...................................................................................... | Salary (2 months)...................................................................................... | $ 40,000 | $ 40,000 |
|---|
| Bonus........................................................................................................ | Bonus........................................................................................................ | Bonus........................................................................................................ | Bonus........................................................................................................ | 35,000 | 35,000 |
| Accrued interest on bond.......................................................................... | Accrued interest on bond.......................................................................... | Accrued interest on bond.......................................................................... | Accrued interest on bond.......................................................................... | 917 | 917 |
| Receivable interest on bond...................................................................... | Receivable interest on bond...................................................................... | Receivable interest on bond...................................................................... | Receivable interest on bond...................................................................... | 500 | 500 |
| Savings account interest............................................................................ | Savings account interest............................................................................ | Savings account interest............................................................................ | Savings account interest............................................................................ | 150 | 150 |
| Rental property income (2 months)........................................................... | Rental property income (2 months)........................................................... | Rental property income (2 months)........................................................... | Rental property income (2 months)........................................................... | 8,000 | 8,000 |
| Recapture on disposition of rental property to daughter: | | | | | |
| — Unit #1................................................................................. | $ 22,000 | $ 22,000 | $ 22,000 | | |
| — Unit #2................................................................................. | 31,000 | 31,000 | 31,000 | 53,000 | 53,000 |
| Capital gains — Taxable: | | | | | |
| — Disposition of 25 shares of Shining Ltd. to son.................. | $ 86,875 | $ 86,875 | $ 86,875 | | |
| — Ssec.70(6.2) election on 32 shares of Shining to wife ½×($7,500–$550)× 32) | — Ssec.70(6.2) election on 32 shares of Shining to wife ½×($7,500–$550)× 32) | 111,200 | | |
| — Disposition of rental property to daughter — Unit #1........... | 14,000 | 14,000 | 14,000 | | |
| — Unit #2........................... | 8,500 | 8,500 | 8,500 | 220,575 | 220,575 |
| RRSP deduction (lesser of $20,000 and 18% of $95,000 (2007 EI))........... | RRSP deduction (lesser of $20,000 and 18% of $95,000 (2007 EI))........... | RRSP deduction (lesser of $20,000 and 18% of $95,000 (2007 EI))........... | RRSP deduction (lesser of $20,000 and 18% of $95,000 (2007 EI))........... | (17,100) | (17,100) |
| Capital gains deduction on QSBC shares...................................................... | Capital gains deduction on QSBC shares...................................................... | Capital gains deduction on QSBC shares...................................................... | Capital gains deduction on QSBC shares...................................................... | (198,075) | (198,075) |
| Taxable income.............................................................................................. | Taxable income.............................................................................................. | Taxable income.............................................................................................. | Taxable income.............................................................................................. | $142,967 | $142,967 |
It is possible for the executor of the estate to make a contribution to your spousal RRSP in respect of Mr. Ricky’s 2010 final return based on his 2009 earned income. This contribution must be made within 60 days of the end of 2010, i.e., March 1, 2011, to be deductible as shown in the calculation above in the 2010 terminal return [ssec. 146(5.1)].
Rights or Things
The bond interest of $500 in un cashed bond coupon due on January 4, 2010 is an enforceable right. In addition, the bonus of $35,000 and $20,000 of salary, unless ordinarily paid periodically, could also be considered an enforceable right; these would be included on a “rights or things” return. The “rights or things” return is a separate return from the terminal return and must be filed by the later of one year after death and 90 days after the assessment of the terminal return. Including this income on the separate return will result in tax at a lower federal tax bracket than on the terminal return (i.e., 15% vs. 29%) and there is the opportunity to claim the same personal tax credits again.
Note that it is possible to assign “rights or things” to a beneficiary, if instructions are provided in the will [ssec. 70(3)]. This would be beneficial, if income splitting could be done with a beneficiary in a lower bracket, since the beneficiary would pay the tax on the assigned income.