Uncle Sam's long arm can even reach Canadian investors
Tim Cestnick The Globe and Mail Saturday, April 29, 2000

It's strange, but true. In 1992, Jeremy Edge, an Owensboro, Ky., high-school basketball player, scored seven points in one second in a January game against Hancock County. He was fouled with one second left in the game and made both free throws. With the clock still stopped, a technical foul was called against Hancock County and Mr. Edge made both shots. When the ball was inbounded, he released a three-point shot before the buzzer sounded. His team won by two points that day.

Some people do their estate planning the same way. They wait until the last possible moment to beat the taxman by taking steps to reduce a potential tax bill on death. Bad idea. Life is different than a basketball game because you don't usually know when the buzzer is going to sound.

Here's a U.S. estate tax tale of a woman who waited a little too late.

U.S. real estate tax

So you think you're immune to U.S. estate tax? Barbara, a client of mine, thought the same thing.

But as a Canadian citizen and resident, you could still be subject to U.S. estate tax if you happen to own any U.S. assets at the time of your death. And the list of assets that could be caught may be longer than you think, and includes U.S. real estate (a vacation property, rental property, private home or business property), shares of a U.S. corporation (public and private companies even if held in a Canadian brokerage account), debt obligations issued by U.S. residents (individuals or government), personal property located in the United States (cars, boats, jewellery, furnishings, club memberships and more). U.S. estate taxes are levied on the fair market value of your U.S. assets on the date of your death, and the tax rate applied is based on a graduated scale ranging from 18 to 55 per cent.

Barbara owned U.S. stocks worth $275,000 (U.S.) at the time of her death. Her total estate was valued at $1.5-million. If Barbara's total worldwide estate had been $1.2-million or less on her death, she would have avoided U.S. estate tax on her stocks.

Why? Because Article XXIX B of the Canada-U.S. tax treaty says that Canadian citizens residing outside of the United States who have estates of $1.2-million or less will only be subject to U.S. estate taxes on certain U.S. property. This property will include real estate, business assets when a permanent establishment is maintained in the United States, and certain natural resource properties. But Barbara was out of luck here. Her estate exceeded the $1.2-million benchmark.

Avoiding Uncle Sam

If Barbara had received proper advice prior to her death, she likely would have set up a Canadian holding company to hold her U.S. stocks. She could have transferred her U.S. stocks to the corporation on a tax-deferred basis under section 85 of the tax law. That's right, there would have been no tax to pay on this transfer.

On her death, Barbara's assets would have consisted of shares in a Canadian corporation, not U.S. securities. The shares of the Canadian company are not considered to be U.S. property, and would not be subject to U.S. estate tax.

Hindsight is, of course, 20/20. But it's too late for Barbara to score points against the taxman now. The buzzer has sounded. What can be done at this stage?

There are three potential credits available to Barbara to reduce her U.S. estate tax bill. The first is called a unified credit. In 2000, the credit is worth up to $220,550. This credit can be used to offset, dollar for dollar, the U.S. estate tax bill otherwise owing. In actual fact, Canadians won't generally receive the full credit of $220,550 because it's prorated based on the percentage of total assets located in the United States.

In Barbara's case, her U.S. estate taxes were calculated to be $79,300 before the unified credit. The unified credit that she was able to claim was $40,434, calculated as follows: $220,550 x $275,000/$1,500,000. Barbara's total estate tax bill was $38,866 ($79,300 minus $40,434). By the way, the unified credit will generally be worth at least $13,000 thanks to U.S. domestic law.

In addition, a marital credit of up to $220,550 (in 2000) is available if you leave your U.S. assets to your spouse on your death.

Finally, a foreign tax credit can often be claimed. That is, the U.S. estate taxes paid can be used to reduce your Canadian tax bill in the year of death to the extent you have to report taxable capital gains on death on that same property in Canada.

Tim Cestnick can be reached by e-mail at tim@waterstreet.ca or on the web at The WaterStreet Group

 

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