Selective U.S. Estate and Gift Tax Planning Considerations - in the Cross-Border Context

In this article, we discuss a few considerations that are relevant when planning for one’s estate in the cross-border context. The objective of this article is to help Canadians or US persons residing in Canada (or anywhere outside the United States) start a dialogue about managing potentially applicable US estate, gift or generation-skipping transfer taxes, proactively. If this topic is of interest to you, you would likely benefit from attending our upcoming webinar on cross-border estate and gift tax planning.

The US estate tax applies to US citizens and US domiciliaries no matter where they are residing and no matter where their assets are located. The US estate tax generally only applies to non-US persons who have US situs assets at the time of death. When a non-US person’s estate is subject to US estate tax, the tax advisor must understand the US domestic estate tax framework and the applicable treaty (in the case of Canada, the Canada-US income tax treaty; the United States also has estate and gift tax treaties with a number of countries).

The US gift tax generally applies to non-US person donors when they make a gift involving real property or tangible property situated in the United States. In straightforward cases, a determination of whether US gift tax applies to a gift is easy, but things get more complicated if there are additional facts, such as the ownership of a partnership interest or transfers of funds.

With the significant increase of the US estate and gift tax applicable unified credit and the basic exclusion amount for individuals who are US citizens or US domiciliaries to US $5,450,000 (for the 2016 tax year) and as much as US $10,900,000 for married couples, the focus and opportunities for relevant small and medium-size estates seems to be shifting. The new focus is on managing US income tax exposure as opposed to primarily mitigating US federal estate and gift tax and US federal generation-skipping transfer taxes. This trend is also fuelled by the difference in the long-term capital gain tax rate (20 percent) and the highest estate and gift tax rate (40 percent). The estate tax exemption for non-US domiciliaries is generally limited to only US $60,000, unless a treaty provides for a higher amount. This is exactly the case under the Canada-US income tax treaty, which allows much higher unified credit amounts to Canadians whose estate is subject to US estate tax (the amount is the same that applies to US domiciliaries, but is prorated based on the ratio of individual’s US situs assets vs. her/his worldwide assets and the value of the individual’s estate). 

Non-tax reasons for post-mortem planning play a bigger role at times in planning for one’s estate or in ensuring a smooth business transition (business succession planning) to the next generation. However, additional factors and the increased number of estates involving US persons or US situs assets makes estate planning, even for small and medium-size estates, one of the most challenging areas for estate and trust tax law practitioners and other tax advisors specializing in the area.

... US citizen or a Green card holder who is contemplating a gift or bequest to a non-US person, spouse or not, should be aware of applicable US tax implications ...

The globalization and ever enhanced transparency, especially between the Canada Revenue Agency (CRA) and the US Internal Revenue Service (IRS) is leading to much closer cooperation between the two tax authorities, enormous information exchange and assistance in collection of tax on both sides of the border, and higher scrutiny of unsuspecting taxpayers. The coordination of the IRS, US Department of Treasury, and the US Department of Homeland Security adds more challenges for delinquent US taxpayers crossing the border, as it is more difficult to hide or rely on one’s calculation of days of presence in the United States (for example, consider more accurate the travel tracking by customs on both sides of the border). The US government has been enforcing the US tax law more rigorously, thus leading to a heightened compliance environment. Finally, Foreign Account Tax Compliance Act (FATCA) of 2010, as implemented in Canada through a Model I Intergovernmental Agreement (IGA) and the Canadian domestic legislation, now requires Canadian financial institutions (including non-traditional entities) to report to the CRA certain information on accounts held or beneficially owned by US persons. CRA, in turn, reports that information to the IRS.

The currently applicable annual exclusion is US $14,000 per donor per donee per year. A married couple can effectively double that amount.

How is this increased compliance environment relevant to a Canadian who may be inheriting or bequesting some assets in Canada? Or why should a US citizen or Green card holder residing in Canada care about this? To be sure, a Canadian with no US situs assets or non US beneficiaries could probably care less. But if a Canadian wants to gift or bequest some assets to a US person, or if she/he wants to do an estate freeze in Canada and if, as part of the proposed transaction, a Canadian trust would have any US beneficiaries or may have a US person funding the trust, directly or indirectly, she/he would be better off to understand potentially adverse US tax implications for the trust, her/himself, or the US person involved in the proposed transaction. Proactive action would save time and potential trouble in the future. By the same token, a US citizen or Green card holder who is contemplating a gift or bequest to a non-US person, spouse or not, should be aware of applicable US tax implications. Understanding the applicable legal framework is more important today, due to hefty penalties.

There are a few simple planning techniques that can get you started. To start, making inter vivos gifts that qualify for an annual exclusion would help you decrease the value of the estate and also help address certain cash needs for donees. The currently applicable annual exclusion is US $14,000 per donor per donee per year. A married couple can effectively double that amount. The annual gift exclusion amount for gifts by a US citizen spouse to a non-US citizen spouse is US $148,000 (for the 2016 tax year). Addressing applicable gift tax implications for life transfers is usually manageable prospectively, and in practice it is rare for someone to make a gift in excess of the annual exclusion amount. However, where gift tax planning becomes critical is when a transfer involves appreciated property. In general, the donee gets the donor’s basis in the property that is transferred by gift used to calculate tax on capital gain upon the property’s sale. You can quickly see that in the absence of  planning, the donee may end up with significant capital gain potentially subject to tax.

Gifting assets that would appreciate in the future would also transfer the tax burden with respect to any income generated by the assets to a donee, which can be both an effective strategy (especially, for example, when the donee is in a lower tax bracket), or a trap for the unwary.

Planning proactively can help clients achieve certain non-tax objectives, including avoiding probate fees, asset protection, and specific succession planning. More sophisticated planning is available by using business entities and trusts, depending on the client’s objectives (in most cases, due to conflicting objectives a client may need to make a sacrifice of one objective so that she/he can achieve the other, more important objective). All those objectives should be carefully evaluated and in rare cases tax would be the main factor for the chosen planning opportunity. Importantly, one should consider the compliance requirements that extend to both filing US estate tax return and other tax forms with the IRS (to qualify for treaty benefits, for example).

We discussed only a few considerations that may be relevant to one’s will or post-mortem planning. However, we hope that this will start a dialogue and alert you to the importance of this topic.