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How Can Canadians with Houses in Palm Springs (and all of the US) Be Subject to the US Estate Tax, Part II

So let’s get into some real detail on the US estate tax, and how the IRS imposes it on Canadians with homes and other assets in Palm Springs (and the entire US). The estate tax is imposed only on the value of US assets (not the value of worldwide assets) of Canadians (provided they are not “domiciled” in the US). This will be most Canadian snowbird visitors to the Coachella Valley. But is it imposed on every dollar’s worth of assets a Canadian dies with in the US? No. Canadians (and Americans) are permitted to exclude a certain amount of assets from the estate tax.

How Much Assets May an American Exclude From the Estate Tax?
For 2011 and 2012, American citizens and residents may exclude their first $5M in worldwide assets (notice the distinction again here as Canadian snowbirds will only be subject to the estate tax on their US assets). What this means generally is that an American who dies in 2012 with $2M is total worldwide assets must recognize $0 estate tax. And, as you will see, a Canadian who dies in 2012 with $2M is total worldwide assets (even if they’re all in the US) must also recognize $0 estate tax.

How Much May a Canadian Exclude From the Estate Tax?
If an American can exclude $5M in (worldwide) assets from the estate tax, how much can a Canadian exclude in (US) assets? At least for the year 2012, if a Canadian citizen were to die with worldwide assets of less than $5M, that individual is not subject to the US estate tax. This high (generous) threshold will surely go down in future years. But again, at least in 2012, a Canadian snowbird with worldwide assets of less than $5M and is not subject to the US estate tax (even if all the assets are located in the US).

Ok fine, but what about the Canadian who dies in 2012 with worldwide assets worth 10M and US assets (a house) worth 1M. How much of the $5M exemption available to Americans can the Canadian citizen use? The US Canada Tax Treaty tells us to use a simple mathematical formula to derive the answer- $5M (for 2012) total possible exemption multiplied by a fraction: the numerator of which is the Canadian citizen’s total US assets ($1M) and the denominator of which is the Canadian citizen’s total worldwide assets ($10M). In our example the formula is: $5M x ($1M / $10M) or $5M x 1/10= $500,000. So the Canadian citizen with a US home worth $1M who dies in 2012 can exclude $500,000 from the US estate tax, but the other $500,000 is subject to the tax. Taxed at a 35% rate means an actual tax paid to the IRS of approximately $175,000. The 35% is a gradual rate maximizing at 35% (taxed at a lower rate for the lower portions of the taxable estate, so the actual estate tax is likely less than $175,000).

And the Estate Tax is Scheduled to Get Much Worse

Note that in 2013, the exemption amount is scheduled to go back down to $1M, and the highest rate of estate tax is scheduled to return to 45%. So after 2012 the US estate tax will likely impact many more Canadians (and Americans).