Canada and the US have highly integrated economies with large volumes of both financial investment and people moving across the border in both directions each year. This social and economic integration means that our tax and estate planning is likely to involve aspects applicable to both Canadian and US rules and issues.
Death Tax Basics
The Canadian Income Tax Act provides for a deemed disposition of essentially all of a taxpayer’s assets immediately prior to death, often resulting in a taxable capital gain for the estate. On the US side, the executor of a deceased person’s estate may be required to declare the fair market value of all taxable assets held at death, and pay an estate tax at rates up to 40% on that value. Even Canadians are liable to estate tax on assets that are within US taxing jurisdiction (e.g. real estate and shares of US corporations).
Fortunately for Canadians, the tax treaty between Canada and the US provides a generous benefit whereby the US exemption can be pro-rated based on the proportion of the Canadian assets that are situated in the US. For many, this means that a Canadian who dies owning US assets will not face US estate taxation unless their worldwide estate value exceeds the threshold available to US citizens in the particular year (currently US$11.4 million), provided their estate files and claims Treaty benefits.
In the context of these very different death tax rules in Canada and the US, let’s look at some specific examples that illustrate the complexities that can arise in cross border tax and estate planning.
Canadians with US Situs Assets
Canadian residents who die owning US situated assets will be subject to both the Canadian deemed disposition on death and the US estate tax in respect of those assets. Treaty benefits can be claimed to reduce or eliminate the tax payable by the Canadian estate, but failure to file the correct forms can result in taxation of the entire value of the assets. In addition, the recipients of assets from a non-resident estate that fails to file an estate tax return will take those assets with a zero cost basis, dramatically increasing the tax payable by the beneficiary on a future sale.
Canadians with US resident beneficiaries
Many Canadians end up living and working in the US. For the parents left behind in Canada, this can create opportunities to implement generational tax planning for their US children. With properly drafted Canadian estate planning documents, the US resident beneficiaries can have their inheritances permanently sheltered from US estate tax by incorporating dynastic trusts into the Canadian wills and trusts.
Having US resident children may also complicate the Canadian planning for the parents. For example, corporate estate freeze strategies involving discretionary family trusts can end up disadvantaging the US beneficiary due to complex rules around foreign trusts and corporations. Careful planning can alleviate these concerns, but sound cross border tax advice is critical during the parents’ planning.
US Citizens in Canada
US Citizens who are resident in Canada are subject to the full force of both the Income Tax Act and the Internal Revenue Code. This means that estate planning strategies require consideration of tax rules in both countries to avoid problematic tax results. For example, estate freezes can result in immediate taxable gifts and excessive tax rates for US beneficiaries of family trusts that receive distributions in the future.
Estate planning can be a complex area to navigate as is. However, when both US and Canadian tax rules are in play, getting advice from a cross-border tax and estate planning lawyer is critical to avoid costly mistakes. It is essential for Canadians with US-situated assets to be aware of the rules for the transfer of taxable assets in both jurisdictions. Filing correct forms under the US-Canada tax treaty can reduce the tax payable. Connect with our tax and estate planning lawyers to learn more about cross-border tax and estate planning.