Articles Posted in International Estate Planning

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congress-e1521771059150-300x231The tax legislation passed by Congress last year is something of a 1950s pop love song to businesses: sweet but not very deep.  It will likely have little impact on Canadians unless they own and operate a US company.  Typically, Canadians invest in US assets, particularly real estate, rather than run US operations.  The tax package has little to offer in that regard.  But one change does make a difference.  The new law doubles the US estate tax exemption amount.  Given the size of the increase, the US estate tax now leaves all but the wealthiest Canadians untouched.  However, this situation is temporary, making long-term estate planning for Canadians with US property tricky.

Canadians And US Estate Taxes

Canadians who own US assets (typically a vacation home) have traditionally been paranoid about US estate taxes.  It’s understandable.  The US estate tax rate has lurched between 35% and 65% in recent history, with a current rate of 40%.  Before 2003, when the exemption amount was $2 million or less, the estate of a Canadian with a valuable vacation home in the US could easily get hit with a significant estate tax.  Still, the anxiety was always exaggerated, given the favorable treatment Canadians receive under the US-Canada Tax Treaty.  This is especially true after 2010, when the exemption shot up to $5 million, with annual upward adjustments.

How The Treaty Works

The Treaty provides Canadians with the most favorable estate tax treatment of any US tax treaty.  Besides mitigating double taxation by providing for a deduction for Canada’s equivalent of an estate tax (the “deemed disposition” tax), the Treaty allows the estates of Canadians to benefit from the exemption amount available to US citizens.  The exemption is prorated based on the ratio of the value of taxable US assets to the value of the worldwide assets owned by the decedent.  To use simple numbers, if a Canadian died in 2011 when the exemption was $5 million, and his total assets were $5 million, with a vacation home located in the US worth $2.5 million, the estate would apply a percentage of the exemption amount equal to the US asset value over the total asset value. Result: a $2.5 million exemption against a US estate worth $2.5 million.  Accordingly, the estate would owe no estate taxes. Continue reading →

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shutterstock_341354720-sm-jpg-300x185-300x185One of the major concerns of Canadians holding US real estate or other assets is whether the property will be subject to the US estate tax when they die.  It’s no small matter.  The estate tax top rate is 40%, and unlike Americans, foreign nationals who own US assets generally only qualify for a paltry $60,000 estate tax exclusion amount, not the $5.5 million unified credit available to American citizens.  Theoretically, if no planning were done and a foreign national died with a US vacation home worth $1 million, his estate would owe about $322,000 in US estate taxes.

Just as important, while American citizens have the benefit of the unlimited marital deduction when they leave their estate to a spouse (which is the typical estate plan), noncitizen couples cannot make use of the marital deduction to reduce or eliminate US estate taxes (unless they establish a QDOT, discussed below).

Fortunately for most Canadians, however, the US-Canada Tax Convention and its protocols, come to the rescue, if they plan right.  Here’s how.

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Executors probating Canadian estates that include US real estate or other assets subject to the US estate tax system, need to know how the US-Canada Tax Treaty may work to their benefit.  Just as important, they have to understand how to timely “invoke” the treaty, so that the tax benefits they are entitled to accrue to the Canadian estate and aren’t lost.

What US Assets Are Subject To US Estate Tax?

Not all US assets owned by a Canadian or other foreign nationals are subject to the US estate tax system. Mainly, the value of their US vacation home or other real estate, and the value of their US securities (stock of US companies) are included in calculating any US estate tax. US securities count no matter where the Canadian holds the stocks. But there is an exception for the US securities held by a Canadian mutual fund. Unfortunately, there is no exception for securities held by a Registered Retirement Savings Plan of a Canadian. The value of US securities held by a RRSP count in determining the US estate tax obligation of a Canadian decedent.

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We are continuing with our series on how the US taxes non-US citizens who visit the US regularly. In the Palm Springs area for instance, we frequently see Canadians who maintain a local property for a good chunk of the winter months. For those Canadian citizens who are not lawful US residents, and do not have a green card, they must stay mindful of the amount of days actually spent in the US. An individual who establishes a “substantial presence” in the United States can make him or herself subject to US tax on their worldwide income (i.e., a potential tax on income of a foreign citizen which otherwise has no connection to the United States). An individual has a substantial presence in the US if the individual is present in the US at least 31 days during the current year and at least 183 days for the three-year period ending on the last day of the current year, using a weighted average approach. The mechanics of this test were discussed in Part I of this series. Even if an individual establishes a substantial presence in the US in a given year, that person can still avoid being subject to US tax by declaring a “closer connection” to a tax home in another country. To accomplish this, the foreign citizen individual must file a Form 8840 with the IRS (the “Closer Connection Exception Statement”).

Even if the individual meets the substantial presence test, the individual can be treated as a nonresident alien (and not pay US tax on their worldwide income) if the individual:

1) is present in the United States for less than 183 days during the year;