Tax Insights: Estate tax update ─ Canadians transferred to the US (2020 edition)

Issue 2020-13

In brief

If you are a Canadian individual¹ who is transferred to the United States, you may be exposed to US estate, gift or generation-skipping transfer tax (collectively, transfer taxes). The exposure depends on whether you are regarded for transfer tax purposes as a US resident or a non-resident alien. Criteria for determining residency for US transfer taxes differ from those for determining residency for US income taxes. Key aspects of transfer taxes are discussed below and summarized in Table 1 below. 

All amounts in this Tax Insights are in US dollars.

In detail

US residents

You will be considered a US resident for transfer tax purposes if you are domiciled in the United States. You acquire domicile in the United States by both:

• being physically present in the United States, however briefly, and
• forming the intent to reside in the United States permanently

Domicile is a subjective test because it depends on your intent to remain in the United States. Courts and commentators have developed some objective criteria to help determine whether the intent necessary to establish domicile is present. These criteria include:

• duration of stay in the United States and frequency of travel outside of the United States
• size, nature and location of residence in the United States, compared to non-US residences
• location of family and friends, and of social and business ties
• declaration of residency in legal documents such as wills, trusts and deeds
• location of personal possessions, business interests, voter registration, automobile and driver’s licence registration, bank and brokerage accounts, and club and religious memberships
• US immigration status²

A Canadian individual who becomes domiciled in the United States will be subject to US transfer taxes as follows:

• Estate tax – on the value of worldwide assets owned at the time of death

You will be entitled to a lifetime estate tax exemption of $11.58 million³ ($11.4 million in 2019; indexed annually for inflation), US estate tax is payable only if your estate is valued at more than that amount. The highest tax rate is 40%.

• Gift tax – on gifts of any property exceeding the $15,000 exclusion amount (indexed annually) per recipient, per year

This increases to $157,000 for 2020 ($155,000 for 2019; indexed annually) if the gift is made to a non-US citizen spouse. In addition, you will be entitled to a lifetime gift tax exemption of $11.58 million ($11.4 million in 2019; indexed annually). However, using the lifetime gift tax exemption reduces your estate tax exemption by a corresponding amount.

• Generation-skipping transfer (GST) tax – on gifts of any property to an individual more than one generation younger than the transferor (e.g. from a grandparent to a grandchild)

GST tax is imposed in addition to any applicable gift or estate taxes. The GST tax rate is 40%. You will be entitled to a lifetime GST exemption of $11.58 million ($11.4 million in 2019; indexed annually), which is in addition to the $11.58 million ($11.4 million for 2019) exemption for estate and gift tax.

Temporary transfers

If you are transferred to the United States on a temporary work assignment, you may not be viewed as domiciled in the United States for US transfer tax purposes because you will not have the intent to permanently reside in the United States. However, if you have cut sufficient ties with Canada, you will be viewed as a resident of the United States (and a non-resident of Canada) for income tax purposes under the residency rules in the Canada-US Tax Treaty (the Treaty).

This could have significant implications in respect of individuals who die owning US assets while on a temporary work assignment in the United States because, for US transfer tax purposes, an individual on a temporary work assignment in the United States who ceases Canadian income tax residency will not qualify for certain estate tax Treaty benefits.

Conversely, an individual who retains his or her Canadian residency status while on a temporary US work assignment is entitled to take advantage of Treaty benefits such as the enhanced unified credit (see Unified credit below).

Non-resident aliens

If you do not become domiciled in the United States, you will continue to be considered a non‑resident alien for US transfer tax purposes and will therefore be subject to US estate, gift and GST tax as if still a Canadian resident, as follows:

• Estate tax – on the value of “US situs” property owned at the time of death

US situs property includes such things as US real estate, US business assets, shares and options of US corporations and certain debt obligations of US persons.

• Gift tax – on gifts of US real estate or tangible personal property (e.g. furniture, jewellery, cash) located in the United States, exceeding $15,000 per recipient, per year
• GST tax – on gifts of US real estate or tangible personal property (e.g. furniture, jewellery, cash) located in the United States to an individual more than one generation younger than the transferor

Rates and exemptions

US estate and gift tax rates, exemptions and corresponding credits are illustrated in Table 1 below. For 2020, estate tax rates start at 18%, and reach 40% for assets worth more than $1 million.

Special transfer tax credits, exemptions and deductions

Unified credit

For 2020, US residents (and citizens) are entitled to a US estate tax unified credit of approximately $4,577,800, which essentially exempts $11.58 million of property from estate tax.

Non-resident aliens are entitled to a US estate tax unified credit of $13,000, which exempts $60,000 of property from estate tax. However, the Treaty allows a Canadian resident to claim an “enhanced unified credit” that may exceed the $13,000 credit allowed under US domestic law and is calculated as:

Consider the following example: Edward is a Canadian resident and a non-resident alien for US transfer tax purposes. He owns a home in Orlando worth $1 million. The gross value of Edward’s worldwide estate at the time of his death in 2020 is $10 million.

Because his US assets constitute 10% of his worldwide estate, he will be entitled to claim a unified credit of $457,780 (10% of $4,577,800) on his US estate tax return. The gross estate tax arising on Edward’s home will be $345,800. In the end, Edward’s estate will not pay any estate tax because his unified credit of $457,780 will be sufficient to eliminate his estate tax liability.

As discussed earlier, benefits under the Treaty, such as the enhanced unified credit, are available to you only if you are a resident of Canada (as determined under the Treaty residency rules). Therefore, in the above example, if Edward had been on assignment in the United States at the time of his death and no longer considered to be a resident of Canada for income tax purposes, he would have been limited to the $13,000 unified credit.

As a non‑resident of Canada, he would not qualify for the enhanced unified credit under the Treaty and therefore, his estate tax liability for the home would now be $332,800 ($345,800 estate tax less the $13,000 unified credit).

Marital transfers

US citizen spouse

An unlimited marital deduction applies for both US gift and estate tax purposes for gifts or bequests made to a US citizen spouse. In other words, no gift tax is imposed on gifts made to a US citizen spouse during his or her lifetime and no estate tax is imposed on bequests made to a US citizen spouse at death.

Non-US citizen spouse

• Gift tax – if the recipient spouse is not a US citizen

The marital deduction is limited to $157,000 for 2020 ($155,000 for 2019; indexed annually for inflation). For example, in 2020, a Canadian individual who gives a US property worth $500,000 to his or her non-US citizen spouse will be subject to gift tax on a gift of $343,000 ($500,000 less $157,000).

• Estate tax – if the surviving spouse is not a US citizen

The marital deduction is not available unless the bequest is made to a special form of trust known as a Qualified Domestic Trust (QDOT). For a trust to qualify as a QDOT:

–       the surviving spouse must receive the income from the trust at least annually

–       no person other than the surviving spouse can be a beneficiary during the spouse’s lifetime, and

–       at least one trustee must be a US individual, US bank or US trust company

If the QDOT is funded with more than $2 million, the trustees must file a bond or letter of credit with the Internal Revenue Service (IRS), unless at least one trustee is a US bank or US trust company. Estate tax is imposed at the earlier of the distribution of trust principal to the surviving spouse and the death of the surviving spouse.

Marital credit

If the marital deduction is not available, the Treaty provides a marital credit against estate tax when property is transferred to a surviving non-US citizen spouse. For this credit to be available certain conditions must be met, but it can be claimed even if the deceased and his or her spouse are both residing in the United States at the time of death (if at least one spouse is a citizen of Canada).

US estate tax example – resident vs. non-resident alien

Consider Diane, a Canadian citizen, who was transferred by her employer from Canada to the United States in 2013. Diane dies in 2020, leaving all of her assets to her spouse who is not a US citizen. At the time of her death, Diane’s worldwide estate is valued at $20 million, which includes a $2 million Orlando home.

If the assignment was temporary and Diane intended to return to Canada at the end of it, she likely would not be considered domiciled in the United States at death. However, if Diane was transferred to the United States on a permanent assignment, and had no intention of returning to Canada, she might be considered domiciled in the United States at death.

The table below shows that if Diane is considered domiciled in the United States, she will have no estate tax liability after the applicable credits.

However, if Diane transfers on a temporary assignment, and is not domiciled in the United States (but is a resident of the United States for income tax purposes under the Treaty), she will be subject to US estate tax on her US situs assets.

This example illustrates that an individual who temporarily relocates to the United States should be cautious when considering purchasing US assets because, on death, these assets will be subject to US estate tax, and Treaty relief (via the enhanced unified credit) will not be available if the individual has ceased Canadian residency for Treaty purposes.

Joint tenants with right of survivorship

It is common in Canada for spouses to hold property as joint tenants with right of survivorship. However, joint ownership may cause unintended US transfer tax consequences as follows:

• Estate tax – if a surviving spouse is not a US citizen

100% of jointly-owned property will be includable in the deceased’s estate and subject to estate tax, unless:

–      the property is transferred by the surviving spouse to a QDOT, or

–      the surviving spouse can prove that he or she contributed funds towards the purchase of the property

In some cases it may be best to sever the joint tenancy in order to pursue planning through the individual’s will.

• Gift tax – for real property purchased after July 13, 1988, and certain bank and brokerage accounts

There may be a gift upon the termination of the joint property interest.

Insurance proceeds

In Canada, insurance proceeds are received by the beneficiary tax-free. However, insurance proceeds will affect a Canadian’s US estate tax as follows:

• US resident – (if domiciled in the United States) at the time of death

The value of any insurance policies on the decedent’s life that the decedent either owned or possessed “incidents of ownership” will be included in the decedent’s worldwide estate at death, and subject to US estate tax.

• Non-resident alien – (if not domiciled in the United States) at the time of death

The value of any insurance proceeds on the decedent’s life will not be considered US situs property and will not be subject to US estate tax.⁴ However, the insurance will be included in the decedent’s worldwide estate for purposes of determining the enhanced unified credit under the Treaty. Therefore, insurance proceeds could significantly reduce the enhanced unified and marital credits available to the deceased taxpayer.

To protect the insurance proceeds from US estate tax, it may be beneficial to hold the insurance in an insurance trust.

Canadian wills

Canadians who are transferred to the United States should ensure that their existing Canadian wills operate effectively from both a Canadian and US tax perspective. To determine this, you may want to seek advice from competent counsel in the state in which you will be residing.

Planning points for temporary transfers

If you are transferred to the United States on a temporary work assignment, you may want to consider the following planning points:

• Life insurance – Term life insurance can fund your current US estate tax liability. Although this is a flexible planning option, a cost-benefit analysis should be done based on your personal circumstances and you should consider the issues discussed above under Insurance proceeds.
• Ownership of US assets – You should limit personal ownership of US situs assets. For example, you may want to consider renting instead of purchasing a US home if this makes sense in your personal circumstances.
• Acquiring a US green card – You should consider the effect that acquiring a US green card could have on your US domicile status, because possession of a US green card indicates an intention to reside in the United States permanently.
• Will planning – You should have a current will and powers of attorney that have been reviewed by US and Canadian advisers to ensure that they operate effectively from the tax perspectives of both countries.

Permanent transfers

If your US assignment changes from temporary to permanent, your domicile may also change because you are now intending to reside in the United States permanently. As a person with US domicile, you will be subject to US estate tax on worldwide assets and will receive the estate tax unified credit that a US person receives.

You should review the planning that has been implemented to ensure that it continues to make sense from a US estate tax perspective based on your domicile. In addition, it may be beneficial to undertake a gifting strategy before becoming domiciled in the United States to avoid the application of US gift tax.

Long-term US residents (green card holders)

Certain long-term residents are subject to the US expatriation rules when they cease US residency. These rules may apply if you held a US green card in at least eight of the fifteen years ending with the year of expatriation.

The expatriation rules include gift tax provisions that may apply after the date of expatriation to gifts or bequests made to US persons. These rules should be reviewed in detail before you relinquish a green card.

State taxes

Certain states have their own transfer tax regime. Although this Tax Insights focusses on federal transfer taxes, the impact of local state transfer taxes needs to be considered and, where applicable, factored into the transfer taxes’ calculation. The exposure to local state transfer taxes will depend on:

• the state you are considered to be a resident of
• the location of your US situs property

<sup>1. This Tax Insights assumes that the Canadian individual being transferred is not a US citizen.
2. While immigration status is relevant, a temporary non-immigrant visa does not necessarily preclude an individual from being considered domiciled in the United States. An individual with certain ties to Canada who is in the United States on a non-immigrant visa that can be renewed annually and indefinitely can still develop the subjective intent to remain in the United States permanently and therefore establish domicile.
3. The American Taxpayer Relief Act of 2012 established an exemption amount of $5 million and indexes this amount for inflation annually. The Internal Revenue Service (IRS) announced that the indexed exemption amount is $5.79 million for 2020 ($5.7 million for 2019). The Tax Cuts and Jobs Act (2017) doubled the original exemption amount from $5 million to $10 million, indexed to $11.58 million for 2020 ($11.4 million for 2019). This enhanced exemption is effective for 2018 through 2025; unless permanent legislation is enacted, the exemption will return to the pre-2018 regime in 2026. The IRS and United States Department of the Treasury clarified in Treasury Decision 9884 (November 26, 2019) that individuals who take advantage of the increased exemption amount from 2018 to 2025 will not lose the tax benefit of the higher exemption amount after 2025 when it is scheduled to drop to pre-2018 levels.
4. The cash value of a policy, underwritten by a US insurer on the life of another person, that is owned by a non-resident alien is considered to be US situs property.</sup>