I want to be just like George Steinbrenner. No, I don't mean that I want to own the New York Yankees, operate a Great Lakes shipping company, or invest in Broadway theatre productions. I simply mean that I want to save more tax dollars that you can shake a stick at.
As it turns out, Mr. Steinbrenner died at precisely the right time to avoid the dreaded U.S. estate tax. The year was 2010, and that was a year – the only year – when the U.S. estate tax was repealed. Forbes estimates that his death in 2010 saved his family about $600-million (U.S.) in estate taxes. George couldn't stand losing. Even in death, he beat the taxman.
Now, just because you may be a Canadian citizen and resident, you're not immune to the reach of the Internal Revenue Service (IRS) south of the border. U.S. estate tax can apply on different types of U.S. assets, with the most notable being U.S. real estate.
The assets
Last week I talked about how to structure your real estate ownership to avoid the tax. In addition to U.S. real estate there are other assets – "U.S. situs property" – that could face a U.S. estate tax problem, including tangible personal property located in the United States (artwork, jewellery, furnishings, boats and vehicles come to mind), stocks in U.S. corporations, debt obligations (bonds, debentures, notes, receivables, written or oral promises), business assets and certain intangibles such as patents and trademarks. Even investments inside your registered plans could be caught if they are otherwise considered to be U.S. situs property.
The good news? If you're a non-resident alien (NRA) – neither a resident in the United States nor a U.S. citizen or dual citizen – then some assets will escape the estate tax: life insurance proceeds, U.S. bank deposits, some less common debt obligations and works of art on loan for exhibition in that country.
The treaty
In most cases, Canada's tax treaty with the United States will provide sufficient shelter from the U.S. estate tax. The treaty can provide NRAs resident in Canada shelter from the long arm of the IRS, in five ways:
- Unified credit: You may be entitled to the same exemption that can shelter the first $5.25-million (in 2013) of a U.S. citizen’s or resident’s estate from tax. As an NRA, however, you won’t be entitled to the full exemption amount, but can claim a pro-rated exemption equal to $5.25-million multiplied by the value of your U.S. situs property divided by the value of your worldwide estate. The bottom line is that, if your worldwide estate is under $5.25-million, you shouldn’t have to pay any U.S. estate tax. (Remember, all currency figures are U.S.)
- Marital credit: If you leave your U.S. property to your spouse at the time of death, you’ll be entitled to a marital credit which is equal in amount to the pro-rated unified credit above. You can effectively double-up your credits here.
- Foreign tax credit: If you end up paying U.S. estate tax on a particular asset on death, your estate can claim a foreign tax credit on your Canadian tax return, but only to offset the capital gains taxes, if any, on that same specific asset. If the asset hasn’t appreciated in value and therefore there is no tax in Canada on any capital gains, you’ll be out of luck if you hope to claim a credit for the U.S. estate taxes.
- Small estates relief: If your worldwide estate is worth less than $1.2-million then you won’t face U.S. estate tax on any assets, with the exception of U.S. real estate, and certain business assets located in the United States.
- Donated amounts: Donating U.S. situs property to a U.S. charity will enable you to avoid estate tax on the donated assets.
Other ideas
If the Canada-U.S. tax treaty won't quite eliminate your U.S. estate tax liability, consider renting rather than owning real estate (perhaps a sale and lease-back makes sense), placing a non-recourse mortgage on your U.S. real estate (which reduces the value subject to estate tax), acquiring a property in an adult child's name (to defer the tax), or using a Canadian corporation to hold your U.S. securities (a corporation never dies so this avoids estate tax, but it won't work with real estate).
Other options worth considering include reducing the size of your worldwide estate (by, for example, transferring non-U.S. assets to your spouse prior to death, which will increase your unified credit), keeping your expensive artwork in Canada and investing in U.S. equities through a Canadian mutual fund corporation or certain mutual fund trusts rather than directly.
Tim Cestnick is president of WaterStreet Family Offices, and author of several tax and personal finance books. tcestnick@waterstreet.ca
Tim Cestnick