With the recent passing of the U.S. Tax Cuts and Jobs Act of 2017, many Canadians who own U.S. vacation property (or other U.S. assets) will no longer be subject to U.S. estate tax at death. While this is a welcomed change, the failure to file a U.S. tax return to claim the benefits of the new tax law will result in negative U.S. tax consequences to those who inherit U.S. assets.
What is a U.S. Asset?
Canadian residents owning certain U.S. assets at death are exposed to U.S. estate tax. Such assets include:
- Real estate located in the U.S.
- Personal property located in the U.S.
- Stock of public or private U.S. corporations (even if held in a Canadian brokerage account, TFSA, RRSP, RRIF, or RESP etc.)
- Debt obligations, such as U.S. corporate bonds
- Business assets located in the U.S.
While you may own U.S. assets on death, relief from U.S. estate tax may be available by claiming benefits of the Canada-U.S. Income Tax Treaty (the Treaty).
Benefits of the Canada-U.S. Income Tax Treaty
If you are a Canadian resident (and not a U.S. citizen), the Treaty allows you to reduce your U.S. estate tax liability by claiming two potential tax credits against your U.S. estate tax. These credits are referred to as the unified credit and marital credit.
While the unified credit is similar to that available to U.S. citizens and residents, the amount of the credit available to a non-U.S. citizen or resident is prorated based on the ratio of the value of U.S. assets at death to the value of the worldwide estate. As the Tax Cuts and Jobs Act of 2017 doubled the estate tax exemption to approximately $11.20 million (for 2018), many Canadians who own U.S. vacation homes will no longer be subject to U.S. estate tax.
For example, if you die in 2018 owning a US$1.2 million U.S. vacation home and you have a worldwide estate valued at US$8.5 million, your U.S. estate tax would be calculated as follows:
|US estate tax before unified credit||$425,800|
|Less: unified credit (per Treaty)||$624,819|
|US estate tax due||$0|
U.S. estate tax may be further reduced (if not already eliminated by the unified credit) if you are able to claim the benefit of the marital credit. The marital credit is available when your U.S. assets pass to your spouse on death and certain conditions are met. The marital credit equals the lessor of (1) the unified credit, and (2) the amount of estate tax remaining after the unified credit.
For example, if you die in 2018 owning a US$3.5 million U.S. vacation home and you have a worldwide estate valued at US$15 million, your U.S. estate tax would be calculated as follows:
|U.S. estate tax before unified credit||$1,345,800|
|Less: unified credit (per Treaty)||($1,032,687) |
|U.S. estate tax due||$313,113|
|Less: marital credit (per Treaty)||($313, 133)|
|U.S. estate tax due||$0|
The doubling of the current U.S. estate tax exemption for those who die in 2018 and later years allows a married couple living in Canada to avoid U.S. estate tax if proper planning is done and the fair market value of their worldwide assets at death does not exceed US$22.4 million.
US Estate Tax Return
A U.S. estate tax return must be filed even where there is no U.S. estate tax. The return is due within 9 months after the date of death unless a 6-month extension of time to file is granted. Failure to file the return causes the beneficiaries of the estate to receive U.S. assets with zero basis. This can result in an unwelcomed tax surprise when, for example, inherited assets are sold at a later date.
It is important to review the rules relating to U.S. estate tax and the relief provided by the Treaty when a Canadian resident (who is not a U.S. citizen) owns U.S. assets at death. Careful planning can be implemented to avoid or limit U.S. estate tax exposure.