David Rotfleisch on What Takes place to TFSA Owners When They Pass Away: A Canadian Tax Lawyer's Perspective

Introduction

A registered investment account known as a Tax-Free Savings Account (or “TFSA”) enables a taxpayer to participate in suitable investments and to take tax-free distributions of the account’s investment growth, capital appreciation, and other profits. A TFSA account’s contributions are not deductible, and neither are any costs incurred during the account’s creation or upkeep. 

The effects of a TFSA holder’s death on the tax status of this form of registered account is briefly covered in this article. The article also discusses the tax on a TFSA account from a common-law partner or a spouse who has passed away.

What Occurs to the TFSA Account in Terms of Tax Status After the Death of the TFSA-Holder?

Typically, a taxpayer’s TFSA is no longer active when he or she passes away. For TFSA accounts with deposits and contracts, this statement is accurate. There are no additional tax repercussions for the late TFSA owner as long as there were no excess contributions made during the account holder’s lifetime. The result is different if there are extra TFSA contributions at the time of death. A special tax will be imposed against the taxpayer, if a taxpayer contributes more than the amount allowed under his or her TFSA contribution capacity. The maximum sum of money that a taxpayer can contribute to his or her TFSA at any given moment is known as the taxpayer’s TFSA contribution limit. The extra tax is equal to one percent of the greatest monthly excess TFSA balance. As long as the additional contributions stay in the taxpayer’s TFSA, this special tax continues to be charged on a monthly basis. In reality, the special tax continues to apply if the surplus is not taken out up to and including the month of the TFSA owner’s death.

What are the tax repercussions of receiving a TFSA account from a deceased spouse or common-law partner?

By designating him or her as either a successor holder or a specified TFSA beneficiary, a person who has since passed away may leave a TFSA to his or her surviving spouse or common law partner. In the TFSA contract or the’ deceased’s will, this designation must be made during the deceased person’s lifetime. The identification of a surviving spouse, whether as a successor holder or a named beneficiary, has significant consequences.

First when a surviving spouse receives a TFSA gift from his or her deceased spouse, the choice of designation affects how that surviving spouse will be taxed.

Second, the kind of designation determines how the unused TFSA contribution limit of the surviving spouse is impacted by a gift of TFSA.

Thus, who may qualify as the successor holder?

A successor holder is a person named as such in the TFSA contract or the decedent’s will who is the spouse or common-law partner of a TFSA-holder at the time of the latter’s death. The TFSA account continues to exist after the death of the TFSA-holder if a successor holder has been named. Instead, the successor holder becomes the new holder of the account upon the demise of the account holder. As a result, the successor holder takes over as the account’s new owner.

The “successor holder” term is not allowed in all provinces and territories, it is crucial to mention. The designation of a TFSA-spouse holder’s or common-law partner as such is only valid if it is permitted by the relevant provincial and territorial legislation, which must be recognized by the TFSA-holder. This distinction is meaningless if there is no law of this kind. At the time this article is being written, Ontario is one among the jurisdictions that recognizes a spouse or common-law partner as a “successor holder.”

A successor holder effectively acquires ownership of two different accounts: his or her individual TFSA account (if there is one) and the TFSA account of the deceased. The successor is holder is permitted to take tax-free withdrawals from the inherited account. More crucially, the inheritance of the deceased’s TFSA account has no effect on the succeeding holder’s TFSA contribution limit.

The investment or annuity contract loses its status as a TFSA at the death of the TFSA holder if the holder has not named a successor holder but has instead named specified beneficiaries. A fresh deposit or annuity contract is presumed to continue upon the holder’s passing, although it is no longer regarded as a TFSA (i.e. earning in the account and the withdrawals are no longer tax-free).

A beneficiary in a will is not the inheritor of a TFSA account, as opposed to the successor holder.  Instead, the beneficiary receives distributions directly from the deceased’s TFSA. The chosen beneficiary gets the payouts on a tax-free basis as long as they are equal to or lower than the fair market value of the TFSA at the time of the TFSA holder’s demise. To put it another way,the beneficiary is exempt from including the amount of distributions in his or her income.  However, any earnings that accrued after the date of death and were subsequently transferred to the beneficiary must be included as income for the beneficiary in the year he or she received them. To put it another way, the designated recipient is obligated to report these payments as income in the year they are received.

In the TFSA contract or in their will, TFSA owners have the option to specify the specified beneficiaries of their choosing. If a designated beneficiary has available TFSA contribution limit, he or she is free to transfer any funds he or she receives from a deceased’s TFSA to his or her own TFSA without incurring any tax consequences. This is true because a chosen beneficiary does not receive a separate TFSA account, in contrast to a successor holder.

Tax Guidance: Extra Contributions May Still Be Subject to a Special Tax Even After Death – There Will Be A Solution

The 1% special tax is charged up to and including the month of a TFSA holder’s death if the TFSA holder made excess payments to his or her account while alive but did not take out those extra funds when he or she passed away. It’s also possible that there may be more penalties and interest. The total sum of the special tax, penalties, and interest may be extremely high.

If all aspects of the taxpayer’s situation fulfill specified requirements, the Income Tax Act offers exemption from the 1% special tax as well as the related interest and penalties. If you want to know if you qualify for this kind of tax relief, contact one of our knowledgeable Canadian tax lawyers.

Our knowledgeable tax lawyers in Toronto, Canada can assist you in understanding the complexities of the Income Tax Act and any remedies that may be available to you if you are currently embroiled in a dispute with the Canada Revenue Agency about your TFSA contributions.

Disclaimer:

“Only general information is provided in this article. Only as of the publishing date is it current. It hasn’t been updated, therefore it could no longer be relevant. It cannot or ought not to be relied upon since it does not offer legal advice. Each tax circumstance is unique to its facts and will be different from the instances described in the articles. You should contact with a lawyer if you have particular legal inquiries.”