How to navigate Obama's new tax proposals if you own property in the U.S.

National Post

2015-01-24


While President Barack Obama's new tax proposals may never see the light of day, given the Republican majorities in both the House and Senate, they have generated discussion among cross-border tax practitioners. Dual citizens living in Canada or Canadians who own U.S. properties may wonder whether they need to reopen their estate plans in case the proposals, referred to by Mr. Obama's advisers as an attempt to close the "trust-fund loophole," ever come into law.

Canada and the U.S. have historically taken quite a different approach to taxation upon death. In Canada, there is a deemed disposition at fair market value of all your capital property (other than your principal residence), as of the date of death and you pay capital-gains tax on any accrued gains on your final tax return. The U.S., however, has an estate tax that taxes the fair market value of a U.S. person's estate above a certain dollar-level exemption (US$5.43 million). Whether or not there was an accrued gain on that property at death is irrelevant.

To illustrate, let's assume Cathy, a Canadian resident, dies with a portfolio of stocks worth $500,000 that have a tax cost of only $100,000. When Cathy dies, she would pay up to 25% capital-gains tax on the $400,000 accrued gain as of the date of the death.

If, on the other hand, she was a U.S. citizen, and not a resident of Canada upon death, she would not pay any U.S. income tax, since the U.S. doesn't currently tax appreciated property at death, nor would she pay any U.S. estate tax since her estate was below the exemption of US$5.43 million. Cathy's heirs would inherit the portfolio with a steppedup cost basis of $500,000, allowing the $400,000 accrued gain to permanently escape taxation.

This is where the new U.S. tax proposal comes in. In this scenario, the appreciated assets a U.S. person owns on the date of death would be subject to tax on the accrued gain, with an exemption of US$200,000 of gains per couple and US$500,000 exemption for the gain on a principal residence. The capital-gains tax paid would be credited against any U.S. estate tax owing to avoid a double tax situation.

"President Obama's proposal is geared toward those individuals that have avoided any tax on assets transferred at death because they fall under the U.S. estate tax exclusion amount," says Michael Pereira, a tax partner with KPMG's Global Mobility Services group in Toronto. Now, what if Cathy were a dual citizen?

Under the new proposal, Cathy would be subject to a deemed disposition on death in both countries. Does that mean she will have to pay tax twice? Fortunately, the answer is no, due to offsetting foreign-tax credits.

What about Canadians who are not dual citizens but simply own a Florida or Arizona condo? Again, no need to update your estate plan due to the foreign-tax credit system.

"Even if this proposal was to become law, Canadians who own U.S. property on death should not expect to see any change in their ultimate tax liabilities between the two countries because of the tax-credit mechanism available in the Canada-U.S. tax treaty," explains Mr. Pereira.