U.S. Estate Tax

Due to various factors such as the economy, the size of the US market, and weather, many Canadians look to the United States as a place to invest. US holdings range from real estate to active businesses to stock portfolios. The IRS views this asset ownership by "foreigners" as an opportunity to increase its tax base. Certain assets that earn income in the US will attract US income tax to the Canadian owner. Other assets will attract an estate tax upon death. The following information pertains to the estate tax.

Basis of Taxation
The US assesses a tax on the value of an individual's estate at the time of his or her death. This system differs from that of most countries, including Canada, in that the tax is not based upon a deemed disposition of assets at death, but on full value. US citizens and estate tax residents are taxed on the value of their worldwide estate. Non-residents for estate tax purposes are only subject to tax on their US situs assets. Estate tax residency is determined by an individual's domicile, which is the country of residence with the intent to remain. Therefore, snowbirds and other temporary residents of the US are likely nonresidents of the US for estate tax purposes. The remainder of this article will focus on how the US estate tax applies to Canadian residents with US assets.

Top of page

US Situs Assets
The following assets are considered US situs assets, the value of which is taxable in the estate of a Canadian resident:

• Stock of US corporations
• US money market funds
• US real property
• US tangible personal property
• US Real Estate Investment Trusts

The following assets are generally not considered US property for US estate tax purposes:

• US bank accounts
• Certain T-Bills, Cash
• Bonds, notes
• Life insurance
• Stock of Foreign Corporations
• US Shares held in Foreign Mutual Funds

Top of page

Expenses of the Estate
Once the value of the US estate is determined, certain direct costs such as funeral and estate administration expenses are allowed as deductions against the value of the estate.

Top of page

Unified Credit (exemption)
Each Canadian that is subject to the estate tax is allowed an exemption from the tax of at least $60,000 US worth of property. Additionally, a larger exemption can be claimed if the percentage of the Canadian's worldwide estate that is located in the US, multiplied by the exemption allowed to US citizens and residents exceeds $60,000. For 2004 and 2005 the full US estate tax exemption is $1,500,000. Although this is commonly referred to as an exemption, it actually works as a tax credit. Therefore, as a rule of thumb, if a Canadian's US estate is worth less than $60,000 US, or his worldwide estate (assuming a death in 2004) is worth less than $1,500,000 US, there would be no US estate tax on that individual.

Top of page

Debt Obligations
In addition to the deduction against the estate value for direct expenses, a non-resident estate can claim a deduction for debt of the estate (mortgages, etc.) on a prorated basis. The proration is based upon the percentage of the worldwide estate that is located in the US.

Top of page

Small Estates
There is an exception to the inclusion of capital property in a US estate for Canadians if their worldwide estate is worth less than $1,200,000 US This exception only applies to capital property such as US stock and mutual funds, and not items such as real estate.

Top of page

Marital Credit
An additional credit is allowed to Canadians that leave their US assets to a Canadian spouse upon death. This credit is effectively a "doubling up" of the unified credit discussed above.

Top of page

Foreign Tax Credit
Because the US and Canada both have a form of death tax, there is the possibility of double tax. To alleviate this problem, Canada will allow a credit against its deemed disposition tax for the US estate tax paid on the same assets. The following is an example of an estate tax calculation.

Mr. A is a Canadian citizen and resident. All property is left to Canadian spouse. His estate at the time of his death in 2004 consists of the following (US $):
- Canadian assets - $3,000,000
- US Stock Portfolio - $500,000

A credit is allowed on Canadian return against Canadian capital gains tax on this portfolio.

Top of page

Estate Tax Rates and Repeal of the Tax
The US passed legislation in the summer of 2001 to repeal the estate tax. The intention is to eventually replace the tax with a "deemed disposition" tax similar to that in Canada. The estate tax repeal legislation is phased in over a ten-year period. This phase-in is accomplished by gradually increasing the exemption amount, and decreasing the tax rates. The tax is fully repealed for deaths occurring in 2010. However, unless Congress votes to extend the repeal, the tax will return in its current form in 2011. Please see table below for rates and exemptions during the phase in of the repeal.

Top of page

Planning
Although the estate tax is being repealed, the permanence of the repeal is in question. Therefore, it is still very important to have a plan in place to minimize or reduce the tax. If an individual already has an estate tax plan, it would be prudent to review such plan in light of the new rules. There are various ways in which the US estate tax can be reduced or eliminated. Among the planning techniques are: · Ownership of US assets through Canadian companies; · Trusts; · Non-recourse financing; · Joint Ownership; · Gifting; · Life Insurance; · Ownership of US securities through Canadian Mutual Funds. The type of planning that is suited to an individual will depend on various factors such as value of estate, types of assets owned, age, health, etc.

Top of page

The material provided in this article is not meant as a substitute for estate tax planning on a case-by-case basis. Anyone that might have exposure to the US estate tax should consult with a qualified tax planning professional.

Carey M. Singer, CPA is a Principal with Mintz & Partners, LLP, a mid-sized C.A. firm in Toronto. Carey is in charge of the Canada/US cross-border tax department at Mintz & Partners. He can be reached at (416) 644-4354.