Unknowing Canadians Should Avoid Being Snared in the Wide Net of the U.S. Estate and Gift Tax

For over 35 years, Hodgson Russ has been offering U.S. legal advice and services to our Canadian clients and friends. It has become obvious that, often, the wide net of the U.S. tax system, particularly the U.S. gift and estate tax, can snare unknowing Canadians who have a connection to the U.S. We have summarized below the three (3) most common scenarios that we see which implicate the U.S. estate and gift tax regimes, and the high-level considerations with respect to the same.

1. Canadian resident couple with one U.S. (or dual) citizen spouse

Commonly, we encounter married estate planning clients who are resident in Canada, but one of whom is a U.S. citizen, usually by birth.  A child born to a U.S. citizen parent will inherit such U.S. citizenship (subject to certain residency requirements).  Additionally, any child born within the United States will also obtain birthright citizenship.  Accordingly, people who don’t often consider themselves to be “American” nonetheless may have U.S. citizenship.

The U.S. tax system follows its citizens across the globe.  Accordingly, a U.S. citizen spouse, even resident in Canada, is subject to U.S. gift and estate tax on all of his or her property.  As a result, such a couple (i) must be careful in titling their assets (or changing title to assets as between them), and (ii) should consider the U.S. estate tax consequences of asset ownership and estate planning structuring (particularly if the non-citizen spouse dies first).  Commonly, this is addressed through the use of an appropriately structured spousal trust.  We regularly work with our Canadian estate planning counterparts to provide review and advice in such cases.

2. Canadian leaving property to a U.S. citizen or resident

It is also common for Canadian residents to have, as part of their estate plan, a named beneficiary who is a U.S. citizen or resident.  This often comes in the form of a child who has moved to the U.S. (and perhaps who has U.S. citizen children of his or her own).  While it is certainly possible to name U.S. persons as beneficiaries under a Canadian estate plan, there are several U.S. tax considerations that are implicated by such a gift or bequest.  These include possible application of the PFIC (Passive Foreign Investment Company) or CFC (Controlled Foreign Corporation) rules on the income tax side.  Further, if it is desired that such gift or bequest be made in trust, the planner must consider the situs of the trust, the tax residency of the trust, and the U.S. tax impacts to the U.S. beneficiary of such trust structure, including the possible application of the accumulation distribution rules.

3. Canadian purchasing U.S. real property

While many Canadians (among others) often flock to the southern United States to enjoy warmer weather, purchasing U.S. real property can give rise to U.S. estate (and gift) tax issues.  While a Canadian is not generally subject to U.S. estate tax, such tax does apply to any “U.S. situs” asset, including U.S. real property.  Because of the unavailability of (i) the unified credit against the estate tax and (ii) the unlimited marital deduction, for foreign persons, the U.S. estate tax can become an issue when a Canadian purchases valuable U.S. real property.  Prior to a purchase of such property, it is best to consider whether the benefits available under the U.S.-Canada Tax Treaty will sufficiently eliminate the estate tax, and if not, to consider alternative ownership structures for such property, including use of a trust.

These issues, and others, commonly arise, unknowingly, for Canadians working through the estate planning process. When there are U.S. issues present, we recommend that you consult with a U.S. attorney who has years of experience on cross-border tax and estate planning matters.

For further information, please contact Carol Fitzsimmons, Britta McKenna, Andrew Besch, or any member of Hodgson Russ’ Cross-Border Trusts & Estates Group.