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Estates & Trusts

US Estate Tax Charitable Deduction

Originally published in Canadian Tax Highlights, Volume 15, Number 11, November 2007. Reprinted with permission.

Whether the goal is to provide for philanthropic organizations, to reduce estate taxes, or both, charitable bequests can play an important role in an estate plan. Special considerations apply in the cross-border context to ensure that a charitable bequest accomplishes its goals. The long-awaited fifth protocol to the Canada-US tax treaty, signed on September 21, 2007, contains several significant changes for US and Canadian individuals and businesses; one less publicized change replaces the estate tax charitable deduction in article XXIX B(1) with a completely new provision.

The United States imposes an estate tax on the transfer of the taxable estate of every deceased US citizen or resident; a deduction is available for the full amount of a bequest to or for the use of any charitable organization. The Code allows the deduction regardless of whether the charitable organization is located in the United States: the Code thus entitles a US-citizen Canadian resident to a full estate tax charitable deduction for US estate tax purposes, whether the property is left to a US or a non-US charitable organization. Neither the current treaty nor the 2007 proposed protocol affects this entitlement.

A decedent who is neither a US citizen nor a US resident (an NRA) is subject to US estate tax on the transfer of assets with US situs at the time of death. (US-situs assets for these purposes include real property and tangible personal property located in the United States, US stocks, and debts of US persons or companies.) Under the Code, if an NRA leaves US-situs property to a US charitable organization, the estate receives an estate tax charitable deduction for the full amount of the bequest, an outcome not affected by the treaty or by the 2007 protocol. However, if an NRA's estate leaves the property to a non-US charity, there is no estate tax deduction under the Code or regulations, although there is currently a deduction under the treaty. The 1995 treaty protocol added article XXIX B(1), which provides that when property is bequeathed by a resident of one state to an exempt organization, it is treated for tax purposes in a state as a resident thereof. Thus, if a Canadian citizen and resident leaves property to a Canadian charity, the treaty (not the Code) allows a US estate tax charitable deduction if the donor directs that the bequest be satisfied from property subject to estate tax. If the donor does not so specify, the estate tax deduction for the US assets that pass to the charitable organization is limited to the proportion that the estate's US assets bear to total assets.

The 2007 protocol proposes to eliminate that benefit. Article 26(1.1) replaces the 1995 protocol's article XXIX B(1). The new rule merely provides that if a Canadian-resident individual bequeaths property to a US-resident organization, the Canadian tax consequences apply as if the individual received proceeds equal to an elected amount between cost and FMV. On its face, the new rule eliminates the charitable deduction provided by its predecessor and precludes the estate of a Canadian citizen and resident from obtaining a US estate tax charitable deduction when US-situs property is given to a Canadian charity. (If a US resident leaves property to a Canadian-resident organization, it is deemed to be a US resident for US tax purposes.) Thus, the benefit granted by the 1995 protocol is eliminated. A literal reading of the new rule also appears to limit the benefit for a US citizen or resident who leaves Canadian real property to a US charity: the individual does not receive any reduction in Canadian tax at death, a change that would negatively affect many US taxpayers who own vacation property in Canada.

Kevin K. Gluc
Hodgson Russ LLP, Buffalo