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September 17, 2007

Cross-Border Estate Planning Issues Presented by: Greg Simpson, CA, CPA, TEP Steve Peters, CA, CPA, TEP. September 17, 2007 . Cross-Border Estate Planning. Overview of US gift and estate tax Legislative uncertainty Treaty relief Impact on Canadians (non-US citizens)

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September 17, 2007

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  1. Cross-Border Estate Planning Issues Presented by: Greg Simpson, CA, CPA, TEP Steve Peters, CA, CPA, TEP September 17, 2007

  2. Cross-Border Estate Planning • Overview of US gift and estate tax • Legislative uncertainty • Treaty relief • Impact on Canadians (non-US citizens) • Focus on identifying issues, avoiding traps

  3. Overview • US estate tax, gift tax and generation-skipping transfer (“GST”) tax form a unified transfer tax system • Estate tax is imposed on property transferred at death • Gift tax is imposed on property transferred during one’s life • GST tax is designed to ensure that property does not skip a generation without a transfer tax being assessed • Executor is personally liable for unpaid estate and GST tax

  4. Overview • US citizens and residents: • subject to gift, estate and GSTT on worldwide assets • Non-resident aliens • subject to estate tax on assets situated in the US (“US situs property”) and subject to gift tax on tangible assets located in the US • Resident = domiciliary • Tax rates begin at 18 percent and increase rapidly to 45 percent

  5. $ Estate _ Deductions % Progressive Tax Rate _ Unified Credit X = Estate Tax Payable US Estate Tax—Calculation • Estate tax is levied on the fair market value of assets transferred on death

  6. Repeal of US Estate Tax ? • In 2010, the estate tax will be completely repealed • No repeal of the gift tax is planned • In 2011, the repeal sunsets. That is, unless there is new legislation in the intervening period, the law will revert back to legislation in effect for 2001 • Democratic Congress

  7. Estate and Gift Tax

  8. Estate and Gift Tax Rates

  9. Decision Tree US citizen or US resident ? Value of worldwide estate > estate tax exemption? YES NO N O E S T A T E T A X YES NO Subject to estate tax on worldwide estate Hold US situs assets ? NO YES Value of worldwide estate >estate tax exemption? Subject to estate tax on US situs assets NO YES

  10. Is Your Client a US Resident (Domiciliary)? • The Residency Test—is your client a US resident (domiciliary) for US estate tax purposes? • A resident is an individual who has his domicile in the US at the time of death. A subjective test—quite different from the (objective) substantial presence test to determine residency for US income tax purposes • Green card holders (lawful permanent residents) are often presumed to be domiciled in the US

  11. Gross EstateUS Citizens and Domiciliaries • The gross estate includes the value of all property in which the decedent had an interest at the time of death • Life insurance proceeds will also form part of the decedent’s gross estate if the estate is a beneficiary of the insurance proceeds or the decedent had possessed certain economic ownership rights or “incidents of ownership” in the policy

  12. Gross EstateNon-Residents of the US • The taxable estate will include property situated within the US • Real property located in the US • Certain tangible property located in the US • Shares of US corporations • Debts of US persons including the US government (not including portfolio debt) • Interests in partnerships carrying on business in the US • US pension plans and annuities including IRA and 401(k) plans • Look through rules for certain foreign trusts • RRSPs

  13. Gross EstateNon-Residents of the US • The following assets will not be included in the taxable estate: • Shares of non-US corporations • US bank deposits • Portfolio debt obligations • Life insurance proceeds

  14. Allowable Deductions • US citizens and domiciliaries: • Funeral expenses • Estate administration expenses • Debts of the decedent • Mortgages and liens • The marital deduction • Charitable donations • Non residents of the US: • Deduction is prorated by the ratio of the value of US situs assets to the value of the worldwide estate

  15. US Estate Tax Credits • Non-resident aliens are allowed a standard credit (under US domestic law) of US$13,000 against estate tax otherwise payable, which exempts US situs estates of US$60,000 or less • If US taxable estate is less than $60,000, it is not necessary to file Form 706NR with the Internal Revenue Service

  16. US Estate Tax for Canadians • Canada – US Treaty provisions for Canadians. • US Relief • Enhanced Unified Credit • Special Marital Credit • Small Estates Exemption • Canadian Relief • Credit for US estate tax • No Relief For • US Gift Tax • GSTT

  17. Treaty Relief – Unified Credit • Article XXIX-B(2) • Applicable to Canadian residents who are not US citizens • Pro rata share of unified credit available to US citizens, based on: (US assets) / (Total assets) • Effect: if total assets do not exceed estate tax exemption ($2,000,000 for 2007), no US estate tax

  18. Treaty Relief – Marital Credit • Article XXIX-B(3) • For property passing to spouse or spousal trust • In addition to, and limited by, unified credit otherwise available: Maximum marital credit = Unified credit X 2 • Effect on death in 2007, if all property passes to surviving spouse or qualifying spousal trust: • Eliminate US estate tax if assets of decedent don’t exceed approximately $3.7M.

  19. Treaty Relief – Foreign Tax Credit • Article XXIX-B(6) • Applies to Canadian individuals and subs. 70(6) spousal trusts • Credit against Cdn death tax for US estate tax on US-situs property • No relief if no appreciation in value • Does not apply to alter ego or joint partner trusts (Treaty rules predated Cdn legislation) • Does it apply to US property held in RRSP?

  20. $10,000,000 Non-US assets $ 2,000,000 US stock portfolio $ 2,000,000 US residence $ 500,000 Mortgage on US residence $ 50,000 Funeral expenses All amounts are in US dollars US Estate Tax Example—Facts

  21. US Person Gross estate = $14,000,000 Deductions (expenses) Mortgage $ 500,000 Funeral $ 50,000 100% $ 550,000 Taxable estate = $13,450,000 $13,450,000 x Tax Rate = Base Tax $ 6,276,800 Unified credit $ 780,800 Tax payable $ 5,496,000 US Estate Tax Example

  22. US Estate Tax Example Canadian Person Gross estate (US situs assets) = $4,000,000 Deductions (expenses) Mortgage $ 500,000 Funeral $ 50,000 $ 550,000 $ 4,000,000 US Situs = 30% $13,450,000 Worldwide $ 165,000 Taxable estate = $3,835,000 $3,836,430 x Tax Rate % Base Tax = 1,661,600 Unified credit (30%) 234,240 Tax payable $1,427,360

  23. Canadian Ownership of US Real Property • Individual Ownership • Low individual income tax rates • Maximum 15 percent (long-term) federal capital gains rates • No individual income tax in the State of Florida • High US estate tax • Foreign Corporate Ownership • Canadian shareholder benefit problems • US corporate income tax rates • 34 percent federal plus state income tax • No US estate tax

  24. Canadian Couple Where One is US Citizen • If US citizen dies first: limited marital deduction • Consider Qualified Domestic Trust • If non-US citizen dies first: minimize assets included in estate of US citizen • Consider testamentary spousal trust which does not create “power of appointment” for US purposes

  25. Power of Appointment • For US estate tax purposes, assets of a trust are included in estate of a person who has certain powers, including: • power to invade principal • power to determine to whom assets pass • Does not apply if power is limited by “ascertainable standard” • support in accustomed manner of living • maintenance in health and reasonable comfort • Canadian Spousal testamentary trust must meet this standard to avoid estate tax inclusion

  26. Power of Appointment - Scenario • X establishes trust. Y is an income beneficiary with power to determine in her will to whom assets shall pass. Y exercises this power. • Trust owns US assets at time Y dies. • Inclusion in Y’s estate for US estate tax purposes: • If Y is US citizen or resident: all assets of trust • If Y is not US citizen: US assets of trust • Double tax: • Because Y is not subject to Canadian death tax on these assets, no foreign tax credit for US estate tax.

  27. Children in US • Important to ensure basis step-up on death • Otherwise, double taxation will arise • For spousal or joint partner trust, basis step-up not automatic but can be accomplished with planning (via power of appointment) • Special issues re: investment holding company • Repeal of US Foreign Personal Holding Company rules removes some obstacles • Many complexities remain • Consider NSULC

  28. Inheritance from US Revocable Trust • US residents typically hold investments in a revocable trust • Purpose: to avoid probate • Trust also serves as estate planning vehicle (will substitute) • For US tax purposes: On death, assets are included in gross estate (because of power of appointment) • Therefore, receive basis step-up

  29. Inheritance from US (cont’d) • If beneficiary is Canadian resident: • No basis step-up under ITA • Double tax if receive trust assets and sell • Consider: • Trust sells assets shortly after death • Trust distributes cash in following year (as capital) • Beneficiary taxable on trust’s income as became payable to the beneficiary in year (ITA 104(13)(a)) • Did beneficiary have right to enforce payment in year trust sells assets (ITA 104(24))?

  30. Alter Ego & Joint Partner Trusts • If trust is revocable, US assets will be included in estate of decedent • power of appointment • No foreign tax credit on T3 return for US estate tax • Moral: don’t hold US-situs assets in these trusts!

  31. US Gift Tax Citizens and Domiciliaries • Imposed on all transfers of property made during lifetime • Based on fair market value of assets transferred • Exemption of $12,000 per year per donee (indexed to inflation and rounded down to the nearest $1,000) • Lifetime gift tax exemption is $1,000,000 (not indexed) • To the extent that the lifetime gift tax exemption is used, there will be a corresponding reduction in the unified credit • Marital exemption • Unlimited gifts to a US citizen spouse • Exemption of $125,000 per year to non-US citizen spouse (indexed to inflation)

  32. Is Your Client a US Citizen? • US citizenship must be formally renounced to be terminated • Renunciation requires filing prior year tax returns • Freeze / Corporate Reorganizations

  33. Greg Simpson, CA, CPA, TEPPartner - Tax Steven Peters, CA, CPA, TEPDirector, International Tax KPMG LLP 1959 Upper Water Street, Suite 1500 Halifax, NS B3J 3N2

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