A commonly overlooked issue in Canadian estate and investment plans is the potential liability for U.S. estate taxes. This tax is not applied only to U.S. residents, or U.S. citizens living in Canada, but also to Canadians who own certain types of U.S. property.
The United States imposes an estate tax on Canadians (who do not have dual U.S. citizenship) at death based upon the fair market value of all assets it considers U.S. property. The estate tax rates start at 18% of the assets' value and move quickly in increments to a top rate of 55%.
There are some credits that may reduce this tax. But they are generally not nearly as generous as those available to U.S. citizens or U.S. residents.
Even with the credits, the potential estate tax consequences are onerous. For example, if a Canadian citizen and resident has U.S. property worth $200,000 (all figures in U.S. dollars) and the fair market value of all this individual's worldwide property (in Canada, the U.S. and elsewhere) -- including homes and registered retirement savings plan -- was $1.5-million, he or she would have a U.S. estate tax liability upon death of approximately $30,000.
The U.S. government ensures collection of estate taxes by entering a lien against any U.S. property at death, prohibiting its sale, until all such tax has been paid.
An important step in estate and retirement planning for Canadians is to determine which assets held will be considered property within the U.S. For some assets the answer is obvious, due to their physical location, such as a vacation condominium in Florida or jewelry in a safety deposit box in New York.
But other assets do not require a physical presence in the U.S. For example, shares of U.S. companies are considered U.S. property, regardless of where the stock certificates are stored.
Where the complexity lies is when these U.S. stocks are held by other entities, such as various types of investment funds or brokerage accounts. Analysis by a professional knowledgeable in U.S. taxation usually is necessary to determine if holding such assets indirectly would impose a future U.S.-estate-tax liability. The following examples illustrate the complexities of these rules.
Shares or units of a mutual fund held with a U.S. brokerage house would be considered property within the U.S. But units of a Canadian mutual fund that invests in U.S. stocks would not be considered property within the U.S.
This treatment is due to an interpretation of U.S. rules regarding the classification of Canadian mutual fund organizational structures. Under such an interpretation, the fund units would be considered foreign stocks -- which are not considered U.S. property -- although these funds invest in U.S. shares. Further analysis should be given to large investments in U.S. equity funds.
Pooled investment funds or wrap accounts frequently are not properly analyzed in regard to U.S. estate tax rules. These funds and accounts are not structured in the same way as mutual funds, as the investor generally holds an interest not in the fund but in its underlying assets. Thus a pooled U.S. equity fund may be considered property within the U.S. and subject to U.S. estate taxes.
A wrap account, which tends to be sold under various names at different brokerage houses, is generally a package of services put together by a broker. The account usually is designed so that a designated manager invests the assets of the account in various types of investments according to a predetermined plan. Again, if any of the underlying assets in the account are considered U.S. property, the investment may be subject to U.S. estate tax.
The point of identifying such property is not to discourage investment in such property. Many of these U.S. funds and stocks may be profitable investments.
However, long-term investment and estate planning must take into account exposure to U.S. estate tax, so that beneficiaries and executors can plan accordingly. Also, there are planning techniques available to reduce or avoid U.S. estate taxes.
Mark Feigenbaum, CPA, is with KPMG's U.S. and cross-border tax services practice in Waterloo, Ont. He can be e-mailed at mfeigenbaum@kpmg.ca.