The Ins and Outs of U.S. Estate Tax
U.S. estate tax is foreign (pun intended) to most Canadians because Canada doesn’t have a comparable tax. This is a complex area of tax law. You can find helpful information on how U.S. estate tax affects your tax bill here, but if you think this tax might apply to your situation, you might want to get some professional advice, because many strategies are available to help alleviate your exposure.
Understanding U.S. estate tax
Here’s how the Internal Revenue Service (IRS) defines estate tax: “Estate tax is a tax on your right to transfer property at your death.” Simply put, it’s a tax payable on the value of your assets at the time of your death. Despite what you might call it, you should be aware that U.S. estate tax exists because it could affect you, even if you’re a Canadian resident and citizen.
Know the assets that can expose you to U.S. estate tax
A Canadian non-resident alien (a Canadian person living in Canada with few or maybe no U.S. ties) is subject to U.S. estate tax on the total value of his or her U.S. estate that includes the following:
Shares or bonds of U.S. corporations (even if held in Canada as part of your Registered Retirement Savings Plan)
Real estate located in the U.S.
Personal property such as cars and furniture in the U.S.
First things first
The first calculation that takes place with the U.S. estate tax is to take your U.S. assets and multiply that value (not the growth, the actual market value) by the current rate of U.S. estate tax. This is a graduated rate, but under current legislation it can be as high as 55 percent in 2013 if you have a very large estate. This can be a very costly tax, hence the need for planning!
Claim credit against U.S. estate tax
Step 2 in calculating your U.S. estate tax exposure is to see whether you qualify for a credit to help offset some of the tax. Any U.S. non-resident (Canadian or otherwise) can claim an estate tax credit of US$13,000, which effectively means no U.S. estate tax applies on the first US$60,000 of a U.S. estate. If you don’t own any U.S. assets or if their value is below this $60,000 threshold, you’re off the hook no matter what the size of your worldwide estate. However, if you still have exposure to this tax, you might find relief in the estate tax credit.
For Canadian residents, an estate tax credit is available to help offset some or all of your U.S. estate tax. However, the amount is prorated using the formula of:
If your U.S. estate was 20 percent of the value of your worldwide estate, you would be permitted a credit of 20 percent of the current U.S estate tax credit.
The U.S. estate tax rates, credits, and exemption amounts are in a state of flux at the time of writing. Announcements regarding changes to this tax are likely to be made. Under the current legislation for 2012, if someone is considered to have a small estate — that is, a worldwide estate worth less than $5 million — no U.S. estate tax would be due.
However, in 2013 the exemption is slated to reduce to only $1 million, and given that your worldwide estate will include the value of your house and life insurance policies, its reach might be farther than you think. Keep your eyes open for media announcements regarding changes that might affect you.
Filing tax returns
The U.S. estate tax can affect two tax returns. The first — and most obvious — is the U.S. estate return (which is completely separate from the U.S. income tax return). The second return that may be affected is the final personal Canadian tax return of the deceased.
Prepare a U.S. estate tax return
A U.S. estate return for non-residents of the United States is IRS form 706-NA, due nine months after the date of death. The return must be filed if the deceased’s U.S. estate was worth more than US$60,000 at the time of death. A return needs to be filed even if the U.S. estate tax liability is zero.
To take advantage of the provisions of the Canada–U.S. tax treaty you must provide the details of the deceased’s worldwide assets to the IRS in this return.
Claim a foreign tax credit on the deceased’s Canadian income tax return
Where a deceased taxpayer paid U.S. estate tax, the tax paid qualifies for a foreign tax credit on the deceased’s final Canadian income tax return. However, the credit is available only up to the extent of the Canadian taxes payable on the deceased’s U.S. source income in the year of death. This can avoid some potential double tax on those assets, but given that the U.S. estate tax rates can be very high, it might not give you full relief. Again, professional help is recommended.