Beware taxes on your U.S. estate
Canada does not have an estate tax. Yet high-net-worth U.S. citizens living in Canada and non-U.S. citizens who own what's known as "U.S. situs property" may still be caught by the U.S. estate tax. The most common examples of U.S. situs property are U.S. real estate, such as a Florida or Arizona condo, or shares in U.S. companies, even if they're held inside Canadian brokerage accounts, including RRSPs, RRIFs and TFSAs.
The U.S. estate tax has a long and colourful history. It was enacted in 1916 and was scheduled to be repealed altogether for 2010. The repeal of the estate tax was announced by President George W. Bush in 2001 as part of a broader tax reform package, which gradually lowered the top tax rate on estates from 55% to 45% and increased the exemption in stages from US$675,000 to a high of US$3.5million in 2009, with the estate tax to be repealed entirely for 2010.
The 2001 legislation, however, had a sunset clause meant to circumvent a U.S. Senate rule that could have allowed senators to block the legislation if it increased the federal deficit beyond a 10-year term. This resulted in a legislative expiry date of Dec. 31, 2010, meaning that if nothing were done, the U.S. estate tax would resurrect itself on Jan. 1, 2011 at the 2001 rates with the much lower exemption.
In late December 2010, new legislation was introduced that retroactively reinstated the estate tax for 2010 deaths at a top rate of 35% and with a US$5-million exemption, which was indexed to inflation after 2011 and was to last until Dec. 31, 2012.
On Jan. 1, 2013, the U.S. Senate passed the American Taxpayer Relief Tax Act of 2012 that made a couple of changes to the U.S. estate tax.
First of all, it raised the top estate tax rate to 40% from 35% and it made permanent the US$5-million exemption, indexed to inflation, which means that for 2013, the exemption is now US$5.25-million.
Canadians who are not U.S. citizens are allowed a prorated exemption under the Canada-U.S. tax treaty, based on the fraction of the value of their U.S. situs property divided by the value of their worldwide estate.
Mathematically, this means if your worldwide estate is under US$5.25million, you will get a full exemption from U.S. estate tax. High-net-worth Canadians who die owning U.S. situs property and have an estate larger than US$5.25-million may have an exposure to U.S. estate tax and should seek professional tax advice.
Some strategies to reduce exposure include changing the ownership structure of your U.S. property while you are alive, perhaps by using a Canadian discretionary trust to own the real estate or seeking a non-recourse mortgage against the U.S. property.
A recent estate tax update from PwC titled Owning a U.S. Vacation Home contains examples, as well as planning tips to mitigate the tax.