Although the impact of COVID-19 has resulted in a temporary decrease in travel, there is no doubt that we are living and working in an increasingly globalized society. In Canada, we are fortunate to have such a longstanding friendly relationship with our neighbours in the United States. As a result, many citizens from both countries have crossed the border to live, work, invest, and do business. Despite the many commonalities between Canada and the US, each country has a significantly different system of taxation when an individual dies. Canadians who are dual citizens or who have US-situs assets (such as US real estate, shares in US corporations, and US pension plans and IRAs) may unexpectedly be exposed to US estate taxes on their death and, absent proper planning, may also unnecessarily expose their beneficiaries to US estate taxes upon their own deaths.
What is the US estate tax?
On an individual's death, a US estate tax is imposed on both US citizens (based on their worldwide estates) and non-US citizens (to the extent that they hold certain US-situs assets). In 2021, US citizens are exempt from estate taxes on their first USD$11.7 million of worldwide assets. Any worldwide assets in excess of this amount are taxed at a rate of up to 40%. It is worth noting that USD$11.7 million is the highest that the estate tax exemption has ever been. The Biden campaign has proposed to reduce the estate tax exemption amount to USD$3.5 million and to increase the top tax rate applied to estates to 45%.
Under the current regime, non-US citizen Canadians who are subject to US estate taxes have their exemption "ground down" based on the proportion of their US-situs assets to their worldwide estate and are subject to estate taxes on the value of their US-situs assets in excess thereof. For example, as the exemption and tax rate currently stands in 2021, a Canadian's US-situs assets that comprise only 10% of his/her worldwide assets at death will only be entitled to an exemption of US$1.17 million and the value of any US-situs assets in excess of this amount will be subject to estate taxes at a rate of up to 40%.
What can I do to reduce my beneficiaries' exposure to US estate taxes?
Thankfully, several estate planning strategies can be implemented to limit (or even eliminate) a beneficiary's exposure to US estate taxes on his or her own death. US estate tax protection is most commonly achieved by using certain "Americanized" trusts in a testator's Will which generally limit payments to a beneficiary of income and capital for "health, education, maintenance, or support" purposes - causing the assets to never formally vest in the beneficiary for US tax purposes (and thus not be subject to US estate taxes upon his or her death). Notwithstanding these income and capital limitations, there is some flexibility in these trusts if payments of income and/or capital beyond these limitations are required. Further, beneficiaries can generally be trustees of their own trusts - affording the beneficiary a certain level of control over the assets. To be effective, this planning must be completed before a beneficiary inherits.
As Canadians and Americans increasingly develop connections and acquire assets on both sides of the border, estate planning becomes more complicated. If you have cross-border planning needs, please contact any lawyer in our Wills and Estates or Tax Groups. We would be pleased to help you successfully navigate these complicated matters.
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.