Tax Insights: Estate tax update – US estate tax exposure for US citizens living in Canada (2018 edition)

Issue 2018-04

In brief

If you are a US citizen living in Canada, you may be subject to both the Canadian and US tax regimes at your death.

US tax reform: On December 22, 2017, President Donald Trump signed into law the Tax Cuts and Jobs Act (TCJA). The changes include the doubling of the federal estate and gift tax exemption amounts from $5.6 million to $11.2 million for 2018 (to be indexed annually). The increase is effective for 2018 through 2025. The exemptions will revert to the pre-2018 regime in 2026 unless permanent legislation is passed.  

All dollar amounts in this Tax Insights are in US currency unless otherwise noted. 

In detail

As a Canadian resident, you are subject to Canadian income tax at death. As a US citizen, you are subject to US estate tax on the fair market value of your worldwide estate at the time of your death. Your worldwide estate includes all property owned at death – regardless of where the property is located – even: 

• life insurance proceeds, if you own the policy or if the proceeds are payable to your estate
• registered plans (e.g. registered pension plans, registered retirement savings plans and registered retirement income funds)
• certain trust interests
• stock options

Are you a US citizen?

US citizenship status is not always clear. For example, while an individual will be granted US citizenship by virtue of being born in the United States, an individual may also be a US citizen if he or she is born outside of the  United States to a parent who is a US citizen. 

If you are unsure about your status, please consult the PwC Law LLP Immigration Team. 

US estate tax rates and lifetime exemption

The US estate tax rate starts at 18% and climbs to 40% when the value of your estate reaches $1 million. As a US citizen, you are entitled to a lifetime estate tax exemption.

The estate tax exemption for 2018 is $11.2 million.¹ The recently enacted Tax Cuts and Jobs Act doubled the exemption amount from $5.6 million to $11.2 million. The increase in the exemption amount is temporary and will revert back to its original $5 million amount (indexed annually) unless permanent legislation is enacted.

This means that, as long as no portion of the exemption was used to shelter lifetime gifts, no estate tax is payable if the value of your worldwide estate does not exceed $11.2 million (indexed annually). 

Foreign tax credits

On death, for Canadian income tax purposes, you will be deemed to dispose of your capital assets for an amount equal to their fair market value on the date of death. As a result, you may pay capital gains tax in Canada.

In addition, you will be subject to US estate tax on the fair market value of those assets.

The Canada-US Tax Treaty (the Treaty) provides some relief against double taxation in the form of foreign tax credits. Under the Treaty, Canada allows a federal credit for US estate tax payable on your property that is located in the United States. The United States allows a credit for Canadian taxes payable at death on the deemed disposition of your property that is located outside of the United States, as illustrated by the following example:

Evan is an unmarried US citizen living in Canada. At the time of his death, Evan owned a Canadian stock portfolio with a fair market value of CA$100,000, which he purchased for CA$25,000. 

Evan’s estate will be subject to Canadian capital gains tax on the accrued gain of CA$75,000, and also to US estate tax on the CA$100,000 stock portfolio. 

The Treaty allows Evan to reduce his US estate tax liability by the amount of the Canadian capital gains tax paid on the CA$75,000 accrued gain. 

In the end, your estate generally pays the higher of the two taxes. Because Canadian capital gains tax rates are lower than US estate tax rates, your estate will likely pay tax at the US estate tax rate. There is an element of double taxation because the foreign tax credit is provided only at the federal level.

Marital deduction and marital credit

As a Canadian resident, you can transfer your assets to your Canadian-resident spouse on a rollover basis at the time of your death. This allows you to defer the payment of Canadian income tax until the death of your spouse. 

For US estate tax purposes, estate tax is deferred only if your assets pass to a US-citizen spouse (referred to as the marital deduction). If your spouse is not a US citizen, the marital deduction is not available unless the bequest is made to a special form of trust known as a Qualified Domestic Trust (QDOT). 

Alternatively, the Treaty provides a marital credit against estate tax if certain conditions are met, allowing a US citizen to effectively double the amount that can pass to a Canadian spouse free of US estate tax. For example, if Evan dies in 2018, leaving a non-US-citizen spouse, he could bequest about $22.4 million of assets to his spouse before his estate would be subject to US estate tax (i.e. double the $11.2 million lifetime exemption, discussed above). 

Unused lifetime exemption 

Any portion of the deceased’s $11.2 million lifetime exemption (indexed annually) that he or she did not use may be used by the surviving spouse’s estate. To take advantage of this exemption “portability”: 

• the surviving spouse must also be a US citizen or resident, and
• the executor for the estate of the first spouse to die must file an election to transfer the unused exemption to the surviving spouse

The election must be filed on time even if the estate is not required to file an estate tax return. 

Filing an estate tax return

In general, even if no estate tax is due, a US estate tax return must be filed:

• if the value of your worldwide estate exceeds the exemption amount for the year, or 
• to elect the transfer of any unused portion of the exemption to the surviving spouse

The filing deadline for the return is generally nine months after the date of death.

US gift tax

You cannot avoid US estate tax by giving away your assets during your lifetime, because the US imposes a gift tax on lifetime transfers. The gift tax is unified with estate tax, so that the gift tax is imposed at the same rate as the estate tax and provides the same $11.2 million exemption (indexed annually). 

However, as discussed, if you use the exemption for gift tax, your estate tax exemption will decrease by a corresponding amount. Gift tax applies to gifts of all types of property, regardless of where the property is located.

Gifts to your US-citizen spouse are not subject to gift tax. However, if your spouse is not a US citizen you will be subject to gift tax if your annual gift to your spouse in 2018 is more than $152,000 (indexed annually).

In addition, you are entitled to an annual exclusion of $15,000 (indexed annually) for gifts made to anyone other than your spouse. For example, if you have four children, you can give up to $60,000 to your children in 2018 and not be subject to US gift tax. 

You will not be required to file a gift tax return and the $60,000 gift will not reduce your lifetime gift and estate tax exemption amount. 

If you and your spouse are both US citizens, you can double your annual gift limit by agreeing to split your gifts. However, in this case you and your spouse will be required to file a US gift tax return. These rules are illustrated in the table below.
 

^{1.  Using your annual exclusion does not affect your lifetime gift and estate tax exemption. The annual exclusions are indexed annually.}

US generation-skipping transfer (GST) tax

The generation-skipping transfer (GST) tax applies for certain transfers to a “skip person” (i.e. an individual who is in a generation more than one generation younger than the transferor –such as a grandchild). The GST tax rate is 40% and a $11.2 million exemption (indexed annually) is provided. 

The GST tax is applied to “skip transfers” in addition to any applicable gift tax. This effectively prevents individuals from transferring property to a skip person to avoid a generation of estate tax. 

The GST tax also may apply if assets are left to a family trust that includes a skip person. For example, it is common in Canada to leave assets in trust for children and grandchildren. In this case, the deceased may have to allocate his or her $11.2 million GST tax exemption to the trust to prevent the application of GST tax, because the assets could pass to a grandchild at some future date. 

^{[1]  The American Taxpayer Relief Act of 2012 establishes an exemption amount of $5 million and indexes this amount for inflation annually. The Internal Revenue Service (IRS) announced that the indexed exemption amount is $5.6 million for 2018. The Tax Cuts and Jobs Act has doubled the original exemption amount from $5 million to $10 million, indexed to $11.2 million for 2018.}