An awful lot is going on south of the border these days. The health care debate has received all the hype and attention of late. Another area that will likely come under the microscope by year-end: The U.S estate tax.

The U.S. imposes a death tax on the right to transfer property at the decedent’s date of death. Known as the estate tax, the gross estate includes the fair market value of all assets owned by citizens and residents as of the date of death, as well as any life insurance policies where the decedent was deemed to have “incidents of ownership.” U.S. citizens and residents are currently entitled to an exemption on the first U.S. $3.5 million of the estate. Tax rates start at 18% and rise to 45% on taxable estates greater than $1.5 million.

That makes it critical for advisors who work with U.S.-citizen clients resident in Canada, to keep abreast of these developments as it may require them to re-examine those clients’ estate plans. For such clients, a will that is properly structured Canadian citizen must also incorporate specific U.S. planning provisions, and could go a long way in reducing or eliminating exposure to U.S. estate tax, whatever the exemption amount ends up becoming.

And, given the renewed flight of the loonie this year and the decline in the U.S. real estate market, more of your clients may be revisiting the prospects of purchasing property in the U.S.

Depending on your client’s objectives (investment or personal use) and the value of his or her worldwide estate, a number of estate-planning strategies can be utilized to minimize or reduce their exposure to U.S. estate tax.

Who’s Affected?

According to the IRS Statistics of Income Division data, in 2007, almost 33,000 estates filed returns in 2007 but fewer than half – only 14,700 [DASH] of those estates had to pay any estate tax at all. Estate tax liability totalled U.S. $21.2 billion. For 2009, the U.S. Tax Policy Center projects 15,400 estate tax returns will be filed, of which about 6,200 will owe estate tax totalling about U.S. $17.9 billion.

Non-citizens (including Canadians) might also be subject to U.S. estate tax at death. Canadians who personally own U.S. real estate or U.S. stock would currently be subject to tax if the value of their worldwide estate exceeds U.S. $3.5 million. Certain provisions of the Canada-U.S. Tax Treaty do provide relief from U.S. estate tax for married couples and Canadians if their worldwide estates are worth less than U.S. $3.5 million.

Last year, the IRS reported that in 2006, 188 non-resident estate tax returns were filed. Of those, 151 were taxable, and 37 were non-taxable. Personally held real estate, and U.S. stock were the main culprits in the imposition of this tax. What is uncertain is how many of these estates were from Canadian decedents.

Prior to passing of The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the top U.S. estate tax bracket was 55% with an exemption on estates less than US. $1 million. When EGTRRA was passed, it included provisions for repeal of the U.S. estate tax in 2010.

The law also came with a sunset clause that gave Congress until December 31, 2009 to extend the law. If it doesn’t, the law will disappear and the laws previous to its passing will go back into effect. This means, if Congress doesn’t make repeal of the estate tax permanent by the end of this year, the maximum estate tax rate of 55% and exemption amount of U.S. $1 million makes a comeback in 2011. For Canadians, the exemption at death would likely return to U.S. $60,000 rather than the more generous prorated exemption currently available under the Treaty.

Changing Times

When the U.S. Congress agreed to repeal estate tax, it had been operating on a budget surplus. Things have completely changed. With budget deficits multiplying as a result of wars in Iraq and Afghanistan, the banking and auto industry bailouts, and other elements of the stimulus package (and looming health care reform), maintaining the U.S. estate tax looks increasingly enticing as a way to help pay the bills.

Currently, there are rumblings about Congress opting for a one-year extension of the current 2009 estate tax rates (U.S. $3.5 million exemption and 45% maximum rate) rather than striking an agreement for a more permanent solution to the uncertainty in estate tax law.

Although the U.S. Senate would welcome a permanent solution, some senators are holding out for a much larger exemption and significantly lower estate tax rates – a result that would seem impossible under current and future projected economic conditions. Currently, three major estate tax bills are being considered in the U.S.: Senate Bill 722, House Bill 2032 and House Bill H.R. 436.

Senate Bill 722 would:

  • make permanent U.S. $3.5 million exemption and top 45% rates;
  • reunify the estate and gift tax credit;
  • allow for portability (transfer of a deceased spouse’s unused exemption to the surviving spouse); and
  • index the exemptions for inflation.

    House Bill 2032 would:

  • make permanent an exemption level of U.S. $2 million;
  • index the level for inflation;
  • establish progressive tax rates of 45% for estates valued between $2 million and $5 million; 50% for estates valued at $5 million to $10 million; and 55% for estates valued over $10 million;
  • reunify the estate and gift tax;
  • create exemption portability;
  • restore the state estate tax credit; and
  • provide indexing for inflation.

    House Bill 436 would:

  • freeze the exclusion and rate at 2009 levels;
  • reunify the estate and gift tax so that the cap on tax-free lifetime gifts would go from its present U.S. $1 million to U.S. $3.5 million;
  • imit the valuation discount for family limited partnerships; and provide strict valuation rules for transfer of non-business assets.

    If the above is not enough, the U.S. Congressional Budget Office (CBO) has prepared four additional options for House and Senate committees to consider:

    Alternative 1 would:

  • set the exemption for the combined tax at U.S. $5 million starting in 2010; index that amount for inflation;
  • set the tax rate equal to the top rate on capital gains (currently 15% in 2010 and 20% thereafter);
  • allow stepped-up basis for assets transferred from a decedent; and deny a deduction or credit for state death taxes.

    Alternative 2 would:

  • make the same changes as Alternative 1, but apply a two-tiered rate:
  • the first U.S. $25 million of taxable assets would be subjected to the top capital gains rate; then taxable transfers above U.S. $25 million would be taxed at 30% (and the U.S. $25 million threshold would be indexed for inflation.)

    Alternative 3 would:

  • retain the U.S. $3.5 million exemption;
  • index that amount for inflation;
  • set the top tax rate at 45%;
  • retain a step-up in basis; and allow a deduction for state death taxes.

    Alternative 4 would:

  • repeal the estate tax in 2010;
  • retain a U.S. $1 million gift tax exemption; and institute a carryover basis regime.

    The main purpose of the CBO’s alternatives is to analyze the financial impact of options already proposed. These reports generally get little public attention. But this time, because of the high political stakes related to U.S. health care reform, the CBO report will likely have a higher profile.

    In general, the increase in the estate tax exemption and the decrease in the estate tax rate some of the proposals offer is good news for clients with large estates (including U.S. citizens with large estates in Canada). However, with greater uncertainty and further changes in the global economic landscape, the likelihood of increased tax revenues meeting current and future budget deficits are unlikely.


  • Terry F. Ritchie, CFP™ (U.S.), RFP (Canada), TEP, EA, is a Calgary-based cross-border financial planner with expertise in both American and Canadian tax regimes, and co-author of The Canadian Snowbird in America, The Canadian in America, and The American in Canada

    Originally published in Advisor's Edge