Few countries seem more alike than Canada and the United States, and few share the friendly relationship these two nations have enjoyed for so long. As a result, many citizens from both Canada and the U.S. cross the border to live, work, invest and do business. But this easy access can come with a cost as some Canadians find themselves accountable to the U.S. tax system. For example, those who own and transfer U.S. property could incur:
- U.S. gift taxes in their lifetime,
- U.S. estate taxes at death, or
- U.S. generation skipping transfer tax (GSTT) for transfers to grandchildren or great grandchildren.
This article – the first in a 2-part series – focuses on U.S. estate tax.
U.S. estate tax isn’t exclusive to U.S. citizens or residents. Under U.S. law, when a Canadian who owns ‘U.S. situs property’ dies, U.S. estate tax may apply. This tax is based on the fair market value of their property at time of death (with deductions for debts, funeral costs, final medical expenses and charitable donations), with rates ranging from 18% to 40%. The top rate applies to transfers of more than $1 million.1
U.S. situs property
What’s included – For estate tax purposes, U.S. situs property includes:
- real estate located in the U.S. such as a vacation home.
- tangible assets located in the U.S. such as a car that’s licensed and garaged in the U.S., jewellery, antiques and works of art (unless those assets are in transit or on loan for an exhibition).
- intangible assets, including:
- U.S. stocks and U.S. mutual funds. Canadian mutual funds are not U.S. situs property, even if the fund owns shares of U.S. corporations;
- cash in brokerage and trust accounts located in the U.S.;
- shares in U.S. corporations owned outright by the individual or in a brokerage account, and shares in U.S. corporations owned in the individual’s RRSP (although shares of U.S. corporations owned in a mutual fund RRSP are not included as U.S. situs property);
- U.S. pension plans such as 401(k) plans and individual retirement accounts (IRAs);
- transfers of U.S. situs property made within 3 years of death;
- debt obligations issued by a person, institution or government (federal, state or municipal) of the U.S. (although publicly traded bonds, regardless of their maturity date, are not U.S. situs property).
What’s exempt – Some intangible assets are exempt, including:
- life insurance death benefits paid on the death of a non-resident/non-citizen, and
- bank deposits and money earning interest held by life insurance companies, where the interest earned isn’t effectively connected with a trade or business carried on in the U.S.
What else you should know – For Canadian clients, U.S. situs assets owned jointly with right of survivorship are included in the estate at full value when the deceased joint owner isn’t a U.S. citizen.
Estate tax credit
Non-U.S. residents, including Canadians, are entitled to a $13,000 U.S. estate tax credit. This exempts their estate from tax on up to $60,000 in U.S. situs property and excuses their executor from filing a U.S. non-resident estate tax return.2 Even with this exemption, filing a non-resident estate tax return may still be helpful. For example, it can lock in date-of-death fair market values for estate assets. Executors should talk with their tax and legal advisors about whether they should file a return even when the value of the deceased’s U.S. situs assets is below $60,000.
When the value of a Canadian’s U.S. situs assets exceeds $60,000, their executor must file a non-resident estate tax return. However, there may be opportunities to reduce or even eliminate estate tax, depending on how much unified credit the estate is entitled to use, and on who the assets are being transferred to.
The unified credit is a federal tax credit U.S. taxpayers can apply against both U.S. gift and estate tax. This credit is indexed to the rate of inflation. For 2015, it eliminates up to $2,113,800 in tax, giving U.S. citizens and residents the ability to transfer up to $5.43 million in wealth, tax-free, during their lifetime or at death. If they use any portion of the unified credit to shelter gifts made during their lifetime, that portion won’t be available in later years. And if they use the entire credit to eliminate tax on gifts made during their lifetime, none of the credit will be available to reduce or eliminate estate tax. For example, if someone dies in 2015 and made taxable lifetime gifts exceeding $5.43 million during their lifetime, their taxable estate would be subject to a 40% tax with no unified credit available to reduce any of that tax.
One feature of the U.S. estate tax system may surprise some Canadians. An estate’s value for U.S. estate tax purposes is generally the value of what other people receive from the deceased, not necessarily what the deceased owned just before death. Consequently, the estate’s value may exceed the deceased’s net worth immediately before death. For example, the present value of the income to a survivor from a deceased person’s pension or annuity is also included as an estate asset.
The Canada-U.S. Tax Treaty (the Treaty) gives Canadians partial access to the unified credit for estate tax purposes, based on the value of their U.S. situs assets compared to their worldwide assets. If a Canadian client’s U.S. situs assets accounted for 50% of the value of their total assets, they’d be entitled to 50% of the unified credit.
EXAMPLE – This example shows how the U.S. estate tax might affect a Canadian who dies in 2015.
|U.S. situs assets||Fair market value on date of death|
|Shares of U.S. corporations||$1,340,000|
|Condominium in Florida||$600,000|
|Boat in Florida||$60,000|
|Total value U.S. situs assets||$2,000,000|
|Non-U.S. worldwide assets||Fair market value on date of death|
|Non-registered Canadian equity mutual fund||$450,000|
|Non-registered Canadian stock and bond portfolio||$700,000|
|Cash and cash equivalents||$100,000|
|Life insurance policy death benefit||$1,000,000|
|Present value of defined benefit survivor’s pension||$1,000,000|
|Total value non-U.S. worldwide assets||$5,000,000|
|Total asset value (U.S. situs and worldwide)||$7,000,000|
|U.S. estate tax on U.S. situs assets||Tax|
|Tentative estate tax on first $1,000,000||$345,800|
|Tentative estate tax on remaining $1,000,000 at 40%||$400,000|
|Total tentative estate tax||$745,800|
|Pro-rated unified credit $2,113,800 x ($2,000,000 / $7,000,000)||$603,943|
|U.S. estate tax payable||$141,857|
If any part of an estate is left to the deceased’s (Canadian) spouse, an additional marital estate tax credit is available under the Treaty. The credit is the lesser of:
- the pro-rated unified credit (in this example, $603,943), and
- the amount of estate tax assessed ($141,857).
In this case, the credit eliminates estate tax on the death of the first spouse. When the surviving spouse dies, there may still be an estate tax issue, depending on whether that spouse still owns any U.S. situs assets.
Relief for small estates
If a Canadian’s worldwide estate is worth less than $1.2 million, U.S. estate tax applies only to U.S. situs real property and to personal property that’s part of a business in the U.S. The tax doesn’t apply to non-business personal property or to intangible property.
Awareness is key
If you have clients with U.S. assets, awareness is key. Share this BrighterLife article, U.S. estate tax primer for Canadians and encourage them to consult with cross-border tax or estate tax experts to learn more about U.S. estate tax, unified and marital credits and other tax-saving strategies involving:
- structures (e.g., trusts) to hold U.S. property,
- U.S. wills and powers of attorney, and
- life insurance.
For your information – U.S. taxes for Canadians with U.S. assets, a report published by Sun Life Financial (authored by Stuart L. Dollar, M.A., LL.B., CFP, CLU, ChFC, Director Tax and Insurance Planning, Sun Life Financial) in December 2014 offers more insight, including information about capital gains and estate tax as well as state inheritance and death taxes.
1 All amounts in this article are in U.S. dollars.
2 See Instructions for Form 706-NA, United States Estate (and Generation-Skipping Transfer) Tax Return – Estate of a non-resident not a citizen of the United States, ‘Who Must File’.