Implications of U.S. Estate Tax on Canadian Estates

When Canadian residents die, they are generally deemed to dispose of their capital property for income tax purposes under subsection 70(5) of the Income Tax Act (Canada), with some exceptions. These deemed proceeds of disposition are equal to the fair market value of such property, unless the property is transferred to a spouse or a spousal trust as a consequence of death.

As a result, in the year of death, a Canadian who owns U.S. real property may have a deemed capital gain with respect to such property for Canadian tax purposes. However, they might also have a significant U.S. estate tax liability, taxable foreign exchange gains, and a capital gain on the disposition of such property. All of which can likely be mitigated with advance planning.

When a U.S. citizen dies, U.S. estate tax applies to the fair market value of the worldwide property owned at the date of death. Similarly, a non-U.S. citizen who is domiciled in the U.S. is also taxed on the value of their worldwide estate at death. The concept of domicile used for estate tax purposes is somewhat different from the concept of residence used for U.S. (and Canadian) income tax purposes.

Notably, a U.S. green card holder and an individual living in the U.S. are generally considered U.S. residents for income tax purposes, though they may not be a U.S. domiciliary for estate tax purposes if they have stronger ties to a country other than the U.S. (such as Canada) and had an intention to return to that other country at the time of their death. Generally, a person is considered to be domiciled in the U.S. for estate tax purposes if they live in the U.S. and had no present intention of leaving.

Therefore, it is possible to be a U.S. resident for income tax purposes, but not a U.S. domiciliary for estate tax purposes. The ultimate determination of one’s country of domicile and tax residency is fact specific and should be assessed with qualified professionals.

U.S. estate tax still can apply to Canadian tax residents (being non-U.S. domiciliaries) when they die owning certain U.S. property, including stock in U.S. companies. In calculating an individual’s taxable estate, deductions for debts and certain expenses are permitted. For Canadian residents, the deductions that would otherwise be permitted are prorated based on the value of their U.S. assets (before deductions) as a proportion of their total worldwide assets.

Notably, an exemption of $60,000 is available against the value of assets includable in the U.S. taxable estate of an individual who was not U.S. domiciled.

A “unified credit” is available which effectively exempts a portion of one’s estate from U.S. estate taxes based on an exemption amount. Historically, the exemption amount has been approximately $5m USD; however, the Tax Cuts and Jobs Act increased the exemption to $10m USD in 2017 and it is indexed to inflation annually. As such, the 2024 exemption amount is $13,610,000, making the unified credit for Canadians approximately $5,389,800 (being the equivalent of the U.S. estate tax liability on $13,610,000 of assets).

The increases are otherwise due to expire on December 31, 2025, and will revert to $5m USD, adjusted for inflation, unless further action is taken.

The value of the taxable U.S. estate is taxed at a graduated rate, starting at 18% on the first $10,000, up to 40% on all amounts exceeding $1,000,000 beyond the exemption amount.

Non-U.S. domiciliaries are taxed on the fair market value of their U.S. situs property, which includes, for example:

• real property and tangible personal property situated in the U.S. at death;
• U.S. securities (including those held in a brokerage account in Canada);
• certain U.S. debt obligations;
• certain U.S. mutual funds, including money market funds;
• interests in certain trusts, to the extent that such assets are situated in the U.S.;
• any business-related assets owned by a sole proprietor and used in a U.S. business activity that are included in the sole proprietor’s estate (this may include land, machinery and equipment, patents, accounts receivable, and goodwill).

Since Canadians are generally not eligible for the same estate tax exemption as Americans, the Canada–U.S. tax treaty (the “Treaty”) provides Canadians some relief from U.S. estate tax by providing a basic unified credit exemption similar to that available to U.S. citizens and residents.

The Treaty allows Canadian residents to benefit from a similar exemption amount that U.S. residents can claim. However, the exemption is prorated based on the ratio of the value of U.S. situs assets compared with the value of their entire worldwide estate. If a Canadian resident’s worldwide estate exceeds $13,610,000 USD consisting of some U.S. situs assets, even if the overwhelming majority is Canadian or other worldwide assets, tax may likely still be payable.

FOR EXAMPLE:

(For Illustrative Purposes Only - Actual Numbers Will Vary)

If a Canadian resident (who is not a U.S. domiciliary) dies in 2024 with taxable U.S. property worth $1,500,000 (USD) (considering the $60k exemption), and has non-U.S. situs assets worth approximately $15,000,000 (USD), for a total estate of approximately $16,500,000 (USD), net U.S. estate tax may be calculated as follows:

In order to claim the benefits under the Treaty, even if no estate tax is due, the executor of the Canadian estate must complete proper U.S. tax compliance and file the correct forms within 9 months after the date of death unless an extension of time to file was granted (an executor can generally apply for an automatic 6-month extension of time to file the return). For non-U.S. estates, where U.S. situs property does not exceed $60,000, a U.S. estate tax return generally may not be required; however, this should be confirmed by qualified professionals in each instance.

The two other notable relief provisions in the Treaty are the marital credit and foreign tax credit treaty relief provisions:

• The marital credit relief provision is a non-refundable marital credit exemption in connection with transfers to a surviving Canadian spouse. An unlimited marital exemption is generally available for transfers to a U.S. spouse.
• The foreign tax credit relief provision provides further relief as U.S. estate taxes payable on death may be eligible as a credit against Canadian income tax in the year of death on U.S. source income.

Planning considerations should generally begin where an individual has more than $60,000 USD in U.S. situs assets, whether or not the estate appears likely to exceed $5m USD (plus inflation), let alone current exemption amounts, as compliance requirements begin at this threshold.

When considering cross-border estate planning, the following are key considerations/touchpoints for discussion between taxpayers and their professionals in Canada and the United States:

- Residency of testator, executor, trustees, and beneficiaries;

- Location of assets;

- Current value AND anticipated value (employing the use of a financial plan where possible);

- Medium- and long-term plans for clients (anticipated purchase or sale, intended changes of residency, etc.);

- How U.S. situs property is held (often corporate ownership and personal ownership are not properly differentiated);

- Potential for property to be held by another entity or use of alternate planning tools (such as use of trusts, inter vivos gifting, use of insurance to offset tax, use of Canadian corporations, reducing the value of the Canadian estate through Canadian tax planning, or other planning methods)

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