With the end of the annual giving season and the beginning of tax season, it’s a good time for an overview of the cross-border tax impacts for Canadians. Affected clients include U.S. citizens and green-card holders living in Canada, snowbirds who own U.S. property, and Canadians planning to move to the U.S.
Since the CRA and IRS have different approaches to taxing gifts, clients may be unaware of their exposure to the U.S. transfer tax system, which includes gift tax, estate tax and the generation-skipping transfer tax.
This article will focus only on gift tax. Let’s begin with a brief refresher on Canada.
Canadian tax treatment of gifts
As Canadian advisors know, there’s no gift tax in Canada. Except for gifts from employers, the act of giving isn’t taxable to either the giver (donor) or the recipient (donee). That doesn’t mean, however, that it’s tax-neutral.
Making a gift of capital property, unlike a gift of cash, has tax consequences because transferring ownership of a capital asset is considered a disposition for Canadian tax purposes.
In Canada, if a father gives his son an appreciated property with a market value of $500,000 at the time of the gift and a cost basis of $300,000, a disposition occurs, triggering capital gains tax to the father on the $200,000 of unrealized appreciation. The son then acquires the property at a cost basis of the $500,000 market value.
Planning opportunity for Canadians moving to the U.S.: pre-exit gifting
Before moving on to the complexities of U.S. gift tax, it’s important to realize that Canadians thinking about moving to the U.S. should consider making any gifts they might otherwise have made in the future before they exit Canada.
Doing so (a trust may be optimal, depending on the client) has two main advantages:
- It allows departing Canadians to simplify their future financial affairs by setting up a structure ahead of time to provide ongoing support to loved ones without having to deal with the complications of the U.S. gift tax system.
- It gives departing Canadians a one-time opportunity to remove assets from their future U.S. taxable estates. This allows that asset value and all future appreciation to escape the U.S. transfer tax system.
U.S. gift tax overview
Unlike Canada, the U.S. imposes gift tax. The tax is imposed on the donor, not on the donee. Advisors need to be aware that, in addition to all U.S. residents, U.S. gift tax applies to:
- all U.S. citizens and green-card holders living in Canada, regardless of where the gifted property is located; and
- all Canadians who gift real and tangible property located in the U.S. (known as U.S. situs property). This affects Canadian snowbirds with U.S. vacation homes. Note that for gift tax—unlike estate tax—U.S. situs property doesn’t include intangible assets such as U.S. investment and bank accounts.
Gift tax is levied at rates that range from 18% to 40%. There are annual exclusions and a lifetime exemption, but Canadians only have access to the annual exclusions.
Annual exclusions (apply to U.S. citizens and residents, and to Canadians gifting U.S. situs property)
Donors can exclude the first US$15,000 (as of 2019) of annual gifts per donee with no limit on the total number of recipients. For example, both members of a couple with three children can give US$15,000 in 2019 to each of their three children with no tax impact.
Unlimited gifts can be also be made to a U.S. citizen spouse with no tax impact. Gifts made to non-U.S. citizen spouses qualify for a special exclusion of US$155,000 (as of 2019).
Gifts that exceed either the US$15,000 or US$155,000 annual thresholds are taxable and must be reported on a gift tax return (IRS Form 709). To qualify for these exclusions, the gifts must be of a “present interest,” which means that the donee has the immediate right to use and enjoy the property received.
Lifetime exemption (only applies to U.S. citizens and residents)
In addition to the annual exclusions, U.S. citizens and residents may claim a lifetime gift tax exemption. This takes the form of a tax credit that eliminates gift tax on up to US$11.4 million (as of 2019) of gifts made during one’s lifetime. It’s called the “unified credit” because it’s unified with the estate tax exemption for U.S. citizens and residents: any taxable gifts made during one’s lifetime reduce the estate tax exemption available at death.
U.S. gift tax exposure for snowbirds and other Canadians
Because Canadians gifting U.S. property can access the annual exclusions of US$15,000 and US$155,000 but not the lifetime exemption for gift tax purposes, Canadians who make gifts of U.S. property above these thresholds must file a U.S. gift tax return and pay any gift tax owing.
This exposure leads to two cross-border tax traps for snowbirds who gift U.S. property. There’s a solution for the first trap but not for the second.
First tax trap: capital gains timing mismatch
Let’s return to the original example of the father giving the property to his son. This time, we’ll make them American.
Gift tax applies (though no tax would likely be payable), but because the U.S. doesn’t treat the gift from father to son as a disposition as Canada does, there’s no capital gains tax. The American father’s cost basis will simply carry over to the son. Using the same numbers as above, this means the entire unrealized capital gain of $200,000 will be taxable to the son when he ultimately disposes of it.
This timing mismatch between the Canadian and U.S. treatment of a capital asset gift creates the potential for double tax when a Canadian makes a gift of U.S. situs property. In Canada, unrealized appreciation at the time of the gift triggers the capital gains tax to the father, while in the U.S. it does not. Gain recognition at different times means that foreign tax credits in both countries won’t be available to offset the full amount of tax, potentially leading to double taxation.
Fortunately, relief from this capital gains double tax problem is available under the treaty, which lets the donor elect to accelerate U.S. tax on the Canadian capital gain. This election forces gain recognition in the U.S. at the time of the gift. This matches the timing of the income tax hit in the two countries and lets the taxpayer use foreign tax credits to eliminate double taxation.
Second tax trap: no Canadian credit for U.S. gift tax paid
For Canadians who have U.S. gift tax exposure on their U.S. assets, a double tax problem remains because of the imposition of U.S. gift tax and Canadian capital gains tax in the same year. (For instance, our Canadian father and son would be double taxed if they gifted a U.S. situs asset.)
The treaty provides a credit for U.S. estate tax against Canadian capital gains tax paid upon death, but it doesn’t provide a credit for U.S. gift tax against Canadian capital gains tax arising from lifetime gifts. The result is double tax.
Cross-border tax planning
Advance cross-border tax planning is necessary to mitigate U.S. gift tax issues for Canadians. For Canadians thinking of moving to the U.S., there’s a key planning opportunity available to make pre-exit gifts. There are also planning solutions available for snowbirds with U.S. vacation homes to avoid U.S. probate without triggering U.S. gift tax. It’s important to seek out professional cross-border advice to deal with the complex interaction of Canadian and U.S. taxes.
Jonah Ravel, B.A., F.Pl., CFP, is a senior cross-border financial planner at MCA Cross Border Advisors Inc.