Introduction: recent trends... CROSS BORDER ESTATE PLANNING. Advocis Breakfast Meeting. Are you American? Is your child? Who should consider U.S. tax?

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1 Introduction: recent trends.... CROSS BORDER ESTATE PLANNING Advocis Breakfast Meeting Will Todd Taxation / Wills, Estates & Trusts Practice Group April 4, Why pay attention now. More Canadian families are headed toward entanglement with U.S. taxation: Growing pressure in the U.S. to increase revenue Unintended consequence of efforts to stop money-laundering and offshore tax fraud Canadians are investing more in U.S. assets Integration of the North American economy Unprecedented disclosure and information sharing More Canadians are U.S. citizens than realize it Who should consider U.S. tax? U.S. Persons (citizens, residents and green card holders) Income annually and wealth at death subject to U.S. tax Spouses and Parents of U.S. Persons Planning may offer opportunities to pay less tax Owners of U.S. situs property Even non-u.s. Persons are subject to U.S. tax Are you American? Is your child? Generally, only two ways to become a U.S. citizen: Naturalized as a U.S. citizen Born in the U.S. or to a U.S. parent who resided in U.S. Only one U.S. parent required Parental residency requirement prior to birth varies with date of birth Citizenship goes back to birth 1

2 Residence - Individuals U.S. statutory calculation: trigger is about 120 days/year Closer connection exception file IRS form 8840 Cannot be a tax resident in both countries Tie-breaker rules under Canada-U.S. Tax Treaty based on centre of vital interests Zombie Green Cards Immigration benefits of green cards expire 10 years after issuance Annual tax filing obligations continue until the card is terminated Termination of a green card more than 7 tax years after issuance can result in Expatriation Tax Income and Asset Tax Reporting U.S. Persons are required to report to the U.S. their: Worldwide income, irrespective of residence Special reporting and taxation on interests in: Trusts that are not U.S. domestic trusts Non-U.S. private companies Canadian mutual funds Report value of financial accounts and assets outside U.S. valued over US$50,000 (US$200,000, if resident outside U.S.) Foreign Bank Account Reporting U.S. persons required to report bank and investment account balances outside U.S. if the total exceeds US$10,000 at any time in that year Due June 30 (no extensions ever) No tax due on filing - significant penalty exposure for late filing 2

3 U.S. Expatriation Tax U.S. citizens renouncing citizenship and persons surrendering Green Cards after more than 7 tax years Subject to expatriation tax if: Net worth exceeds US$2 million; or Annual income tax averages more than US$155,000 over past five years Generally, a deemed disposition of assets resulting in accrued gains over US$668,000 (in 2013) to be taxable Tax on receipt of gifts and bequests to U.S. persons Cross Border Estate Planning U.S. Transfer Taxes Estate Tax for U.S. Couples Estate Tax for Cross-Border Families U.S. Estate Tax for Canadians Gift Tax and Gift Tax Planning U.S. Transfer Taxes Canadian Perspective Generally, Canada s transfer taxation is unitary same tax treatment if you: Sell Gift Die Emigrate Each triggers recognition of capital gains U.S. Transfer Taxes are Not Unitary U.S. taxes each event differently: Sale of property triggers capital gains tax Gift tax on value of gift; estate tax collected early Estate tax on value of estate assets, not appreciation U.S. expatriation tax 3

4 U.S. Capital Gains Tax Entire gain subject to tax at 10-20% federally, plus state tax, if applicable Principal residence exemption only for first US$250,000 of appreciation Tax basis increased to fair market value of property subject to estate tax U.S. Estate Tax U.S. citizens and U.S. permanent residents Very inclusive view of estate Large exemption ($5.25 million, indexed)* High tax rate above exemption amount (40% on value)* * the chaos of expiring tax provisions was eliminated by January 2, 2013 amendment. Broad Base for Tax Value of estate on date of death Gross estate very inclusive: Land and immovables Tangibles and intangibles Business interests Life insurance proceeds RRSPs Most jointly-owned property Trust assets depend on terms of trust Traditional U.S. Estate Planning Preserving the exemption of the first spouse to die Reduce estate with gifting Lower value of estate with valuation strategies 4

5 Credit Trust to Preserve Exemption Credit trust uses exemption of first spouse to die to preserve it until second death: Allows surviving spouse to use trust assets, if needed Does not expose the growth of the assets of the Credit Trust to estate tax on second death But does not work on assets in joint title Cross-Border Marriage but I married a Canadian U.S. spouse can use a Qualified Domestic Trust (QDOT) to defer estate tax until death of Non-U.S. spouse or marital credit under Treaty for gifts to Canadian spouse or spousal trust, but not both QDOT vs. Marital Credit QDOT guarantees no tax on prior death of U.S. spouse, but: Requires on-going compliance with U.S. trust rules Any assets remaining in QDOT subject to tax on second death Marital Credit Almost doubles exemption amount on gifts to spouse or properly constructed spousal trust Future exposure to U.S. estate tax only on U.S. property if non-u.s. spouse does not move to U.S. POP QUIZ: Expanding U.S. Estate Tax Exposure Innocent victim: Non-U.S. citizen resident in Canada Does not own any U.S. situs property Entire estate (eventually) could be subject to U.S. estate tax Who am I? 5

6 Cross-Border Marriage so I married an American Trust by Non-U.S. spouse avoids surviving U.S. spouse having combined estate Must address U.S. trust reporting Trustee powers of surviving U.S. spouse technically restricted Not possible for joint assets U.S. Persons with Interests in Foreign Trusts Failure of beneficiary to file annual information return subject to $10,000 penalty Distributions from current year taxed on same basis as if earned directly Distributions from the trust of income or gain earned by the trust in prior years are taxed as if they were ordinary income received in the year earned, plus interest at the IRS rate for late paid tax Trust Distribution of Long-term Capital Gain A Canadian trust sells a property it acquired 3 years prior for a gain of US$300,000 and distributes to beneficiary who is a US taxpayer: gain is allocated $100,000 to each of the 3 years: $100,000 is taxed as ordinary income (up to 40%) and subject to interest for two years $100,000 is also taxed as ordinary income (up to 40%) and subject to interest for one year $100,000 is taxed as capital gain (10-20%) for the current year Often these calculations result in an amount of tax plus interest exceeding the amount distributed, in which event the amount of tax plus interest is reduced to the distributed amount U.S. Law: Spouses and Joint Title Full exemption for transfers to U.S. citizen spouse No same-sex marriage recognized for federal estate tax (DOMA policy may result in change) Joint title to property is if both are U.S. citizens, but if not rule is 100% owned by first to die (unless you can prove survivor provided funds from separate assets) 6

7 Estate Tax on Non-U.S. Persons U.S. Estate Tax and Gift Tax are due on U.S. situs assets: U.S. land Tangible property located in the U.S. Stock of U.S. corporations and institutions But not if held through certain non-u.s. entities Same tax rate, different exemptions Credit for estate tax paid can reduce Canadian federal tax on deemed disposition on death Exemptions for Canadians $60,000 exemption for all Non-U.S. Persons Canada-U.S. Tax Treaty allows Canadians the portion of the U.S. Person exemption that their U.S. assets bear to their worldwide assets Exemption almost doubled if transfer is to surviving spouse and no deferral spousal trust Exemption under Canada-U.S. Tax Convention Cdn Exemption = US Exemption x Value of U.S. Property Value of Entire Estate Estate very inclusively calculated Valuation of all non-u.s. assets can be burdensome and expensive Using a Testamentary Trust to Avoid Double Tax Property that is not in joint title can be transferred to a specially structured trust in the Will of the owner to prevent survivor s estate paying additional estate tax Should be considered for both surviving spouse and future beneficiaries 7

8 Gift Tax for U.S. Citizens and U.S. Property All inter vivos transfers by U.S. persons (or of U.S. situs property) at 40%, unless exemption: Unlimited exclusion of gifts to U.S. legal spouse $5,250,000 cumulative lifetime exemption for U.S. citizens Reduces estate tax exemption as used $143,000 annual exclusion for non-u.s. legal spouse $14,000 annual exclusion; per donee per year Tuition and healthcare directly to provider Charitable gifts to U.S. charities Gift Planning Strategies Cross-border couples can use US$143,000 annual exclusion to gift principal residence to Canadian spouse U.S. citizens can gift up to US$14,000 to each family member annually minority interests in family businesses can augment gifting by discounting to fair market value U.S. Real Property Structures Assumptions: Non-U.S. citizens purchasing Not intending to become U.S. resident U.S. situs property, so subject to U.S. tax U.S. Situs Property Issues Rent received reportable as U.S.-source income U.S. withholding / capital gains tax on sale Foreign tax credit for Canadian capital gains tax Capital gains rates impacted by structure choice Estate tax Gift tax Probate costs and delay Liability as an owner by a U.S. court 8

9 Personal Use Properties: Canadian Trust to Buy Structured Trust must purchase from third party Typical Canadian discretionary/family trust does not work because interest of contributor of assets or broad powers held by trustees Capital gains taxes at favourable individual rates Protection from owner s liability Assets of trust not included in estate of either spouse for both probate and estate tax If you already own U.S. property: Less flexibility cannot use trust (U.S. gift tax and retained interest rules) Gift tax is always the worst option Sell and buy your neighbour s property using a trust Other Ownership Options Ownership by poor spouse to increase exemption available Reduce gross estate with lifetime transfers of Canadian property Joint tenancy may increase estate tax exposure Divide tenants-in-common interests and benefit from discounted valuation of minority interests Buy life insurance to fund anticipated tax (use irrevocable trust to purchase life insurance to avoid increasing gross estate) Sell property while living perhaps to your children Probate expense and delay may still justify revocable trust structure Investment Properties: consider the trade-offs U.S. Limited Liability Companies (LLCs) usually result in foreign tax credit mismatch increasing income tax Limited partnerships generally receive parallel tax treatment in both Canada and U.S. Corporations face higher capital gains rates in the U.S. Trust planning addresses probate exposure, but may result in foreign tax credit mismatch for taxes at death Joint title addresses probate exposure, but may increase estate tax exposure 9

10 Questions? Thank you for your interest Will Todd Wills, Estates & Trusts Group at Davis LLP Kate Bake-Paterson Paul Beckmann, Q.C. Lauren Blake-Borrell Rhys Davies, Q.C. Tim Duholke, FCA Emma Ferguson Mary Hamilton Canada-U.S. Immigration Michelle Isaak Howard Kellough, Q.C. Paul Lailey Roger Lee Shane Onufrechuk, CA Sadie Wetzel Selina Koonar 10

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