John Archer: U.S. estate tax changes are looming
John Archer: U.S. estate tax changes are looming
For Canadians who are fortunate enough to have worldwide assets exceeding $1 million U.S., there may be a U.S. estate tax time bomb that ticks louder as we approach Dec. 31. Urgency is building as a current law that provides for a U.S. estate tax exemption of approximately $5 million is due to expire and is expected to be reduced to $1 million. This has led those who might be affected to find potential tax-saving solutions.
According to Jonathan Levy, a Montreal chartered professional accountant with the firm UHY Victor (and an expert in cross-border planning issues), “Canadians can be subject to U.S. federal estate taxes if they own U.S. situs assets upon death.” U.S. situs assets are those assets that have a U.S. location or connection, and which may include: U.S. real property net of non-recourse debt (including real estate investment properties, country places and condominiums); U.S. personal property (including boats, vehicles); stocks of U.S. corporations (including those held in RRSPs and RRIFs); and debts of U.S. companies and persons. Levy points out that excluded assets include: U.S. government bonds; U.S. bank accounts; U.S. (or Canadian) life insurance policies (but included in the world wide asset values — which is an important fact to take into consideration when reviewing one’s overall potential estate tax exposure); and Canadian mutual funds which hold U.S. investments.
This means that even if you are not a U.S. citizen or green card holder, you may still have a U.S. estate tax liability. Levy states that “Canadians who die in 2012 holding U.S. situs assets in excess of $60,000 US can be subject to U.S. federal estate taxes at a rate of up to 35 per cent.” In addition, some states will also charge probate and their own estate taxes. However, if your worldwide estate is $5.12 million or less upon death, then, currently, there would be no U.S. estate tax payable, regardless of the value of U.S. situs assets, due to the exemption. On the other hand, if death were to occur in 2012, and your worldwide estate was greater than $5.12 million, and you had U.S. situs assets in excess of $60,000, then there could be U.S. estate tax on the value of U.S. assets.
In 2013, if no further legislation is enacted, the estate tax rate will increase up to 55 per cent and the exemption amount will reduce to only $1 million US. Looking for the bomb shelter yet?
There are various ways for Canadians with U.S. situs assets to potentially reduce their exposure. These include, but are not limited to:
Purchasing U.S. real estate (and other assets, like U.S. stocks) through a Canadian corporation, trust or partnership. For example, Levy sites a typical example of a Canadian who owns substantial U.S. stocks. “These stocks could be sold and replaced with Canadian equivalents. Alternatively, the U.S. stocks could be transferred to a Canadian holding company while deferring the imbedded capital gains or losses.”
Levy also counsels clients considering big ticket real estate purchases to not own them outright but rather own them within a trust, limited partnership or corporation. However, holding U.S. real estate, especially a vacation property, in a Canadian corporation may not be a desirable ownership structure and that can be discussed with an accountant or specialist.
Having a ’non-recourse’ mortgage against your U.S. real estate. This special type of mortgage reduces the value of U.S. real estate subject to U.S. estate tax, dollar for dollar.
Gifting U.S. situs assets before death. For Canadian residents who are not U.S. citizens and not green card holders, there is generally no U.S. gift tax when intangible property such as stocks, bonds and cash are transferred to another individual (although be careful of making gifts of cash from U.S.-based financial institutions). However, U.S. gift tax does apply to Canadians that gift real estate and other tangible property located in the U.S., if the value exceeds certain thresholds. Also, a gift of an appreciated property to anyone other than a spouse is a disposition at market value for Canadian tax purposes and this could trigger a capital gain that is taxable in Canada.
Using life insurance to provide for liquidity for the estate tax liability. One of the simplest methods to provide for potential U.S. estate tax is to maintain sufficient life insurance to cover this liability. Life insurance premiums will depend on your age and health. In addition, you should consider the effect it may have on your exposure to U.S. estate tax. Ironically, for purposes of calculating the value of your worldwide estate, you must include the amount of the death benefit if you have ‘incidents of ownership’ within the policy (generally meaning you had the ability to: name or change beneficiaries, borrow against the policy, access the cash value or assign or cancel the policy). Therefore, purchasing a life insurance policy can potentially increase your exposure to U.S. estate tax.
If obtaining life insurance will increase your exposure to U.S. estate tax, consider holding the policy in a special Irrevocable Life Insurance Trust (ILIT). With an ILIT you do not own the policy outright; the trust owns the life insurance policy thereby meaning you do not have ‘incidents of ownership’. As such, the death benefit paid will not be included in your worldwide estate, thereby minimizing U.S. estate tax.
John Archer is a financial security adviser with RBC Wealth Management Financial Services in Montreal. For a full report on “U.S. Estate Tax for Canadians in 2012” visit :www.johnarcher.ca or call 514-878-5040.