Family business estate planning: U.S. estate tax considerations for Canadians

Have you factored the U.S. estate tax into your family’s estate planning?

The U.S. estate tax is a relevant concern for two primary groups of Canadian residents: those who also hold U.S. citizenship, and those who own certain U.S. assets, such as real estate (such as vacation properties) or shares in U.S. corporations. For these two groups, it is essential that they be aware of their potential U.S. estate tax exposure and that their estate planning documents be drafted accordingly. This article will outline the U.S. estate tax considerations generally for these two groups. A further subset of Canadians needs to be aware of the U.S. income tax consequences to U.S. resident or citizen beneficiaries of their estates (all those Canadian kids who move to the U.S. to study, for work or for love).

When a U.S. citizen dies, whether U.S. resident or not, his or her entire worldwide estate is subject to the U.S. estate tax, save and except for a certain exempt amount. Effective as of January 1, 2013, the U.S. estate tax exemption is “permanently” fixed at USD$5,000,000, as adjusted for inflation. “Permanent” simply means the legislation itself is not drafted to change automatically over time; there is always the possibility of legislative amendment. For 2015, the inflation adjusted figure is USD$5,430,000. The top estate tax rate is now also fixed at 40%. The amount of tax that would be payable on USD$5,430,000, if there were no credit against that tax under U.S. law (the “Applicable Credit”), is $2,117,800.

Canadian citizens (who are not also U.S. citizens) who are not resident in the U.S. are not subject to U.S. estate tax on Canadian assets but are subject to U.S. estate tax on property situated in the United States. This includes:

• stock in a corporation incorporated in the U.S.;
• debt obligations of U.S. persons including the U.S. Government;
• U.S. real estate;
• certain tangible personal property located in the United States;
• interests in certain partnerships engaged in a U.S. trade or business; and
• an interest in certain trusts if the underlying assets are considered to be situated in the United States.

A non-U.S. citizen, non-U.S. resident is only entitled to a credit sheltering $60,000 of his or her taxable estate. The Canada - United States Tax Convention (1980) (the "Treaty"), allows a Canadian resident (non-U.S. citizen) an alternative credit equal to U.S. assets over worldwide assets multiplied by the Applicable Credit (the “Treaty Credit”). Depending on the numbers, currently U.S. property of a value between $60,000 and $5,430,000 may be sheltered from the estate tax by the Treaty Credit.

Property which would be subject to the U.S. estate tax and passes to a non-U.S. citizen spouse may be placed in a qualified domestic trust which defer the payment of the estate tax until a distribution of capital from the trust or the death of the surviving spouse. The trust must have at least one U.S. trustee and other complex and burdensome conditions must be met. These are now rarely used in Canada.

The Treaty also permits an extra credit (the “Marital Credit”) where a spouse or a specially drafted spouse trust is the recipient of the property which is subject to the U.S. estate tax. To qualify for the Marital Credit, the Executor of the decedent’s estate must timely elect to take the benefits of the Treaty and waive the use of a qualified domestic trust.

Canada will also permit a credit under the Treaty to Canadian residents and spouse trusts for U.S. federal or state estate tax paid on U.S. situs property.

Even where Canadians have no U.S. assets or are not U.S. themselves, if they have U.S. citizen or resident children or other beneficiaries, their own estate planning should be carefully planned. Otherwise, a Canadian parent’s planning can significantly impact the U.S. tax liabilities of children (or other beneficiaries) who live in the U.S. or who hold U.S. citizenship. Accidentally causing significant U.S. tax due to Canadian corporate and trust structures is easily done, as is causing a double tax problem when U.S. beneficiaries inherit assets, unless proper planning is undertaken.

For U.S. citizens resident in Canada, often the estate tax exemption and the Marital Credit eliminate the U.S. estate tax. For other Canadians, the combination of the Treaty Credit and Marital Credit may eliminate a U.S. estate tax liability. In many cases, however, Will and asset allocation planning should be implemented to make sure this is the case. In some situations more complex planning, including trusts and charitable giving, are required to reduce or eliminate the liability. It is strongly recommended that U.S. citizens and green card holders seek specific estate planning advice, as should Canadians who wish to acquire U.S. assets or who have already done so without first considering appropriate planning in addition to those Canadians who have children or other beneficiaries who are U.S. citizens or residents.