The complicated landscape of U.S. estate tax

Canadians who own assets in the U.S. may be subject to U.S. estate tax.

This tax is based on the fair market value of all U.S. assets owned at the time of death. It can reach 40%, depending on the value of U.S. assets and the world-wide estate.

But not all Canadians who own U.S. assets will be subject to U.S. estate tax. A close look at the new U.S. estate tax rules will help you determine whether your Canadian clients are exposed to U.S. estate tax.

New U.S. estate tax rules

On January 2, 2013, President Obama signed the American Taxpayer Relief Act of 2013 (the Act) into law. The Act resolves many of the issues raised by the fiscal cliff.

Pursuant to the Act, U.S. estate tax liability of non-U.S. residents depends on the answers to the following two questions:

• Is the value of the U.S. estate more than $60,000?
• Is the value of the worldwide estate greater than $5,250,000?

If the fair market value (FMV) of U.S. assets is less than $60,000 on the date of death, then there is no U.S. estate tax. If the value of U.S. assets on death exceeds $60,000, a Canadian’s estate may still be exempt from U.S. estate tax if the value of his or her worldwide estate upon death is less than what is known as the “exemption.”

Worldwide exemption for 2013 and beyond

The Act provides an exemption from U.S. estate tax if a non-resident dies with a worldwide estate with a FMV of less than $5,250,000. This exemption amount is inflation-adjusted. Everything counts when calculating a Canadian client’s worldwide estate—including RRSPs and life insurance.

Additionally, when advising a married couple about U.S. estate tax exposure, it’s important to calculate the value of both spouses’ estates combined.

Clients often ask whether the U.S. estate tax is on the worldwide estate. The answer is no; the IRS does not tax a Canadian resident (who is not a U.S. citizen) on his or her worldwide estate.

The only assets that are subject to U.S. estate tax for Canadians are U.S. assets.

What are U.S. assets?

Common U.S. assets include real estate in the U.S. and personally held stocks of U.S. corporations, both public and private.

Here’s a complete list of U.S. assets subject to U.S. tax:

• real estate property located in the U.S;
• certain tangible personal property located in the U.S., such as furniture, vehicles, boats and airplanes;
• golf club equity memberships;
• shares of U.S. corporations, regardless of the location of the share certificates (even inside RRSPs or RRIFs);
• interests in partnerships owning U.S. real estate or carrying on business in the U.S.;
• U.S. pension plans and annuity amounts (IRAs and 401K plans);
• stock options of a U.S. company;
• U.S. mutual funds;
• money owed to Canadians by American persons; and
• money market accounts with U.S. brokerage firms.

The following is a list of U.S. assets not subject to U.S. estate tax:

• U.S. bank deposits;
• certain debt obligations, such as U.S. government bonds;
• American depository receipts;
• term deposits/guaranteed investment certificates;
• real estate situated outside the U.S.;
• Canadian mutual funds denominated in U.S. dollars that invest in U.S. stocks;
• life insurance proceeds payable on the death of a Canadian citizen and resident who is not an American citizen; and
• non-U.S. stocks, bonds and mutual funds.

Many Canadians own assets subject to U.S. estate tax with vacation homes and shares of U.S. corporations topping the list. How can you help clients who own these assets?

The following scenario provides some answers.

Strategies for Canadians who own U.S. assets

Richard is a Canadian citizen and resident, single, with a worldwide estate of $10 million. He owns an $800,000 property in Ft. Lauderdale, Fla.

Richard’s inherited 25% of the shares of four Florida corporations from his deceased father, which he estimates have a value of $200,000. Each corporation owns an apartment building in South Florida.

The chart “Example estimates” (this page) approximates Richard’s 2013 exposure to U.S. estate tax.

Tax planning for U.S. real estate

The goal of any tax-planning for a Canadian owner of U.S. real estate is to ensure the estate of the Canadian decedent is not subject to U.S. estate tax. Consequently, title should not be in his or her name. Alternative ownership structures include:

• corporation;
• cross-border trust (irrevocable or revocable); and
• limited partnership.

These ownership structures avoid probate and guardianship proceedings in the case of incapacity and can defer or avoid U.S. estate tax.

Tax planning for stocks

Although Richard’s shares of U.S. stock are considered U.S. assets, there are tax-planning techniques for avoiding U.S. estate tax.

01 Sell

This may trigger capital gains tax in Canada, though Richard may have some capital losses to apply against it.

02 Create a Canadian holding corporation

Transfer the shares of U.S. stocks on a tax-free basis into a Canadian corporation, of which Richard is the shareholder.

Should Richard pass away with U.S. stock in his Canadian holding company, there will be no U.S. estate tax because Richard no longer owns shares of a U.S. company; he only owns shares of a Canadian holding corporation that owns shares of the Florida companies that Richard’s father passed on to him.

The U.S. Foreign Investment in Real Property Tax Act (FIRPTA) may apply to Richard’s transfer of U.S. stocks into a Canadian company. FIRPTA requires that 10% of the sale price or transfer value of U.S. real estate by a non-resident of the U.S. be withheld and remitted to the IRS. Richard can avoid this with proper structuring and reporting, which we’ll explain next time. No withholding will be required and no disposition will have occurred.

Example estimates of U.S. Estate Tax Payable for 2013

U.S. Taxable Estate	$1,000,000
Worldwide Estate	$10,000,000
Estimated Taxable Amount	$1,000,000
Estate Tax Marginal Rate	40%
Estimated Estate Tax Amount	$345,800
Unified Credit Amount	$204,580
Estimated Tax Payable	$141,220

David A. Altro, B.A., LL.L., J.D., D.D.N., TEP, is a Florida attorney and Canadian legal advisor and the managing partner at Altro Levy. He can be reached at (416) 477-8155 or daltro@altrolevy.com