In doing your estate planning, it's important to know if you or any of your intended beneficiaries are U.S. citizens. Citizenship is not always obvious to determine. It may sound farfetched, but a person can be a U.S. citizen without knowing it.
It's important to consider the tax implications that go with U.S. citizenship or residency. The U.S. is unique because it imposes tax based on citizenship even if a person is not resident in the U.S.
Under U.S. rules, there is an enumerated list of persons who can be U.S. citizens at birth and there are a number of factors to be considered based on different circumstances. For example, under the Immigration and Nationality Act 301(g), in general, a person born outside the U.S. may acquire citizenship at birth if (1) the person has at least one parent who is a U.S. citizen and (2) the U.S. citizen parent meets certain residence or physical presence requirements in the U.S.
If any of the following circumstances are relevant for you or your intended beneficiary, you may wish to get advice regarding whether you or the beneficiary may be a U.S. citizen:
- Born or resided in the U.S
- One or both parents were born or resided in the U.S.
- One or both parents are U.S. citizens
U.S. Citizenship and Immigration Services has helpful charts under the Appendices section outlining the different requirements for acquiring U.S. citizenship depending on the time period in question.
In the example above, if the child was born in wedlock and on or after November 14, 1986, the U.S. citizen parent had to have been physically present in the U.S. for at least 5 years, including at least 2 years after the age of 14.
In addition to U.S. income tax compliance and certain reporting requirements, U.S. citizens are subject to the U.S. estate tax regime, or more broadly the U.S. transfer tax regime. Generally, on death, U.S. estate tax is calculated at graduated rates based on the gross value of certain assets owned by an individual at death.
In the U.S., the current federal unified estate and gift tax exemption amount is $11.7 million (USD) for 2021. The first $11.7 million (USD) of assets of a U.S. person are sheltered from U.S. estate tax. The estate value over the exemption limit is subject to the top tax rate, which is 40% for 2021. The current exemption amount is set to revert to its original $5 million (USD) amount indexed for inflation in 2026 (although it may change sooner under the Biden government).
It's important to keep in mind that assets that may not be obvious are included in the calculation of the value of a U.S. citizen's worldwide estate, including the proceeds of life insurance policies owned by the deceased, the total value of property held in a joint tenancy with right of survivorship (unless it can be established that the deceased did not contribute to the property), and certain trust interests.
There are various estate planning strategies that can be considered to minimize exposure to U.S. estate tax if you or someone you wish to benefit in your will is a U.S. citizen. One example is a "by-pass" trust, the value of which would be excluded from the U.S. beneficiary's estate for U.S. estate tax purposes. Under a by-pass trust, the U.S. beneficiary's powers are restricted so that he or she does not have too much ownership and control.
From a Canadian tax perspective, if this type of "by-pass" trust is set up for the benefit of a U.S. surviving spouse, the trust can be drafted to also qualify as a Qualified Spousal Trust under the federal Income Tax Act in order to take advantage of a deferral of capital gains tax until the death of the surviving spouse.
For a more fulsome discussion of different planning techniques designed to minimize U.S. estate tax, check out our Advisory, "Will and Estate Planning Considerations for Canadians with U.S. Connections".
The rules are complex and the analysis is factual. U.S. legal advice should be obtained where there is a possibility that you or any of your intended beneficiaries may be U.S. citizens in order to confirm your or their status.
It is important to determine whether you or your intended beneficiaries are U.S. citizens (or residents) and consider whether any special planning needs to be undertaken to minimize U.S. estate tax exposure, and as well to make sure you or your intended beneficiaries are compliant with U.S. income tax rules.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.