On Dec. 17, 2010, when U.S. president, Barack Obama passed a law governing tax on inherited wealth, most Canadian family business owners probably didn’t sigh with relief—but in fact many had good reason to.
“It’s remarkable how many Canadians don’t realize that if they have a child who is a U.S. citizen or resident, U.S. estate laws apply to them,” says Beth Webel, partner, tax services, PwC. “There’s a naivety and lack of understanding about the U.S. tax regime here. A U.S. citizen or a resident in the U.S. is subject to an estate tax on everything they own— their worldwide estate. In its simple form: if the person dies, the U.S. government values their estate and slaps a very high tax on it based on that.”
In a worst-case scenario, this can translate to a family-owned Canadian business being ravaged by a U.S. estate tax bill that it cannot afford to pay. “For example, if the parent owners of a family business pass away and leave shares in the business to one of their children living in the U.S., when that child dies, the value of the company is subject to U.S. estate tax,” says Webel.
Estate taxes south of the border over the years have ranged from a whopping 35 percent on the total market value to a potentially catastrophic 55 percent. “Typically, Canadian private company owners understand there’s capital gains tax at death here, so they will get life insurance to cover 25 percent of whatever the gain is,” says Webel. “But even if they realize that as a U.S. citizen or resident, they’re going to have to get insurance to cover U.S. estate taxes and even if those taxes are at a 35 percent rate, the insurance is going to be very expensive. And life insurance in the U.S. is typically taxed, so if you don’t structure your life insurance properly, you would subject that to a high tax rate as well. There are cases of family businesses with children in the U.S. who simply can’t get enough insurance. The cost of the insurance is killing them because the estate tax exposure is so significant on the assets.”
The law U.S. President Obama passed at the end of 2010 increased the estate tax exemption to $5 million from $1 million and decreased the top estate tax rate to 35 percent from 55 percent. “However, this welcome relief expires at the end of 2012,” says Webel . “This was a temporary measure negotiated between the Democrats and Republicans at the last minute. After 2012, the exemption will be $1 million and the top rate 55 percent unless new legislation is passed. While only temporary, it is helpful and it does provide an opportunity to do some planning over the next two years. But come 2013, we’re going to be back at the drawing board and if we don’t get a permanent fix, Canadian families affected by U.S. estate taxes will have to review their whole plan again.”
Webel advises Canadian families with a child who is a U.S. citizen or who resides in the U.S. ensure their tax advisor is very well informed—and up-to-date—on U.S. tax laws and that they update and revisit their estate plans regularly. “It is absolutely imperative that one, they identify U.S. family members, and two, they have frequent checks on their estate planning because the U.S. tax regimes keep changing and that might require more frequent changes to wills and plans for these families,” says Webel.
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