The below excerpt is from the newly released book, Strategic Use of Trusts in Tax and Estate Planning, written by tax lawyer Caroline Rhéaume. If you wish to order this book, please visit https://shop.wolterskluwer.ca/en/strategic-use-of-trusts-in-tax-and-estate-planning.html or call customer service at 1-800-268-4522.
Tax Liability of US Citizens Living in Canada and US Estate Tax Planning
When advising a US citizen client living in Canada and married to a Canadian resident, certain questions arise in the estate-planning context. A US citizen is subject to US tax laws, which may involve the payment of income tax, gift tax, estate tax, and a tax called “generation-skipping transfer tax” (“GSTT”). This liability does not preclude the US citizen living in Canada from also being subject to Canadian tax.
US Estate Tax—Background US Citizens
There are three general methods to acquire US citizenship: citizenship based on one’s place of birth, citizenship based on the citizenship of one’s parents, and citizenship based on naturalization. The rules are found in the Immigration and Nationality Act. A person born in the United States is a US citizen at birth. No action is required to confirm this status. A child born in Canada may be a US citizen if one or both parents are US citizens and depending on the number of years the parent(s) spent in the United States prior to the child’s birth. Some rules apply to a child born in wedlock, whereas other rules apply to a child born out of wedlock.
US citizens and individuals domiciled in the United States are subject to gift tax on lifetime transfers of assets, and are subject to US estate tax at the time of their death on the value of their worldwide assets. Section 2001(a) of the Internal Revenue Code (“IRC”) indicates that a tax is imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. A US resident for gift tax and estate tax purposes is a decedent who, at the time of his or her death, had a domicile in the United States.
A person acquires a domicile in a place by living there, even for a brief period of time, with no definite present intention of later removing therefrom. Residence without the requisite intention to remain indefinitely will not suffice to constitute domicile, nor will intention to change domicile effect such a change unless accompanied by actual removal.
As a green-card holder is deemed domiciled in the United States, he or she will generally be subject to US estate tax on worldwide assets. A green card will only be issued to someone who plans on residing in the US permanently. However, depending on the facts and circumstances, it may be possible to prove that a green-card holder was not domiciled in the US at the time of his or her death.
President Donald Trump signed, on December 22, 2017, the most extensive US tax reform bill since 1986. This tax reform is commonly referred to as the Tax Cuts and Jobs Act. Several provisions of this Act make changes to US estate tax and gift tax. Under this Act, a US$11.18 million lifetime gift tax exemption is available to US citizens for 2018. A US citizen may also claim a US$11.18 million estate tax exemption for 2018 to reduce his or her US estate tax liability (US$22.36 million in the case of married couples). The current estate tax exemption amount represents a unified credit of US$4,417,800 for 2018 (exempting $11.18 million from tax). However, the provisions of the Act relating to estate, gift, and generations skipping transfer taxes are not permanent and will expire on December 31, 2025. As of January 1, 2026, the exemptions should revert to the 2017 exemptions adjusted to inflation.
Considering the fact that the increased exemptions could apply only until the end of 2025, many US lawyers and US tax specialists recommend to people to take advantage of the enhanced gift tax exemption and make gifts to their children and grandchildren outright or in trust.
The Act retains “portability” of estate tax exemption between spouses, which provides that the amount of federal estate tax exemption that a deceased spouse does not use can be transferred to the surviving spouse. This exemption is commonly called DSUEA for “deceased spousal unused exclusion amount”.
Thus, a US citizen’s surviving spouse may take advantage of the unused portion of the estate exemption amount from the predeceased spouse’s estate (portability clause). This provides the surviving spouse’s estate with a much larger exemption amount. As an example, if a married US citizen dies and uses US$7.18 million of his or her estate tax exemption, the surviving spouse, provided he or she is a US citizen or resident, now has a US$15.18 million exemption, using the 2018 figures ($4 million of unused exemption from the deceased spouse plus current exemption of $11.18 million). As a general rule, portability is not available to a surviving non-resident of the United States, except if the survivor is a resident of a country that has an applicable treaty with the United States. Special rules apply for the calculation and use of a non-citizen surviving spouse’s DSUEA where property passes to a qualified domestic trust (“QDOT”) set up for a non-citizen surviving spouse.
A surviving spouse is entitled to the unused exemption of his or her most recently deceased spouse. Portability, however, is not automatic. The executor of the deceased spouse’s estate must make an election on a timely filed estate tax return, even if a return would not otherwise be required.
In In the matter of Estate of Vose, the Supreme Court of Oklahoma ruled that the deceased’s legal representative must take all the required measures to transfer the unused exemption to the surviving spouse.
For US citizens and residents living in the United States, it is important to verify whether or not portability is recognized in their state of residence. It is not always the case.
The highest estate tax rate for 2018 is 40%.
Portability also applies to gift tax. The surviving spouse can then claim the unused portion of his or her spouse’s exemption when making gifts. However, portability does not apply to GST.
It must be noted that the use of the lifetime gift tax exemption exhausts or reduces the estate tax exemption, those two regimes being unified. For example, if a US citizen used $2 million of his or her lifetime gift tax exemption, he or she would have an estate tax exemption of $9.18 million at death, using the 2018 figures.
However, specific exemptions are available when making gifts, which will have no impact on the lifetime gift tax exemption. A US citizen can make gifts to a US citizen spouse without paying any US gift tax, and without having to utilize his or her lifetime exemption. All gifts made to a spouse who is a US citizen are exempt from federal gift taxes due to the unlimited marital deduction. If the spouse is not a US citizen, the US citizen may gift up to US$152,000 to the spouse (for 2018) without paying gift tax or using the lifetime exemption. As for other beneficiaries, a US citizen may claim a US$15,000 annual gift tax exclusion per beneficiary (for 2018). Those amounts are usually indexed every year.
Canadian residents (who are neither US citizens nor domiciled in the United States) may be subject to US estate tax if they hold US-situs assets upon their death. Generally, US-situs assets are those assets that are “situated” in the United States. This typically includes real property, such as land and buildings, tangible personal property, such as artworks and jewellery, stocks of US companies (held inside or outside RRSPs and RRIFs), US pension plans, and debt obligations of US persons or entities (including stock options). Canadian residents may also be subject to gift tax on US-situs assets, but for that purpose, intangible property, such as US stocks, is excluded from the application of gift tax. It should be noted that a Chief Counsel Advice was released by the Internal Revenue Service (“IRS”) on January 22, 2010, dealing with RRSPs and US estate tax. The Chief Counsel, after reviewing the facts submitted, came to the conclusion that a Canadian decedent’s RRSP was not to be included in his or her gross estate for US estate tax purposes, because the RRSP’s Canadian mutual fund holdings were most likely characterized as corporations for US tax purposes, and not as trusts, even though they were trusts under Canadian law. As such, the decedent died owning shares of Canadian corporations not subject to US estate tax. In this case, the RRSP held shares of Canadian mutual funds that owned shares in US corporations.
A Canadian resident cannot claim the unlimited marital deduction and cannot claim the US$11.18 million estate tax exemption. The IRC provides complete relief to Canadians who own US property at death worth less than US$60,000 (which represents a US$13,000 credit). Moreover, under the Canada–U.S. Income Tax Convention, Canadian residents may find tax relief by claiming a unified credit in 2018 equal to the greater of:
- US$13,000; and
- The unified credit allowed to US citizens under the IRC, being US$4,417,800 for 2018 multiplied by the value of their US-situs assets divided by the value of their total worldwide assets.
To the extent that a Canadian-resident decedent pays Canadian income tax on the accrued gains of his or her US-situs property, he or she may be able to offset some, or all, of the Canadian income taxes relating to the US property by claiming the US estate tax as a foreign tax credit (depending on the province of residence, such a credit may not be available at the provincial level).
If the value of the US assets does not exceed US$60,000, a Canadian resident does not have any exposure to US estate tax and does not have to file a US estate tax return. If the value of the US assets exceeds the US$60,000 threshold, calculations have to be made to determine whether or not US estate tax applies in a particular situation.
Based on the 2018 exemption amount, as a rule of thumb, if the value of a Canadian’s worldwide estate does not exceed US$11.18 million (US$22.26 million for a married couple), there is no US estate tax exposure, but a US estate tax return has to be filed with the IRS to obtain relief under the Canada–U.S. Income Tax Convention. Otherwise, where the worldwide estate exceeds the US$11.18 million threshold, there would most likely be US estate tax payable.
Clients who own real property in the United States should also consider having a US will and power of attorney drafted under the laws of the state where the property is located.