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Advanced tax planning is the best way to minimize taxes on the deceased spouse’s final tax return.kali9/iStockPhoto / Getty Images

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In addition to grieving the loss of a loved one, surviving spouses often find themselves dealing with new tax challenges related to estates, pensions and changes to their income.

Whether a death is sudden or expected, grief – and not tax issues – should be the initial focus, says Matt Trotta, vice-president of tax, retirement and estate planning with CI Global Asset Management in Calgary.

“The best advice for a lot of people in that situation is to take a deep breath and handle the personal matters first, say goodbye on their own terms,” he says. “The tax issues and the estate issues will be there when they’re ready. That’s because panicking often creates a lot of damage.”

Advanced tax planning done years before one spouse passes away is the best way to minimize taxes on the deceased spouse’s final tax return and keep taxes as low as possible for the surviving spouse, Mr. Trotta says.

But often, widows and widowers encounter surprises as they adjust to their new circumstances.

The ‘shock’ of higher taxes

The biggest change to a widow or widower’s tax return is the fact there’s no one to split income with anymore, says Armando Minicucci, a tax partner with Grant Thornton LLP in Mississauga.

“It’s a big shock to the surviving spouse seeing how much additional tax they’re paying, and that’s just simply because we have a graduated tax rate system in Canada,” he explains. “As your income creeps up, you’re now paying taxes at significantly higher rates. And for many years, they’ve benefited from very low tax rates.”

Now, all income from employment or pensions, pension survivor benefits, Canada Pension Plan (CPP), Old Age Security (OAS), investment income, registered retirement income fund withdrawals and dividends or interest are included on one tax return, Mr. Minicucci says.

The increase in taxes “is something that people may not have considered or may not have planned for,” says Jamie Golombek, managing director and head of tax and estate planning with CIBC Private Wealth in Toronto. “And there’s not much to do about it, really, at the end of the day.”

Re-evaluate retirement and financial plans

The passing of a spouse requires the widow or widower to stop and take stock of their finances, cash flow, lifestyle expenses and income needs, says Trevor Fennessy, a private wealth advisor and associate portfolio manager with CWB Wealth Partners in Calgary.

If the deceased spouse was receiving OAS, that will stop as there are no survivor benefits. The amount of total pension income will also drop as the survivor pension benefits from a private plan or CPP are likely to be less than before.

“Take a look at sources of taxable income that have been lost or gained – for example, insurance proceeds or the sale of a secondary property that’s then reinvested in the [surviving spouse’s taxable] portfolio,” Mr. Fennessy says. “Then, just try to plan around what the new reality looks like in terms of the need for after-tax cash flow from the portfolio. And then try to position that to be as tax effective as possible.”

If the spouse who passed away was collecting CPP, then the surviving spouse may get survivor’s benefits. However, if the surviving spouse wasn’t receiving CPP or OAS yet, they can delay it until age 70 to maximize their CPP and OAS income if they can manage financially. Those moves would reduce their current income and the taxes they pay, Mr. Minicucci says.

However, the surviving spouse will not receive more than the maximum CPP benefit, Mr. Golombek says.

“If this survivor was already getting a maximum CPP on their own, there may actually be no survivor benefits because they’re still maxed out at the maximum CPP you’re going to get,” he says. “It’s not like you’re going to get double the CPP.”

Don’t rush to divvy up the estate

One strategy to reduce taxes is to leave the assets in the estate rather than distributing them quickly, Mr. Minicucci says, especially if it’s an estate with a graduated tax rate. However, there needs to be “a reasonable basis for leaving the assets in the estate, and, usually, it’s just as simple as it takes some time to administer the estate,” he adds.

By leaving assets in the estate, you can delay receiving income into the next taxation year and benefit from the graduated tax rates. The Canada Revenue Agency says the estate can only be a graduated rate estate for up to 36 months after death.

Consider an estate freeze

Another tax-planning strategy is an estate freeze, which puts assets such as real estate or an investment portfolio into a corporation and “freezes” the value of the assets at that point in time, which fixes the tax liability.

Then, “the surviving spouse takes back fixed value preferred shares equal to the value of the portfolio that went into the corporation,” Mr. Minicucci explains. “The future increase in value would accrue to other family members,” such as adult children, who would also be shareholders.

That means all the income from the portfolio is inside a corporation and “the widow [or widower]can time the receipt of income,” which is when the corporation declares dividends, he says. Income can be taken at different times to minimize taxes, and dividends benefit from the dividend tax credit.

This is a complex strategy with certain costs, such as setting up a company, filing a tax return for the corporation and producing financial statements, so it needs to be done with the help of professionals.

Maximize the use of tax losses, RRSP room

There are also ways to take advantage of the tax losses the deceased spouse has carried forward. The surviving spouse can elect to take some registered retirement savings plan (RRSP) or other assets at fair market value to use up those tax losses, Mr. Minicucci says.

If the deceased spouse had RRSP contribution room available, the executor of the estate can make a spousal RRSP contribution to reduce taxes. It’s also important to transfer over funds from a deceased spouse’s tax-free savings account (TFSA) to the surviving spouse’s TFSA and not collapse the deceased’s account, he adds.

Be charitable with donations

If the survivor and their spouse donated to charities, it can be beneficial to keep that practice up as all the donations go on one tax return and offer a significant tax credit, depending on the province and level of income, Mr. Minicucci says.

It may be better to give to charity annually to help reduce income while alive rather than waiting to give a donation upon death, Mr. Golombek adds.

For more from Globe Advisor, visit our homepage.

Editor’s note: This article has been updated to correct an error regarding ways to take advantage of the tax losses a deceased spouse has carried forward. Tax-free savings accounts do not fit into this strategy since their transfer doesn’t trigger any tax.

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