Most Canadians don’t have to worry about US estate taxes, especially after the recent US tax legislation (effective as of 2018) increased the US estate tax exemption from $US 5.6m to $US 11.18m. This increase effectively protects most US citizens or domiciles living in Canada, as well as most Canadian residents that have US assets. However, it is increasingly becoming a concern for those individuals who consider themselves “high net worth”.
What is little known is that there is not much protection for Canadians who move to the US for a definite term and become non-residents of Canada while they are in the US – their US estate tax exemption on US assets is limited to $US 60,000. As a result, they could face a significant US estate tax liability if they were to die owning US assets such as US real estate or US securities.
The US estate tax regime divides individuals into two buckets: (1) those that are US citizens or domiciles, and (2) those that are neither US citizens nor US domiciles. The former could be subject to US estate on their worldwide assets, for example, Canadian real estate. The latter are only potentially subject to US estate tax on US assets such as US real estate or US securities.
While the US Code refers to US domiciles as “residents”, the meaning here is not the same as with US income tax residents. One can very well be an income tax resident of the US,[1] without being a domicile and therefore not being a US estate tax “resident”.
For example, a Canadian citizen who is assigned to the US for employment purposes and intends to live and work there for 10 years, may likely become an income tax resident of the US, and an income tax non-resident of Canada, without necessarily becoming a US domicile, particularly if they have an intention to return to Canada after their US employment. [2]
Such an individual may acquire a US real estate property, as well as shares of his or her US employer, in addition to a myriad of US stocks, bonds, mutual funds, or ETFs in his of her (US or foreign) brokerage accounts.
If they are US citizens or domiciles of the US, even though their worldwide assets can be included in their US estate on death, they can generally take full advantage of their US lifetime estate tax exemption which is currently $US 11.18m. Alternatively, if they are not US citizens or domiciles, but are income tax residents of Canada, the Canada-United States tax treaty (the “Treaty”) will provide them with an exemption that effectively protects them against US estate taxes on their US assets as long as their total worldwide assets are below the general exemption (currently at $US 11.18m). However, this Treaty exemption only applies if they are residents of Canada on the date of death. If they are not Canadian tax residents, and they are neither US citizens or domiciles, their US estate tax exemption, on US assets, will be limited to $US 60,000. As a result, they could potentially face a US estate tax of up to 40% on the value of their US assets on death.[3]
For example, if an individual dies owning US real estate worth $3m and US securities worth $2m, he or she can face a US estate tax of up to $2m. This will be the case even if his or her worldwide assets are limited to that $5m. In fact, there could be a US estate tax exposure even if their US real estate is worth $200k and their US securities are worth $10k.
For this reason, their executors may want to argue that the deceased did indeed become a US domicile by the date of death. Such an argument may be difficult but successful if there is clear evidence that they intended to return to Canada. Or, the executors may determine that the individual did indeed become an income tax resident of Canada prior to his or her death and able to take advantage of the Treaty exemptions. However, the facts must support the argument that the individual’s ties to Canada became closer than those to the US, so as to be eligible to be treated as a Canadian tax resident under the Treaty.
To avoid this risk, the individual may consider obtaining US citizenship to be eligible for the general exemption.
Alternatively, the individual may want to consider acquiring US assets through some type of entity that serves as an effective protection against US estate tax. For example, they may wish to hold US real estate or securities through a non-US corporation. Such a “corporation” is an entity that is structured legally as a partnership but which files a “check the box election” with the IRS to be taxed as a corporation. They may also wish to have a trust acquire such assets and if properly designed, the assets of the trust would not be included in the US estate of the contributor to, or beneficiary of, the trust.
Assessing and implementing strategies for reducing or eliminating the US estate tax risk is critically important for individuals who are temporarily in the US. Consider consulting with a tax professional to evaluate your exposure and options these and more tax risks before its too late.
[1] For example, either because of days of presence in the US under the “substantial presence test”, or by virtue of having a US green card and thus being a “permanent resident”.
[2] There is no objective test as to when an individual is a domicile of the US. It depends on facts and circumstances. Generally, domicile looks at the long-term intentions of the individual (ex., where does the individual intend to spend his or her retirement years). In this way: on the one hand, one can become a US domicile on the first day of presence in the US, if the intention is to stay in the US indefinitely; on the other hand, one can very well be living in the US for 20 years without having yet become domiciled in the US, if one intends, for example, to eventually return to one’s country of origin. While having a green card can be a factor that indicates one’s domicile in the US, it is not necessarily determinative.
[3] This $US 60,000 exemption does not only apply to former Canadian residents. It can also apply to any non-US individual who resides in a country which does not have an estate tax treaty with the US, and who owns US assets.