A Canadian estate with U.S. connections can face complications due to the presence of any one of a number of factors. Sometimes these issues are known, and sometimes events occur which were not anticipated. When a child moves to the U.S., parents should review their estate plan and consider what changes this move might require in light of the tax consequences that can arise in such cases. This blog discusses issues relating to distributions from a parent's estate to a child who has become a U.S. resident.
If a child of Canadian-resident parents becomes resident in the U.S., most complications created for the parents' estates are tax matters. Upon the parents' deaths, their estates may have additional tax filings or need to obtain a clearance certificate under section 116 of the Income Tax Act (Canada) each time a distribution is made to the U.S.-resident child.
Section 116 applies to dispositions of "Taxable Canadian Property", which includes:
- Real property located in Canada;
- Assets used in a business in Canada;
- Shares in a private Canadian corporation where more than 50% of
the value of the shares is derived from Canadian real property or
certain Canadian resource property;
- An interest in a trust (which under the Income Tax Act includes an estate), where more than 50% of its fair market value was derived, directly or indirectly, from Canadian real property (or certain Canadian resource property) in the 60 months prior to the disposition.
For the purposes of an estate or trust, the disposition of an interest in the estate or trust happens whenever the estate or trust makes a distribution to a non-resident beneficiary. If this distribution is of Taxable Canadian Property, a clearance certificate must be obtained prior to the disposition, or in certain circumstances, a filing regarding the disposition may be made instead within 10 days of the disposition date. If such filings are required, they do not typically mean that additional tax will be payable.
Other tax issues can have serious financial repercussions and may require careful or extensive planning. For example, if a parent owns shares in a private corporation and wishes to pass some or all of them to a U.S.-resident child, the parent should be aware of the significant tax issues which may result. If their U.S.-resident child was to hold shares in a foreign corporation, certain U.S. tax rules may apply which impose punitive tax results on such ownership. This may necessitate more complex post-mortem tax planning by the executors or the distribution of different types of assets to beneficiaries depending on their residency status. Other in-kind distributions to U.S. residents may result in negative tax consequences.
If a separate trust is to be set up under the parent's will for a U.S.-resident child with U.S. trustees in order to create a U.S.-resident trust for tax purposes, the trust may be deemed to also be resident in Canada for tax purposes unless careful planning is undertaken in the wind-up and distribution of the parent`s estate. A Canadian-resident trust would create tax complications and additional tax filing requirements. Post-mortem planning by the executors can alleviate the effects of these tax rules, but it can mean that the distribution to the U.S.-resident child will be delayed for a considerable period after his or her parent's death.
Non-residents of Canada are also subject to withholding tax on payment of certain types of income earned in Canada, including rental income, dividends, royalties and income from an estate or trust. The payor of the income must withhold the tax and remit it to Canada Revenue Agency, although the payee may file a Canadian tax return for a partial or full refund of the tax paid (assuming such a refund is available to them). The usual withholding tax rate is 25%, however, the Canada-U.S. Income Tax Treaty reduces the withholding tax rate on some types of income, including to 15% on dividends and estate or trust income and 10% for royalties (although certain royalty payments are exempt from withholding tax).
Finally, while it affects a limited number of individuals, it is important to know in certain circumstances U.S. inheritance tax may be payable by a U.S. resident on an inheritance from a person who previously was a U.S. citizen, but who renounced his or her citizenship, and the usual exemption limits may or may not apply.
When a child becomes a U.S. resident, their parents need to be aware of the tax and other consequences of the estate planning they currently have in place and discuss the planning options available to alleviate them and the pros and cons of such options. It is important to consider what the parents' ultimate goals for each child are, and how best to achieve them when unexpected matters arise to complicate their best-laid plans. Given the complexities of these issues, it is critical to obtain professional legal and tax advice in order to successfully navigate them.
Originally published 26 May 2020
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.