Mark A. Feigenbaum U.S. Attorney at Law Certified Public Accountant (U.S.) Chartered Accountant (Canada)

Transcription

1 Mark A. Feigenbaum U.S. Attorney at Law Certified Public Accountant (U.S.) Chartered Accountant (Canada) 1137 Centre Street, Suite 201 Thornhill, ON L4J 3M

2 1. Basis for US Estate Taxation 2. Basic US Estate Taxation 3. US Estate Tax Example Credit Shelter Trust 4. US Estate Tax Example Marital Credit 5. US Estate Tax Example QDOT 6. US Estate Tax Example ILIT 7. Hybrid US Real Property Ownership 8. Expatriation Agenda

3 Transfer Tax Basics US citizens are subject to transfer taxes on transfers during their lifetime (gift taxes) or at death (estate taxes) Gift and estate taxes are based on approximately 35% of the fair market value of the transfer

4 Taxation US Citizens taxed on entire worldwide estate US Residents taxed on entire worldwide estate based on domicile Non-Resident Aliens taxed only on property within the US For estate, gift and generation-skipping transfer tax purposes, a resident is an individual who, at the time of his death or at the time he makes a gift, has his domicile in the US

5 US Estate Taxation The Basics US Estate Tax is calculated on the Gross Estate of an individual. Depending upon the Citizenship/Residency of an individual, certain deductions and credits can be applied to reduce the value of the Gross Estate and thereby reduce taxation. The goal is to reduce the value of the Gross Estate of an Individual.

6 Life Insurance Life Insurance proceeds are includible in the Gross Estate of the deceased if the deceased possesses any incidents of ownership in the Life Insurance Policy. Most common strategy to avoid this is to transfer the ownership of a policy into an Irrevocable Life Insurance Trust (ILIT). ILIT strategy will be discussed in detail (Fact Scenario #5) after providing basic background in US Estate Planning.

7 Dr. Smith

8 Fact Scenario #1 - #1: Dr. Smith Dr. Smith is a US Citizen residing in Canada His spouse Flora and his child are also US citizens Dr. Smith s Will leaves everything to his wife outright upon his death Flora s Will leaves everything to the child

9 Fact Scenario #1 - #1: Dr. Smith (cont d) Dr. Smith s Assets are: Eco-Techo (Hi-Tech Canadian Environmental Company) - $1,000,000 US Several recreation properties in Canada - $3,000,000 US Canadian Mutual Funds etc. - $2,500,000 US Hippies R Us (Cdn. Internet Business) - $300,000US Other Assets in Canada - $200,000 US

10 Gross Estate Gross Estate equals the value at the time of death of all property, real or personal, tangible or intangible, wherever situated Gross Estate Less: Taxable Estate Administration expenses & indebtness Marital deduction/charitable deduction

11 Gross Estate (cont d) Gross federal estate tax Less: Applicable credit amount State death taxes Federal gift taxes Tax on prior transfers Net Estate Tax Payable

12 Dr. Smith s Gross Estate Value of Dr. Smith s property Eco-Techo Recreation Properties Canadian Mutual Funds RRSP s Hippies R Us Other Assets in Canada $1,000,000 US $3,000,000 US $2,500,000 US $1,000,000 US $300,000 US $200,000 US Total Gross Estate for Dr. Smith $7,000,000 US

13 Marital Deduction Marital deduction Every US citizen can transfer and unlimited amount of property outright to their US Citizen spouse and thereby take advantage of the marital deduction Five requirements to qualify for marital deduction 1. Surviving spouse must be a US citizen 2. Property must be included in decedent s gross estate 3. Property must pass or have passed to the surviving spouse 4. Decedent and the surviving spouse must be married at the time of the decedent s death 5. Surviving spouse s interest must not be a terminable interest

14 Unified Credit Each and every citizen of the US has a unified credit from estate and gift taxes This exclusion amount is $1,730,800 for death in 2011 Often this credit amount is referred to as $5,000,000 Reason is that the amount of tax payable on an estate of $5,000,000 is $1,730,800

15 Dr. Smith s Estate Tax Fact Scenario #1 Dr. Smith s Will states that all of his property will go to his wife outright upon his death She is a US citizen, the property is transferred outright and thus Dr. Smith is entitled to a marital deduction His estate tax payable is will be as follows: Gross Estate: $7,000,000 Taxable Estate Prior to Marital Deduction: $7,000,000 Marital Deduction (7,000,000) Taxable Estate: $ 0 Tax Payable $ 0

16 Flora s Estate Tax Fact Scenario #1 Upon death of Flora, however, assuming the assets have not grown, the value of her gross estate will be $7,000,000 She will have no marital deduction Her estate tax payable will be as follows: Gross Estate: $7,000,000 Taxable Estate: $7,000,000 Tax Payable Before Unified Credit: $2,450,000 Unified Credit: ($1,730,800) Tax Payable $719,200

17 Dr. Smith Credit Shelter Trust

18 Fact Scenario #2 Credit Shelter Trust #2: Dr. Smith Same facts as Fact Situation #1, but with a different Will Will of Dr. Smith leaves a portion of his estate to his child in trust, with the income of the trust payable to his wife, Flora.

19 Credit Shelter Trust The gross estate of an individual only includes the value of the beneficial interests in assets in which the decedent owns or controls at death. If the decedent has no right to transfer an interest at death, the value of that property interest is not included in their gross estate.

20 Dr. Smith s Estate Tax Fact Scenario #2 Dr. Smith will states that $2,000,000 of his estate is to be transferred to a trust for his child and the remainder of his estate ($5,000,000) is to go to his wife outright. His estate tax payable will be as follows: Gross Estate: $7,000,000 Taxable Estate prior to Marital Deduction $7,000,000 Marital Deduction (5,000,000) Taxable Estate: $2,000,000 Tax Payable Before Unified Credit $700,000 Unified Credit: (1,730,800) Tax Payable $0

21 Flora s Fact Scenario #2 Since Flora has no control or ownership of the Trust, the value of the trust is not includible in her gross estate Assuming no growth in the value of the assets that were transferred to her upon Dr. Smith s death ($5,000,000), Flora s estate tax payable will be as follows: Gross Estate: $5,000,000 Taxable Estate $5,000,000 Tax Payable Before Unified Credit $1,730,800 Unified Credit: (1,730,800) Tax Payable $0

22 Marital Credit Under Canada/US Treaty Fact Scenario #2 Dr. Smith Dr. Smith is a US Citizen residing in Canada His spouse Flora and his child are also Canadian residents and are not US Citizens. Dr. Smith s will leaves everything to his wife outright upon his death

23 Marital Credit Under Canada/US Treaty Fact Scenario #2 Dr. Smith (cont d) Dr. Smith s assets are: Eco-Techo (Hi-Tech Canadian Environmental Company) - $1,000,000 US Several recreation properties in Canada - $3,000,000 US Canadian Mutual Funds etc. - $2,500,000 US Hippies R Us (Cdn. Internet Business) - $300,000 US Other assets in Canada - $200,000 US

24 Marital Credit Under Canada/US Treaty Remember: a requirement of receiving an unlimited marital deduction is that the surviving spouse to whom the assets are transferred be a US citizen The Canada-US Income Tax Convention ( Treaty ), however, provides a marital credit, instead of a marital deduction, for non-citizen surviving spouses who are Canadian residents

25 Marital Credit Under Canada/US Treaty (cont d) The marital credit allowed upon the death of the decedent is the lesser of: a) the unified credit allowed under the laws of the US, and b) the amount of estate tax that would otherwise be imposed by the US on the transfer of qualifying property

26 Dr. Smith Marital Credit

27 Dr. Smith s Estate Tax Fact Scenario #3 Dr. Smith s will transfers his entire estate to Flora outright, upon his death. Since Flora is not a US Citizen, Dr. Smith will not be entitled to an unlimited marital deduction. Dr. Smith can instead make use of the marital credit available to him under the treaty which is calculated as follows: Unified Credit $1,730,800 Amount of Estate Tax Otherwise Payable $2,450,000 Marital Credit = Lesser of Unified Credit or Amount of Estate Tax Otherwise Payable $1,730,800

28 Dr. Smith s Estate Tax Fact Scenario #3 (cont d) Dr. Smith s estate tax payable will be as follows: Gross Estate: $7,000,000 Taxable Estate $7,000,000 Tax Payable Prior to Credit s $2,450,000 Unified Credit ($1,730,800) Marital Credit ($1,730,800) Tax Payable $0

29 Qualified Domestic Trust (QDOT) An alternative to the marital credit under the treaty, is to put assets into a qualifying domestic trust, and thereby be eligible for the unlimited marital deduction

30 Qualified Domestic Trust (QDOT) (cont d) To establish a QDOT, the trust must meet the following requirements: At least one trustee must be a US citizen or a domestic corporation No distribution of corpus may be made from the trust unless the trustee has the right to withhold the estate tax imposed on the distribution The executor must irrevocably elect to have the trust treated as a QDOT; and, The trust must adhere to any regulations that may be issued to ensure the collection of estate tax imposed on the trust

31 Dr. Smith QDOT

32 Fact Scenario #4 QDOT #4: Dr. Smith Dr. Smith is a US Citizen residing in Canada His spouse Flora and his child are also Canadian residents and are not US Citizens. Dr. Smith s Will leaves everything to a qualifying domestic trust

33 Fact Scenario #4 QDOT #4: Dr. Smith (cont d) Dr. Smith s assets are: Eco-Techo (Hi-Tech Canadian Environmental Company) - $1,000,000 US Several recreation properties in Canada - $3,000,000 US Canadian Mutual Funds etc. - $2,500,000 US Hippies R Us (Cdn. Internet Business) - $300,000 US Other assets in Canada - $200,000 US

34 Dr. Smith s Estate Tax - Fact Scenario #4 Dr. Smith s will transfers his entire estate to a QDOT Compare use of QDOT to use of marital credit under treaty in previous example His estate tax payable will be as follows: QDOT Marital Credit Gross Estate: $7,000,000 $7,000,000 Taxable Estate $7,000,000 $7,000,000 Marital Deduction (7,000,000) $0 Taxable Estate: $0 $7,000,000 Tax Payable Prior to Credits $0 $2,450,000 Unified Credit: (0) ($1,730,800) Marital Credit (Treaty) N/A ($1,730,800) Tax Payable $0 $0

35 Flora s/qdot Estate Tax Fact Scenario #4 The QDOT is taxable upon any distribution before the death of the surviving spouse and upon the value remaining in the QDOT upon the death of the surviving spouse. The amount of tax payable is measured by reference to the amount of estate tax that would have been imposed if the amount of the taxable occurrence (death of surviving spouse or distribution) had been included in the decedent (Dr. Smith s) estate.

36 Flora s/qdot Estate Tax Fact Scenario #4 (cont d) Once again compare with Marital Credit example. Assume that all of the corpus is removed from the QDOT during Flora s lifetime or upon her death.

37 Flora s/qdot Estate Tax Fact Scenario #4 (cont d) Her QDOT estate tax payable will be as follows: QDOT Marital Credit Gross Estate of Dr. Smith if no QDOT $7,000,000 Flora has Taxable Estate $7,000,000 no US Estate Tax Tax Payable Before Unified Credit $2,450,000 Liability as Unified Credit ($1,730,800) she is a Actual Estate Tax Paid by Dr. Smith (0) Canadian Resident and not a Citizen of the US Tax Payable by QDOT / Flora $719,200 $0

38 Dr. Smith and Flora s Total Estate Tax Fact Scenario #4 Death Of Tax Payable Under QDOT Tax Payable Under Marital Credit Dr. Smith $0 $0 Flora / QDOT $719,000 $0 Total Tax Paid $719,000 $0

39 Dr. Snowbird ILIT

40 Fact Scenario #5 Mr. Snowbird Facts Mr. Snowbird is a Canadian resident (not a US Citizen) with assets in Canada as follows: RRSP s Rental property Transport Co (Oil & Gas Industry) Life Insurance proceeds Other assets $150,000 US $150,000 US $400,000 US $3,500,000 US $100,000 US Mr. Snowbird also has assets in the US as follows: Arizona recreation property $700,000 US Brokerage accounts holding blue chip US shares $600,000 US

41 Unified Credit for Non US Citizens Under US Domestic Law the Unified Credit is reduced to $13,000 for non US Citizens However, under the treaty between the Canada and US, a unified credit is allowed to Canadian residents with US assets in an amount that is the greater of $13,000 or the amount determined as follows: Unified Credit = Value of US Assets Value of Worldwide Assets Unified Credit Amount X ($1,730,800 for 2011)

42 Mr. Snowbird s Estate Tax Fact Scenario #5 As Mr. Snowbird is a non-resident alien, he will only be taxable on his property located within the US. Mr. Snowbird s unified credit is calculated as follows: Unified Credit = Unified Credit = Value of US Assets Value of Worldwide Assets $1,300,000 $5,600,000 Unified Credit Amount X ($1,730,800 for 2011) Unified Credit Amount X ($1,730,800 for 2011) Unified Credit = $401,793

43 Mr. Snowbird s Estate Tax Fact Scenario #5 (cont d) His estate tax payable will be as follows: Gross Estate: $1,300,000 Liabilities: $0 Taxable Estate $1,300,000 Tax payable Prior to Unified Credit $455,000 Unified Credit (401,793) Tax Payable $ 53,207

44 Irrevocable Life Insurance Trust (ILIT) Use of an irrevocable trust to hold the life insurance allows one to remove the life insurance proceeds from the estate of both the insured and the insured s spouse while making them available by the spouse or other family members without the estatetax bite.

45 Small Estate Rule Canada/US Treaty If the value of the worldwide gross estate of an individual is below $1.2 million US, the US is only allowed to impose tax upon real property situated within the US. It will no longer be necessary now that the unified credit exemption is greater than $1.2 million

46 Mr. Snowbird s Estate Tax Fact Scenario #5 Life Insurance into ILIT If Mr. Snowbird puts his life insurance into an ILIT, his gross taxable estate will be reduced by $3,500,000. As such, his worldwide gross estate is also reduced by $3,500,000 to a value of $2,100,000. His gross estate in the US is now only the Arizona recreation property valued at $700,000 US and Brokerage accounts valued at $600,000

47 Mr. Snowbird s Estate Tax Fact Scenario #5 Life Insurance into ILIT Compare use of ILIT to tax payable without use of ILIT as shown in previous example. Mr. Snowbird s Unified Credit is calculated as follows: Unified Credit = Value of US Assets Value of Worldwide Assets Unified Credit Amount X ($1,730,800 for 2011) Unified Credit = $1,300,000 $2,100,000 Unified Credit Amount X ($1,730,800 for 2011) Unified Credit = $1,071,448

48 Mr. Snowbird s Estate Tax Fact Scenario #5 Life Insurance into ILIT (cont d) His estate tax payable upon his death will be as follows: ILIT No ILIT Gross Estate: $1,300,000 $1,300,000 Taxable Estate $1,300,000 $1,300,000 Tax payable Prior to Unified Credit $455,000 $455,000 Unified Credit (1,071,448) (401,793) Tax Payable $ 0 $53,207

49 Final ILIT Notes Clients must understand trust is irrevocable Best policies to use are: Individual term Group term Whole life are preferable to paid up Variable life, or Single premium policies Best idea is for trust to be the applicant and owner of policy

50 Hybrid U.S. Real Property Ownership Assumptions: You have never been a U.S. citizen or been considered a resident You are a resident of Canada You own real property in the U.S. You intend to rent the property or purchase securities through the proposed structure You intend to leave the property to your spouse when you die It is expected that the real property will increase in value

51 Hybrid U.S. Real Property Ownership Property held in Canadian partnership: Beneficial for Canadian tax purposes: Canadian shareholder benefit rules would not apply Earnings would be considered that of its partners and would not be subject to additional tax if held through corporation Provincial capital tax does not apply to partnerships For U.S. purposes the IRS would consider the property to be owned directly by the partners Considered property within the U.S. and subject to U.S. estate tax rules

52 Hybrid U.S. Real Property Ownership Ultimate structure would be an entity which holds the U.S. property considered a partnership for Canadian purposes and Canadian (foreign) Corporation for U.S. The shares of the Canadian corporation would not be subject to U.S. estate tax

53 Reverse Hybrid Entity Refers to an entity that a foreign (i.e. Canadian) jurisdiction treats as a partnership but has elected to be taxed as a corporation for U.S. income and estate tax purposes You and another partner organize a partnership in Canada The partnership would elect at the first spouse s passing, for U.S. purposes, to be treated and taxed as a corporation

54 Reverse Hybrid Entity You will own a partnership interest and not a direct interest in the property Your Will should direct that the partnership interest be bequeathed outright or left to a spousal trust

55 Expatriation to Avoid Tax Every US Citizen who loses US Citizenship, may be subject to the Departure Tax in accordance with provisions of the IRC. ( 877A & 2103)

56 Long Term Residents of US Long Term Residents of the US who cease to be lawful permanent residents of the US will be treated in the same manner as US Citizens who renounce their US Citizenship. A Long Term Resident of the US is one who is a lawful permanent resident of the US in at least 8 of the 15 preceding taxable years.