Expect U.S. estate tax changes no matter who’s elected

By Jessica Bruno | October 18, 2016 | Last updated on September 15, 2023
7 min read

Repeal taxes, or raise them?

Your cross-border clients face two vastly different estate tax bills depending on who wins the U.S. presidential election next month.

Democratic Party candidate Hillary Clinton would re-set U.S. estate tax rules to 2009 levels – meaning estates will be subject to the tax if their worldwide values exceed US$3.5 million. That’s more than US$2 million lower than the current threshold of US$5.45 million. Canadians with U.S. assets of US$60,000 or more, and all U.S. persons, must pay estate tax if they exceed the threshold.

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Clinton would also increase the tax rate for eligible estates from 40% to as much as 65%. Her campaign estimates the changes would affect four in 1,000 estates.

The higher rates would widen an existing gap between your client’s U.S. and Canadian estate liabilities. The U.S. taxes estates on their values, while Canada taxes a person’s capital gains on death. The policy difference can result in a hefty U.S. bill, says cross-border advisor Matt Altro, of MCA Cross Border Advisors in Montreal.

Let’s say a Canadian with U.S. assets above the threshold buys a $6-million home and then dies the next day. “In Canada, you have no tax because the property [value] hasn’t gone up, but on the U.S. side you do, because it’s a value tax,” he explains. “If you have a gain, you can use it as a credit against the U.S. tax, but oftentimes you have a mismatch.”

Read: Crossing the border could be harder under Trump

Clinton would also eliminate the step-up basis for wealthy estates, which allows capital gains to pass from estates to heirs without being taxed. The platform doesn’t say at what threshold the rule would apply, but it would “include exemptions to ensure this change only affects the high-income families who by far benefit the most from this loophole” while “protecting” middle-class families, farms, homes and closely-held businesses.

Portion of estate’s value Current rate Proposed rate
US$3.5 million or less Not taxed Not taxed
US$3.5 million to US$5.45 million Not taxed 45%
US$5.45 million to US$10 million 40% 45%
US$10 million to US$50 million 40% 50%
US$50 million to US$500 million 40% 55%
US$500 million and up 40% 65%

Note: Thresholds are for single taxpayers. Source: Tax Policy Centre.

Real-time election forecasting

Clinton’s plan would also affect mass-affluent households with tax ties to the U.S., says Altro. Their worldwide assets (including Canadian homes, RRSPs and life insurance) may have been comfortably under the US$5.45 million threshold when they decided to buy U.S. properties, but at US$3.5 million, their estates may now have to pay.

If that were to happen, Altro says to consider putting the U.S. assets into a cross-border irrevocable trust. That may not work in all situations, he says, because transferring the property into the trust would trigger capital gains tax in both the U.S. and Canada for your client. Clients with U.S. stocks could also hold them in Canadian private corporations.

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Meanwhile, all this would be unnecessary should Republican candidate Donald Trump win and follow through with his plan, notes Altro. “You could have wealthy people buying property in the U.S. and not have any concerns about that.”

Trump would scrap the estate tax altogether. Instead, there would be a 20% maximum capital gains tax for estates with US$10 million or more in gains on death.

“It would be a huge change for the tax system,” says lawyer Max Reed of Trump’s pledge. Reed is a cross-border tax lawyer at SKL Tax in Vancouver.

Not having estate tax to worry about would also open a new capital gains tax planning avenue for clients with U.S. real estate or operating businesses, says Abe Leitner, lawyer and director of tax planning at Goulston and Storrs in New York City.

“If you invest in a flow-through structure, you can get individual capital gains rates upon sale. But people try to avoid that because of the U.S. estate tax,” he says. “If the estate tax weren’t in the way, I think you’d see a lot more Canadians using flow-through structures rather than corporations.”

Read: New trust rules impact U.S. citizens in Canada

Higher threshold for gift tax

The candidates diverge again on gift tax rules. Currently, U.S. persons can gift up to $14,000 a year without diminishing their US$5.45 million lifetime estate tax exemption. In tandem with her estate tax tightening, Clinton would establish a US$1-million lifetime gift tax exemption, effectively raising the overall exemption rate.

For instance, a client who gives a grandchild the maximum $14,000 a year for 20 years would have gifted $280,000. Under the new rules, that client could give up to $50,000 a year over the same period without affecting her estate tax exemption.

Trump has the same plan for the gift tax as he does for the estate tax – elimination. No tax, on even the higher threshold, would turn what is currently a planning mistake into a viable strategy, says Altro.

Take a Canadian parent with a home in Florida, he says. She wants to avoid Florida probate, so she puts her son’s name on the deed. The IRS considers the home a gift, which triggers tax for the parent. If Trump repeals the tax, this would be a reasonable probate solution.

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Changes ahead for FATCA and FBAR

Regardless of who’s in the White House, there are changes in store for cross-border tax compliance. While Trump and the Republicans would ditch FATCA altogether, the Democrats say they’d reform the reporting regime.

“We will make sure that law-abiding Americans living abroad are not unfairly penalized, by finding the right solutions for them to the requirements under the Foreign Account Tax Compliance Act (FATCA) and Report of Foreign Bank and Financial Accounts (FBAR),” states the Democratic platform.

The party doesn’t specify how it would reform either system, but the experts say relief would be welcome. As it stands, FBAR and FATCA requirements are redundant, says Altro. Much of the information on FATCA’s Form 8938 is already covered by FBAR Form 114.

Reforming or repealing FATCA wouldn’t change U.S. persons’ obligation to pay tax, notes Reed, but it would “significantly change the tax experience of Americans in Canada.”

Read: IRS can revoke passports of Americans in Canada

Citizenship-based taxation on notice

The Republicans are pushing not only for FATCA’s repeal, but also for scrapping citizenship-based taxation. The U.S. is one of two countries (the other is Eritrea) that taxes based on citizenship and not residency.

The party would replace the current system with residency-based taxation. Leitner points out that President Barack Obama unsuccessfully proposed a similar measure in 2015. That provision would have eliminated tax on accidental citizens, such as people who never obtained a U.S. passport, only got a passport to leave the U.S., or didn’t know they were citizens and renounced their status within two years of discovery.

“A provision like that — and I don’t know if that’s what the Republicans have in mind or not — would actually be quite helpful to a lot of Canadians,” Leitner says. “I keep seeing people who were born in Canada, never got a passport, and in many cases never were aware that they were U.S. citizens.”

Read: Is it possible to ditch U.S. citizenship retroactively?

Financial planning for U.S. persons in Canada is presently limited by their U.S. tax obligations, says Altro. The tax policy puts TFSAs, RESPs, mutual funds, estate freezes and some life insurance policies out of reach.

“These traps can cost people a lot of money for not understanding or doing it the right way,” he says. “If that were to go away, that would be tremendous for U.S. citizens here.”

While nixing citizenship-based taxation would be a boon, Reed says he’s not optimistic. “Expats have not traditionally been a priority for the U.S. government, and the U.S. has imposed taxes on the basis of citizenship for more than 130 years. It would be a major change.”

On the other hand, Trump’s proposed tax bracket reform could make becoming a full-time U.S. resident more appealing to snowbird clients, says Altro. Trump would reduce the number of tax brackets from seven to three, and the top marginal tax rate would go from 39.6% to 33%.

For clients already spending time in the U.S., this could make them reconsider where to call home. Altro explains that becoming a non-resident of Canada would exempt clients from Canadian tax, which is already higher than U.S. rates.

“You’d go from the 54% tax rate in Ontario down to a maximum of 39.6% — and if Trump gets in, it’s 25% or 33%,” he says. (His proposed tax bracket for low-income taxpayers is 12%.)

Further, retirees who would otherwise be at top Canadian tax brackets could pay as low as 15% tax on RRSP withdrawals under today’s rules if they become U.S. residents.

“If Trump gets in, this already favourable strategy of becoming a U.S. resident and adding a significant amount to your retirement nest egg could become even more lucrative,” says Altro, “whereas if Hillary gets in, it may become less lucrative.”

Read: The true withholding tax for U.S. retirement accounts

No matter who is chosen for the White House come November, there’s no guarantee she or he will be able to implement any tax changes, notes Reed.

“The way laws are made in the United States requires the collaboration of the president and Congress, and everything is subject to negotiation,” he explains.

And ideas like estate tax reform or repeal aren’t new – Republicans and Democrats have been spending years blocking each others’ efforts.

“For most of the last three years, it’s been very hard for the U.S. government to do any substantial tax reform,” Reed says. “Whether that changes after the election is hard to know, but it could.”

Jessica Bruno