Canada-US Cross-Border Will Planning August 2006 Nadja Ibrahim - PowerPoint PPT Presentation

AGENDA

• 1. U.S. Estate Tax Regime
• 2. Insurance
• 3. Will Planning:
• US citizen spouse
• US citizen decedent
• US beneficiary

4. Charitable Deduction Planning

5. Inheritance Trust Planning

• U.S. citizens or residents (including dual citizens):
• Taxed on FMV of worldwide estate at death
• If assets < US$2 million  No U.S. estate tax
• Unified credit available = $780,800
• Non-resident aliens (“NRA”):
• Taxed on FMV of U.S. situs property owned at death
• If worldwide estate < US$2 million  No U.S. estate tax; otherwise,
• If U.S. assets < US$60,000  no U.S. estate tax
• May be increased under the Canada-U.S. Treaty

• Enhanced Unified Credit / Exemption
• Allows for a pro-rated amount of the unified credit available to a U.S. person, calculated as follows:
• Unified Credit ($780,800) X US assets/worldwide assets
• Unified credit is never less than $13,000 provided for under US domestic tax law

2002 $1 million

2003 $1 million

2004 $1.5 million

2005 $1.5 million

2006 $2 million

2007 $2 million

2008 $2 million

2009 $3.5 million

2010 N/A (repealed)

2011 & after $1 million

Unified Credit Highest

(US$) Estate Tax Rate

$345,800 50%

$345,800 49%

$555,800 48%

$555,800 47%

$780,800 46%

$780,800 45%

$780,800 45%

$1,455,800 45%

N/A 0%

$345,800 55%

Insurance Common Mistake

• Owning life insurance personally can have adverse US estate tax consequences.
• “Incidents of ownership”, include the following:
• right to change beneficiaries or their shares
• right to surrender the policy for cash or to cancel it
• right to borrow against the policy reserve
• right to pledge the policy as collateral
• right to assign the policy or cancel an assignment

Insurance

• Implications of having incidents of ownership:
• US citizens are subject to US estate tax on the proceeds of life insurance which they own/have incidents of ownership, or if their estate is the beneficiary of the life insurance policy.
• Value of insurance proceeds added to worldwide estate of Canadian which reduces tax credit allowed under Treaty
• US person could create trust and contribute premiums to trust
• Trust is owner of insurance policy
• Family members are the beneficiaries
• US person is not a trustee
• Trust must be structured from both estate and gift tax perspective

US Citizen Spouse Will Planning

• Mr. Brown - Canadian resident and citizen
• Significant wealth, all assets left to Mrs. Brown on death
• Mrs. Brown – Canadian resident and US citizen
• On Mr. Brown’s death:
• No US estate tax (unless significant US assets)
• On Mrs. Brown’s death:
• Will be subject to US estate tax on the value of her worldwide estate (including assets from Mr. Brown)
• Current estate tax exemption is $2 million USD.
• Watch insurance

• Canadian spouse trust
• Migration clause (possible move to US)
• Structured to keep assets out of Mrs. Brown’s estate
• No general power of appointment. Can’t appoint assets to
• Herself
• Her creditors
• Her estate
• Her estate’s creditors
• Canadian spousal rollover applies

• Mrs. Brown – Trust terms:
• Entitled to all income, including capital gains, to avoid adverse US throw-back rules
• Discretionary capital entitlement
• 5 and 5 power
• Right to demand greater of $5,000 and 5% of trust capital once a year
• Can be a trustee
• Subject to an ascertainable standard restriction (health, support, maintenance and education).
• Can’t participate in decisions to distribute to herself above the standard

• Mr. Brown
• Canadian resident, US citizen
• Significant wealth
• Assets pass to Mrs. Brown on his death
• Mrs. Brown
• Canadian resident, Canadian citizen
• On death of Mr. Brown
• No marital deduction for outright transfer to non-US citizen spouse (but marital credit under Treaty)
• US estate tax liability on worldwide assets
• May need to trigger Canadian tax to get FTC

SOLUTION 1

Mr. Brown’s Will:

• Transfer to spouse/spouse trust
• Qualifies for Canadian income tax rollover
• Qualifies for marital credit – combined with unified credit shelters approx. $3.7 million USD from estate tax
• Keep in mind amount of insurance owned by Mr. Brown – may increase estate value beyond $3.7 million USD.
• If significant US assets ensure spousal trust created to avoid US estate tax exposure for surviving spouse on the US assets

SOLUTION 2 – For Estates over $3.7 million USD

• Qualified Domestic Trust (QDOT) for US purposes
• Eligible for the marital deduction
• Estate tax deferred until death of Mrs. Brown
• Terms of QDOT:
• Spouse entitled to all income
• No one other than spouse can take capital during lifetime of spouse
• At least one trustee must be a US citizen
• If assets >$US 2 million
• Provide security (bond or letter of credit) OR
• US financial institution must be a trustee
• Evaluate benefits of deferral
• assess whether Canadian tax liability sufficient to offset US estate tax

US BeneficiaryWill Planning

• Create special trust for US beneficiary to ensure assets do not form part of beneficiary’s estate for US estate tax purposes.
• US beneficiaries are taxed on distributions from a Canadian trust. The US calculation is complicated and often involves an interest component – pay income/gains from trust annually.
• US beneficiary needs to file Form 3520 if he/she receives any distribution from the Canadian trust. Form 3520 needs to be filed even if the distribution is non-taxable.
• Penalty for failure to file Form 3520 is 35% of the value of the distribution received by the beneficiary.

US BeneficiaryWill Planning

• US anti-deferral rules:
• Rules may apply when a Trust or Estate owns shares in a Canadian company and there is a US beneficiary – usually applies if Canadian investment holding company involved.
• Rules require the beneficiary to include his/her share of the company’s income on the beneficiary’s US income tax return, regardless of whether an amount is actually received.
• Income is taxed to the beneficiary at regular tax rates.
• Evaluate whether US beneficiary’s entitlement may be satisfied with assets other than company shares.

Charitable Deduction Planning

• Planning is available for a Canadian resident who wishes to make a charitable bequest and owns US property (say, US securities), which will be subject to US estate tax on death
• US provides deduction for donation of US property to US domestic charity
• Canada-US Treaty provides for charitable deduction for bequests to Canadian registered charity
• If Canadian property is donated the deduction is prorated.
• If US property donated there is a dollar for dollar deduction
• Particularly attractive given new legislation which eliminates Canadian capital gains on donation of securities to charity.

Charitable Deduction Planning

Example:

• Canadian resident taxpayer died in 2006 (never a U.S. citizen)
• No spouse
• Total worldwide assets = US$3,500,000
• Includes U.S. securities = US$400,000
• Charitable bequest in will = US$100,000
• Taxpayer provides in will that bequests to charity should be satisfied with US securities.
• Charitable deduction planning will eliminate or reduce US estate tax payable.

Charitable Deduction Planning

Inheritance Trust PlanningClient Scenario

• Sally – Canadian resident, US citizen
• Sally’s mother – US resident and US citizen
• Mother is quite elderly and Sally expects to inherit significant wealth from mother’s estate.
• Client’s Question: How should I receive the inheritance?

Inheritance Trust PlanningStructure

Beneficiaries:

- Sally

Sally’s mother (US)

(only contributor)

NRT

Trustees:

• Sally and U.S. resident

• Sally’s mother establishes US domestic trust under will for benefit of Sally:
• Beneficiary’s interest is discretionary
• Beneficiary given limited power of appointment
• Trust assets invested

Inheritance Trust PlanningIncome Tax Opportunity

• Reduced income tax rates on investment income
• 15% on qualified dividend income
• 15% rate on long-term capital gains
• State tax
• Limits US estate tax exposure for US citizen beneficiary
• subject to Generation Skipping Tax Limit in the US
• Canadian non resident trusts rules do not apply
• 21 year rule does not apply

RRSPs and US Estate Tax

• US assets held in RRSP are subject to US estate tax
• Elimination of foreign content rule in RRSPs may see increase in US estate tax exposure
• Canada allows a foreign tax credit for US estate tax paid against Canadian taxes arising on US property on death due to the Treaty
• CRA has indicated that Treaty relief does not apply to RRSPs.
• Can apply to Competent Authority if the result is double tax – should be allowed since IRS has allowed such a credit.
• Problem likely to be resolved as a result of current Treaty negotiations.