US Estate Tax for Canadians and Other Cross Border Tax Issues

US Estate Tax for Canadians and Other Cross-Border Tax Issues

Estate Planning Council of Abbotsford

June 19, 2013

Benita Loughlin, KPMG LLP

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), a Swiss entity. All rights reserved.

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Restrictions and Limitations

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

Any advice herein is based on the facts provided to us and on current tax law including judicial and administrative interpretation. Tax law is subject to continual change, at times on a retroactive basis and may result in incremental taxes, interest, or penalties. Should the facts provided to us be incorrect or incomplete or should the law or its interpretation change, our advice may be inappropriate. We are not responsible for updating our advice for changes in law or interpretation after the date hereof.

KPMG’s advice is for the sole use of KPMG’s client. The advice is based on the specific facts and circumstances and the scope of KPMG’s engagement and is not intended to be relied upon by any other person. KPMG disclaims any responsibility or liability for any reliance that any person other than the client may place on this advice.


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US Vacation Property

Estate tax is the biggest concern Canadians have

No US estate tax if worldwide assets US$5,250,000 or less (because of Canada-US Treaty credit)

If married, worldwide assets of first to die can be about US$10,000,000 without estate tax applying (because of Canada-US Treaty marital credit) if property transferred to surviving spouse (no estate tax if surviving spouse is a US citizen)

Maximum rate is 40%

US estate tax on first $1,000,000 is $345,800; any excess value is taxed at 40%

The lifetime exemption amount for US citizens is $5,250,000 which is equivalent to $2,045,800 of estate tax (the applicable credit amount)

Canadians are allowed a pro-rata portion of the exemption amount based on US assets divided by worldwide assets


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Example #1

Michael has worldwide assets valued at $7,000,000 Vacation home in US valued at $2,000,000 Shares of Apple valued at $1,000,000

Estate Tax on $3,000,000

On first $1,000,000 $ 345,800

On $2,000,000 at 40% 800,000

Total estate tax before credits 1,145,800

Treaty credit is 3/7 x $2,045,800 < 876,771 >

Net estate tax payable $ 269,029

If married an additional $876,771 credit available (or $269,029 in this example) If not married or transfer property to children then estate tax will be payable

because worldwide assets > $5,250,000 If married and property to spouse then no estate tax because worldwide assets <

$10,000,000 In many cases surviving spouse will sell before death


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Example #2

George owns a home in Arizona valued at $4,000,000 George has worldwide assets valued at $20,000,000 George dies and leaves his assets to his spouse, Gina

Estate Tax on George’s Death

On first $1,000,000 $ 345,800

On $3,000,000 at 40% 1,200,000

Total estate tax before credits 1,545,800

Treaty credit is 4/20 x $2,045,800 < 409,160 >

Treaty Marital Credit < 409,160>

Net estate tax payable $727,480


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Alternatives to Minimize or Eliminate US Estate Tax Exposure

Play the odds Spouse with lower worldwide assets buys US assets (with own funds) Joint ownership (each with own funds) Sell after first to die Canadian company (if mostly rental) Non-recourse debt (never actually use) Life insurance Donation to US charity Canadian Trust (properly structured) Canadian Limited Partnership (with US check-the-box election) Minimize assets of surviving spouse with spouse trust (with no general power

of appointment) Transfer US property to trust for surviving spouse (with no general power of

appointment); structure to qualify for treaty marital credit


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Canadian Trust for US Vacation Property

Establish trust before looking for property One spouse is the settlor The other spouse is the life beneficiary The settlor is neither a beneficiary nor a trustee The trust is settled with cash Children are the remainder beneficiaries Pay rent after beneficiary spouse dies Individual capital gains rate on gain Can avoid 21-year rule if structure as spouse trust Settlor has to part with the cash Need to be married No US estate tax


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Canadian Limited Partnership for US Vacation Property

Elect to treat partnership as corporation for US tax purposes (check-the-box election)

Avoids US estate tax (property is owned by Canadian corporation for US tax purposes)

No shareholder benefit rules because partnership for Canadian tax purposes

Need some type of “business” in the partnership (e.g., stock portfolio, LP interests or rental income)

Corporate tax rate on capital gains realized

Can transfer property already owned to the Canadian limited partnership but preference is to set up before purchase


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US Citizens Resident in Canada

Born in the US = US citizen

Can renounce US citizenship

Possible retroactive determination of loss of citizenship (depends on facts)

Subject to US income tax, estate tax, gift tax and generation skipping transfer tax on worldwide income/assets

File US tax returns, all related forms and foreign bank account reporting forms

Estate planning should take into account US citizenship


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Renouncing US Citizenship

Need appointment at consulate (need prior legal advice) Deemed disposition of assets at fair market value Immediate recognition of certain deferred compensation/pension amounts

(including stock options, RRSP and non-US pensions) $668,000 tax-free capital gains (not for deferred compensation/pensions) US heirs subject to US estate and gift tax (forever) Exception if:

- < $2,000,000 net worth; and

- Filed last 5 years of tax returns; and

- Average annual US tax liability less than $155,000 Exception if:

- Dual from birth; and

- Reside in the other country; and

- Not US resident in 10 of the last 15 years Exception if:

- Under age 18½


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Renouncing US Citizenship - Planning

Use $5,250,000 exemption to reduce net worth below $2,000,000

Check dual from birth exception

Check amount of gains

Match timing of US and Canadian tax (e.g. withdraw RRSP, exercise stock options, reorganization of corporate structure)

Retroactive determination of loss of citizenship

Deal with children before age 18½


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US Citizen with Residence with Accrued Gain

In Canada can use principal residence exemption for main home or vacation home (not rental property)

Gain in excess of $250,000 taxable in US

Use lifetime gift tax exemption amount to transfer house with accrued gain to non-US citizen spouse before sale

Current long term capital gains tax rate 20% in US; Canada is nil

Structure will so house not bequeathed to US citizen spouse


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US Citizen Estate Planning

Reduce worldwide assets Do not increase worldwide assets Estate freeze results in gift for US tax purposes

- Preferred shares deemed to have zero value unless fixed cumulative dividend

Use annual gift tax exemptions

- $14,000 to anyone

- $143,000 to non-resident alien spouse Pay tuition and medical expenses directly Establish trust in will of non-US spouse so that assets not included in estate

of US surviving spouse

- No general power of appointment

- Spouse can’t be sole trustee with unlimited capital encroachment powers Establish trust in will of US spouse (up to exemption amount) so that assets

not included in estate of US surviving spouse; keep increase in value out of US estate tax

Use $5,250,000 lifetime gift tax exemption amount for assets that will increase in value


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Canadian Trusts with US Beneficiaries

All income retained in trust is taxable to a US beneficiary when eventually distributed

For US purposes cannot designate a distribution as a distribution of capital

For US purposes current year income is distributed first, then accumulated income and finally capital

Even if the beneficiary is only a capital beneficiary (trust law vs. tax law)

Any accumulation distribution is treated as having been made over the term the trust existed

US tax is calculated on the amount allocated to each year as if it was earned in that year


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Accumulation Distribution Example

Trust created 10 years ago with $1 Trust earned $10,000/year of dividend income Trust paid Canadian tax of $2500/year Distribution of $75,000 in Year 11

US beneficiary reports $ 75,000

Gross-up for tax paid by trust 25,000

Income reported on US return $100,000

US tax calculation $ 35,000

Foreign tax credit 25,000

Net US tax owing $ 10,000

Interest is charged on $1000/year of US tax for 10 years, 9 years, 8 years etc…in some cases the US tax plus interest is more than the distribution


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How to Deal with Potential US Beneficiaries of Canadian Trusts

Do not include any US beneficiaries

Do not make distributions to US beneficiaries

Provide in trust that US beneficiaries not entitled to any distributions

Distribute all trust income including capital gains every year

Distribute all trust income including capital gains before beneficiary moves to the US

Distribute all income including capital gains to Canadian beneficiaries in Year 1 and then distribute to US beneficiaries in Year 2

Careful bookkeeping (tracking trust income and taxes paid each year) – in many cases enough Canadian tax was paid to eliminate US tax

If records not available use “default method” to determine accumulation distribution – can improve result by making distributions over several years


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Provide Flexibility in Trusts

Trust can move to another jurisdiction (i.e. to US if US beneficiaries)

Trust can be split if some beneficiaries are in the US

If US is a possibility provide that a court within the US is able to exercise primary supervision over the administration of the trust if trust to become US resident (need to meet court and control test to be considered a US resident trust)

For 21-year rule (in order to have Canadian resident beneficiary):

- Distributions can be made to entity wholly owned by beneficiary

- Beneficiary can transfer interest in trust to wholly owned entity

- Create the entity (ULC) and make it one of the beneficiaries


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Alter Ego Trusts

Do not use for US assets

Canadian tax on death payable by trust

US estate tax payable by settlor

No offsetting credits in Canada because different taxpayers

US will allow credit for Canadian tax on Canadian assets

Ok to use if no estate tax payable


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Holding Companies

US citizens do not benefit from holding companies

US anti-deferral rules similar to FAPI

No integration in US

Consider ULC

Restructure before death if US heir

Restructure in estate if US heir (foreign estates are subject to less onerous US rules than trusts)


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Delinquent US Filers

Need to deal with the issue

The issue won’t go away

Fix it and then renounce if don’t want to be a US citizen

IRS streamlined process simpler/less costly than Offshore Voluntary Disclosure Initiative


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Greencard Holders

Greencard holder = US resident

Even if greencard no longer valid for immigration

Required to file US tax returns

Expatriation rules apply if greencard held in 8 or more of the last 15 years at time of surrender

Tie-break to Canada using treaty, surrender greencard at border or greencard confiscated = expatriation

Deemed disposition of assets/recognition of pension value – same as US citizens renouncing

Nexus application will identify greencard holder


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Summary

Determine US estate tax exposure

Ask about US citizenship

Ask about greencards

Ask about US residents in family

Lots of opportunities to plan for tax minimization but opportunities are better before death, expatriation, freeze, distribution, reorganization etc

Questions?

Thank You

Presentation by Benita Loughlin

KPMG LLP

[email protected]

© 2012 KPMG LLP, a Canadian limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (KPMG International), aSwiss entity. All rights reserved. Printed in Canada The KPMG name, logo and "cutting through complexity" are registeredtrademarks or trademarks of KPMG International Cooperative (KPMGInternational).

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US Estate Tax for Canadians and Other Cross Border Tax Issues