Handle U.S. estate tax exposure

If your clients own U.S. Securities, their executors may have to pay U.S. estate tax when they die, and their executors may have to file the related tax returns.

The estates of U.S. citizens and people who hold certain types of property may be subject to the tax. That property could include:

• shares of U.S. public corporations and units of U.S. mutual funds, even when held in Canadian retirement plans
• U.S. private company shares
• certain holdings in brokerage accounts located in the U.S.
• U.S. retirement plans and annuities.

Canadian mutual funds holding U.S. securities and U.S. bank deposits aren’t automatically subject to the tax.

The January 2013 fiscal cliff bill continued a unified estate and gift tax exemption, which is $5.25 million for 2013. Anything above that could be taxed at a rate of up to 40%. For U.S. citizens and people considered U.S. persons for estate tax purposes, the IRS takes into account the value of their worldwide estates, even if they’re also Canadians.

Are you a U.S. citizen?

A person might be a U.S. citizen by being born to at least one U.S. citizen birth parent. The rules governing U.S. citizenship acquired at birth are complex and may take into account:

• birthdate
• whether the person has one or two U.S. citizen birth parents
• whether, and for how long, those U.S. citizen birth parent(s) were U.S. residents before the person’s birth

What about Canadians who are not U.S. persons?

Canadians who are neither U.S. citizens nor U.S. persons for estate tax purposes only have to pay the estate tax for property that’s generally either located in or has a direct connection to the U.S. This is known as U.S. situs property and includes:

• U.S. real estate
• U.S. personal property (such as artwork or household effects) located in the U.S.
• certain U.S. securities, as mentioned above.

Certain deductions, credits, and exemptions may be available to Canadian residents under the Canada-U.S. Tax Treaty. For example, Canadian residents who aren’t U.S. persons may be entitled to an enhanced unified credit. The amount would be based on the unified credit under domestic law, but pro-rated according to the value of their U.S. situs assets as a portion of their worldwide estates.

Unlike Canadian capital gains tax on death, U.S. estate tax is based on the value of the property owned at the date of death, not the change in value over time. As a result, your client may owe U.S. estate tax on a portfolio of U.S. securities that has not increased in value—or has experienced a loss.

To mitigate a client’s exposure to U.S. estate tax if he’s not a U.S. person, consider restructuring how investments are held (e.g., hold U.S. equity investments in a Canadian mutual fund, or in a Canadian holding company if appropriate), suggesting life insurance to fund the anticipated estate tax liability, or giving to charities from U.S. situs assets.

Margaret O’Sullivan

Tax & Estate

Margaret O’Sullivan is founder of O’Sullivan Estate Lawyers LLP.