What Prince can teach you about U.S. estate taxes, and why Canadians should pay attention
Prince’s estate is estimated to be valued at over US$300 million — and growing by the day, due to the value of his unpublished music. As Prince reportedly had no will, nor a spouse, kids or a living parent at the time of his death, litigation over who ultimately will receive the proceeds of his estate will likely continue for years, especially given the recent emergence of “distant relatives” that have suddenly surfaced hoping to grab a piece of the pie.
But perhaps the largest beneficiary of Prince’s estate will be Uncle Sam. That’s because the U.S., unlike Canada, has an estate tax that applies to the fair market value of a U.S. person’s assets upon death. With the top federal U.S. estate tax rate currently 40 per cent, plus the Minnesota rate of 16 per cent, about half of Prince’s estate could wind up in the coffers of the federal and state governments.
The U.S. estate tax was originally enacted in 1916 and was scheduled to be repealed altogether in 2010 as part of George W. Bush’s broader tax reform package, but a sunset clause in that legislation meant that the estate tax was effectively only eliminated for one year – 2010 – and was resurrected as of Jan. 1, 2011. There is an exemption equal to US$5.45 million indexed annually to inflation.
Contrast this with Canada, where we don’t have an estate tax on death based on the fair market value of your assets, but rather we tax only the unrealized appreciation of assets upon death, other than your principle residence which can be passed on tax-free. (We also tax the fair market value of your RRSP or RRIF on death, but not your TFSA).
Could Canadian residents, living in Canada, ever be subject to the U.S. estate tax?
High-net-worth U.S. citizens living in Canada, including dual citizens, and non-U.S. citizens who own what’s known as “U.S. situs property” at the time of death 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 an Arizona or Florida condo, or U.S. shares, even when held inside Canadian brokerage accounts, either non-registered or registered (including RRSPs, RRIFs and TFSAs).
Canadians who are not U.S. citizens are allowed a prorated US$5.45 million 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 (the denominator in the fraction) is less than US$5.45 million, 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$5.45 million may have exposure to U.S. estate tax and should seek professional tax advice.
Some strategies to reduce this exposure include changing the ownership structure of a 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. Similarly, U.S. investments, such as shares of U.S. corporations, could be transferred, generally on a tax-free basis, to a Canadian investment holding corporation to avoid being included the value of your estate upon death.