Canada-US Cross-Border Will Planning August 2006 Nadja Ibrahim

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Canada-US Cross-Border Will PlanningAugust
2006Nadja Ibrahim

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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

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US Estate Tax Regime

• U.S. citizens or residents (including dual
  citizens)
• Taxed on FMV of worldwide estate at death
• If assets lt US2 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 lt US2 million ? No U.S.
  estate tax otherwise,
• If U.S. assets lt US60,000 ? no U.S. estate tax
• May be increased under the Canada-U.S. Treaty

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US Estate Tax Regime

• 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

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US Estate Tax Regime

• 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

• Year (US) Exemption (US)
• 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• 2010 N/A (repealed)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

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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

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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

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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. Browns death
• No US estate tax (unless significant US assets)
• On Mrs. Browns 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

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US Citizen SpouseWill Planning

• Canadian spouse trust
• Migration clause (possible move to US)
• Structured to keep assets out of Mrs. Browns
  estate
• No general power of appointment. Cant appoint
  assets to
• Herself
• Her creditors
• Her estate
• Her estates creditors
• Canadian spousal rollover applies

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US Citizen SpouseWill Planning

• 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).
• Cant participate in decisions to distribute to
  herself above the standard

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US Citizen DecedentWill Planning

• 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

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US Citizen DecedentWill Planning

• SOLUTION 1
• Mr. Browns 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

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US Citizen DecedentWill Planning

• 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 gtUS 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

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US BeneficiaryWill Planning

• Create special trust for US beneficiary to ensure
  assets do not form part of beneficiarys 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.

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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 companys income on the
  beneficiarys 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 beneficiarys entitlement may
  be satisfied with assets other than company
  shares.

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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.

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Charitable Deduction Planning

• Example
• Canadian resident taxpayer died in 2006 (never a
  U.S. citizen)
• No spouse
• Total worldwide assets US3,500,000
• Includes U.S. securities US400,000
• Charitable bequest in will US100,000
• 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.

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Charitable Deduction Planning
Cdn. assets donated (US) U.S. securities donated (US)
FMV of US property 400,000 400,000
(less charitable deduction) (11,400) (100,000)
Taxable estate 388,600 300,000
US estate tax payable 28,700 nil
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Inheritance Trust PlanningClient Scenario

• Sally Canadian resident, US citizen
• Sallys mother US resident and US citizen
• Mother is quite elderly and Sally expects to
  inherit significant wealth from mothers estate.
• Clients Question How should I receive the
  inheritance?

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Inheritance Trust PlanningStructure
Beneficiaries - Sally
Sallys mother (US) (only contributor)
NRT

• Trustees
• Sally and U.S. resident

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

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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

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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.