Death and Taxes – U.S. Citizens Living in Canada
U.S. citizens who die while resident in Canada face taxation issues from two countries: Canadian income tax on unrealized gains and certain tax deferred assets and U.S. federal estate tax on the fair market value of all assets. This blog briefly summarizes the tax issues and offers some suggestions on how to minimize U.S. federal estate tax.
The death of an individual resident in Canada results in a deemed disposition of their assets at fair market value on the date of their death. As a result, the individual is subject to tax on the appreciation of capital assets including investment accounts, shares in their holding corporations and other capital assets. Assets within pension plans such as a Registered Retirement Savings Plan, Registered Pension Plan and US pension plans are also subject to income tax as if all the assets within the plans are withdrawn on the date of death. In general terms, a married individual can defer this Canadian income tax where their assets are transferred to their spouse at death.
The same individual, if a U.S. citizen, is also subject to U.S. federal estate tax on the fair market value of their worldwide assets. This includes all assets regardless of type and location. U.S. federal estate tax rates start at 18% and reach a maximum of 40%. Assuming that an individual did not make a taxable gift during their lift, the first $5.25 million (all amounts are in US dollars) of their estate’s value is exempt from U.S. federal estate tax. Where the U.S. citizen’s spouse is not a U.S. person, U.S. citizens can use provisions under the Canada-U.S. Income Tax Treaty to defer some amounts of U.S. federal estate tax where their assets are transferred to their surviving spouse.
A number of strategies exist to reduce exposure to U.S. federal estate tax, including:
- Use of Trusts
families often use trusts either created during an individual’s life or upon their death to defer or eliminate U.S. federal estate tax. For example, consider a situation where a married couple consists of a non-U.S. citizen husband and a U.S. citizen spouse. They want to ensure that if the non-U.S. citizen spouse passes away first, his assets do not form part of the U.S. citizen spouse’s estate upon her death to reduce her exposure to U.S. federal estate tax. A properly set up trust in the husband’s will can achieve this and still allow his wife use of his assets and receipt of income from them.
US federal gift tax law generally prevents U.S. citizens from giving away their assets during their life to avoid U.S. federal estate tax. However, there are exemptions within U.S. federal gift tax law that allow for U.S. citizens to make gifts without U.S. federal estate or gift tax implications. U.S. citizens can give up to $14,000 annually per person without such gratuitous transfers being subject to US gift taxes. Where a U.S. citizen has three children and seven grandchildren, they can give $140,000 total ($14,000 to each of the ten of them) each year or $1,400,000 over ten years. This amount doubles where both spouses are U.S. citizens. A U.S. citizen can also give their non-U.S. citizen spouse up to $143,000 annually without being subject to US gift taxes. Both annual gift exemptions are indexed annually for inflation.
U.S. citizens should be cautious of the Canadian tax implications of giving assets. A gift of an asset with unrealized gains to a related party is deemed to be disposed of at fair market value resulting in Canadian capital gains tax. Income from assets gifted to certain family members may be subject to the Canadian attribution rules resulting in the income being taxed in the hands of the donor.
- Ownership of Assets
Non-U.S. citizens not domiciled in the U.S. are subject to U.S. federal estate tax on US situs assets which can include shares in U.S. corporations and businesses and ownership of U.S. real property. In our previous example of a non-U.S. citizen husband and U.S. citizen wife, the couple should consider having the U.S. citizen spouse own all the US situs assets which would allow her to use her $5.25 million exemption on her death. Where the non-U.S. citizen husband does not own any US situs assets, he would not be subject to U.S. federal estate tax on his death.
Proper review and planning can reduce, defer or eliminate a Canadian resident and U.S. citizen’s exposure to U.S. federal estate tax.