U.S. estate tax certainty begins in the New Year

Last Friday, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 was passed and signed by President Obama. Since U.S. lawmakers seem to like to use acronyms a lot, I thought I’d give this one a try myself. How does TRUIRJCA sound? Don’t quote me on that. Let’s just call it the 2010 Act.

As you recall from my previous article, “U.S. Estate Tax Uncertainty Still Exists” from last week, one of the more surprising elements of the new 2010 Act relates to the increased U.S. estate basic exemption of $5 million and lower maximum rate of 35%. This will – for at least the next 2 years – reduce the level of estate tax exposure for many Americans in Canada and those Canadians who own U.S. real estate or U.S. shares personally.

New Rate and Exclusion Amounts

The rate at which the 35% maximum rate kicks in is when the taxable estate exceeds $500,000. Based on the new maximum estate rate of 35%, the unified credit or “tax” on the basic exclusion amount of $5 million would now be $1,730,800. That would now be the number that would be utilized under the Canada-U.S. Tax Treaty to determine the pro-rated credit available for Canadians owning U.S. situs property.

I have put together a few hypothetical examples of the level of what the net U.S. estate exposure would be assuming various worldwide estate and values of personally held U.S. assets (like real estate or U.S. shares). As you will notice and as my previous article pointed out, the levels of exposure are substantially reduced – at least for the next 2 years – for single Canadians with a U.S. dollar worldwide estate of less than $5 million or Canadian married couples with a U.S. dollar worldwide estate of less than $10 million.

U.S. estate planning for a married couple where the surviving spouse will likely have a gross estate of greater than the basic exclusion amount will still be required to reduce or eliminate any U.S. estate at the surviving spouse’s death. This can be achieved through ownership planning (tenants in common) or through the role of a spousal trust within the first to dies will or other trust planning. Life insurance could also be used to cover estate exposure, however, special planning would be required to ensure that the proceeds would not form part of the decedent’s worldwide estate. Planning using a non-recourse mortgage – although hard to find – could also be used for U.S. real estate ownership.

Portability Provisions

One of the more interesting elements of the 2010 Act provides for “portablility” of the exclusion amount between U.S. citizen spouses. This allows the surviving spouse to elect to take advantage of the unused portion of the estate exclusion from the predeceased spouse’s estate. This should provide the surviving spouse’s estate with a much larger exclusion amount. This type of planning was typically achieved for U.S. married couples through the use of “credit shelter” or “bypass trusts” within wills in Canada or more often than not, Trusts in the U.S.

To give you an example of how this would work, let’s assume that John has an estate worth $3 million and his wife Ruth has an estate worth $4 million. Assuming that John dies in 2011, his estate would pay no U.S. estate tax ($5M exclusion exceeds his $3M estate). Ruth would now have an estate of $7 million ($4M herself + John’s $3M estate) Assuming that Ruth were to die in 2012 with an estate of $7M she would be entitled to use John’s unused $2 million exclusion along with her own exclusion of $5 million which would eliminate her exposure to U.S. estate tax. John would have had to make an election on his estate tax return to allow Ruth to use his unused exclusion amount.

Apparently, under the new law, if the surviving spouse is predeceased by more than one spouse, the exclusion amount available for use by the surviving spouse would be limited to the lesser of $5 million or the unused exclusion of the last deceased spouse.

Fun stuff. Well the fun begins again in another 2 years. As I ended my last article……Stay tuned!

Terry F. Ritchie is a Calgary and Phoenix based advisor with Transition Financial Advisors (www.transitionfinancial.com) who specializes in U.S./Canada financial, tax and estate planning matters. He is the co-author of the books, The Canadian in America, The Canadian Snowbird in America and The American in Canada (www.ecwpress.com).