Effectively, the contributions and earnings are tax deferred until removed from the plan. As such, withdrawals from an RRSP during the annuitant’s lifetime are subject to tax. In addition, the death of an RRSP annuitant creates an income inclusion for the deceased equal to the fair market value of the property held within the RRSP. This income amount is included in the annuitant’s income for the year of death, adding to other tax liabilities that may arise in the final tax return.
There are some rollover situations that create exceptions to the general rule. For example, when the deceased’s spouse or financially dependent children or grandchildren are named as beneficiaries, the flow of the funds can create an offsetting deduction for the deceased and eliminate the tax liability that would otherwise arise from the deemed disposition. Through these rollover exceptions, an amount equal to the RRSP “refund of premiums” (which is essentially the value of the plan at the date of the annuitant’s death) offsets the deceased’s income inclusion. Funds are then taxed in the hands of the beneficiaries when withdrawn from the plan.
A beneficiary designation on an RRSP directs the funds to the named beneficiary. When a beneficiary receives RRSP funds directly under the terms of the plan, and no rollover applies, he or she becomes jointly and severally liable together with the deceased for the amount of taxes owing in respect of the proceeds received.
The issue of joint and several liability arose in a July 2016 Tax Court of Canada case, Sylvia O’Callaghan v. The Queen. The facts of the case were quite simple.
• Siegfried Starzyk passed away on July 19, 2007.
• Sylvia O’Callaghan (Siegfried’s sister) was the named beneficiary on his RRSPs and received $274,050.83 directly from the RRSP carrier.
• Sylvia paid $135,000 to Bruno Starzyk (Siegfried’s brother) who, nine months later, became the executor of Siegfried’s estate.
• The estate filed the deceased’s final tax return that showed all taxes owing were in respect of the deemed disposition of the RRSP. The estate subsequently paid $38,980 toward the total income taxes owing, leaving an outstanding tax liability of $57,704.54.
• The CRA issued a reassessment against Sylvia because they had reason to believe that the estate did not have sufficient funds to pay the remaining taxes owed.
Justice Favreau concluded that Sylvia, as beneficiary of the RRSP, was jointly and severally liable with the estate in respect of the income taxes owed on the disposition of the RRSP at the time of Siegfried’s death. It was Justice Favreau’s position that the joint liability provision of the Income Tax Act “does not impose any obligation on the Minister to attempt to collect an amount from the estate or from the legal representative of the estate before issuing an assessment.”
While Sylvia attempted to persuade the court that her payment of $135,000 to Bruno was in his capacity as the estate representative, Justice Favreau concluded this was not the case. He explained that the payment to Bruno was in his personal capacity, several months before being appointed the estate representative. In addition, he noted “payment of any tax amounts owing should be paid directly to the Receiver General.”
The take away from this case is that named beneficiaries of an RRSP should consult appropriate professional advisors for guidance. Planning might involve setting aside a portion of the RRSP funds received and communicating with the CRA and estate representativemto ensure all taxes have been paid.
(Reprinted with permission from The Institute for Advanced Financial Education, from Comment, edition 299)