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Strategies can limit exposure to steep U.S. estate taxes

Personal-use property and shares of U.S. companies are just two examples of financial holdings that can attract a large tax bill after a death


Date: June 11,2014

After a long, hard winter such as the last one, growing numbers of Canadians dream of owning vacation property south of the border. Or, if they prefer to use their money to warm up their portfolio returns, they may turn to more lucrative U.S. securities.

But Canadians who own a place in the sun or own stocks in U.S. companies might subject their estates to a steep tax bill when they die. Experts say that high-net-worth individuals and their families should especially learn the rules that govern U.S. estate taxes and consider a variety of strategies to limit their exposure to them.

“This can surprise people,” says Peter Bowen, vice-president of tax and research solutions for Fidelity Investments Canada, noting that the issue is particularly relevant to Canadians looking to the United States to buy real estate and seeking the optimal way to do it.

“People who are buying U.S. property should be very careful and get proper advice, because this will put them into a web of taxation at some point in the future,” he warns.

Beth Webel, a tax partner at PricewaterhouseCoopers LLP, based in Oakville, Ont., who specializes in cross-border estate and trust taxation, says that U.S. estate taxes are “a huge issue” as Canadians become increasingly mobile.

“It’s very tough to find families with any level of wealth who do not have a U.S. connection,” she says, from boomer snowbirds owning property to family members who are born, work or study there. “It’s the way we live our global lives now; people don’t just stay in Canada anymore.”

Ms. Webel says that with “a constant stream of money going south of the border in one form or another,” she is often asked about U.S. estate taxes. The kind of U.S. assets that can attract estate taxes include personal-use property, direct shares of U.S. companies, some U.S. debt instruments and U.S. pensions or IRAs held by Canadians who have worked there.

Whether estates will face an estate-tax hit is based on individual circumstances and “running the numbers,” Ms. Webel says, which especially means projecting the value of a person’s U.S. and worldwide assets at the time of death. “There’s some crystal-ball gazing involved.”

The PwC partner notes that the Canada-U.S. Tax Treaty and the 2012 American Taxpayer Relief Act (ATRA) provide some relief in the form of exemptions, credits and minimums.

For example, under the treaty, “non-resident aliens” pay no U.S. estate tax if their U.S. assets are worth less than $60,000 (U.S.) Under the ATRA, they have a U.S. estate tax liability only if their worldwide assets are currently valued at more than $5.34-million (U.S.), (the amount was set at $5-million in 2012, and is indexed to inflation.) They pay the estate tax only on their actual U.S. assets, and are eligible for a tax credit that is prorated by the value of the U.S. property as a percentage of their worldwide estate.

People who are likely to have modest estates and U.S. assets “don’t have an estate tax problem,” Ms. Weber says.

For those who do have to pay U.S. estate taxes, the rate can be “quite hefty,” Mr. Bowen says, under a graduated scale that “gets up to 40 per cent fairly quickly. And that’s 40 per cent of the market value of the assets,” not the capital gain that Canadians are more familiar with in paying estate income taxes.

Those who anticipate an estate tax liability often opt to have a U.S. property owned by a family trust or a limited partnership, so that the individual doesn’t actually “own” it, and therefore no estate tax is triggered upon death. However, trusts can be costly to set up, as well as “tricky and technical, and they require structuring and proper advice,” Mr. Bowen says, noting that they may need to be administered and have annual tax returns filed, for example.

“It’s all a matter of cost benefit,” says Ms. Webel, noting that some structures have significant complexities and compliance costs and “aren’t for the faint of heart,” although they can be worthwhile if a large estate tax exposure is anticipated.

She cautions that trusts can lead to a lack of control for the actual property owner or owners, so “people need to know what they’re getting into.” They can be complicated to unwind and assets must be distributed within the entity, for example to all family members, if the property is sold. Indeed, in her experience, people who buy real estate in the south often end up upgrading to larger properties. “You have to be very careful.”

Some high-net-worth families simply decide to claim the $60,000 treaty exemption for estate taxes on their U.S. assets and pay the tax on the rest, to avoid disclosing the details of their worldwide assets to the IRS.

Another option is for the individual who owns the U.S. assets to hold insurance that pays out upon death, which gives the heirs the money to pay the U.S. estate tax bill.

Ms. Webel does not advise people to give away property to family members before their death, because it can trigger a huge gift tax and no longer allows families to claim estate tax exemptions under the treaty.

“It’s better to let it fall into your estate,” she says, although it’s also possible to sell it to another family member, as long as it is sold at fair market value. Stocks can be sold before death or given away without incurring a gift tax, Ms. Webel says.

Mr. Bowen points out that while shares of U.S. companies such as IBM and Google are caught by the U.S. estate tax rules, Canadian mutual funds do not count as U.S. assets. That is the case even if the underlying holdings of the mutual fund are U.S. shares, he adds.

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