What is U.S. estate tax and why is it important to you?
U.S. estate tax applies to the value of assets upon death and is taxed at graduated rates ranging from 18% up to 40% for 2022 (when the value of your estate reaches $1 million). U.S. estate tax does not just apply to U.S. citizens or residents but can also be applied to non-residents!
Canadian individuals who are non-residents of the U.S. may be subject to U.S. estate tax if they die owning certain U.S. assets referred to as U.S. situs property. U.S. situs property that is subject to estate tax for non-residents includes:
- U.S. real estate, including condominiums, co-operatives and timeshares;
- Household goods and other property normally located in the U.S., including furniture, artwork, cars and boats;
- U.S. issued securities including stocks (such as Starbucks or Apple), mutual fund units and money market units. Note these can be held in both registered accounts, such as RRSPs or RRIFs and non-registered accounts;
- U.S. pension plans;
- Debt issued by U.S. persons or entities, or debt secured against U.S. situs property, such as vendor take-back mortgages on the sales of U.S. real estate.
It should be noted that cash in a U.S. bank account or other deposit account is not considered a U.S. situs asset nor are U.S. Treasury Bills or Certificates of Deposit.
Are you subject to U.S. Estate Tax?
To determine if a resident of Canada has potential exposure to U.S. estate tax on their death, they need to consider two questions:
- Does the value of their U.S. situs property exceed $60,000 USD?
- Does the value of their worldwide estate exceed the exemption amount in effect for deaths in that year?
If the answer is no to the first question and the value of the U.S. assets are less than $60,000 (USD), then there is no exposure to U.S. estate tax and the estate would not be required to file a U.S. estate tax return.
If the value of the U.S. assets is over the $60,000 threshold, then the estate would be required to file a U.S. estate return. However, if the total worldwide value of the estate is under the U.S. estate exemption limit, then there should not be any U.S. estate tax owing.
In 2017, the Tax Cuts and Jobs Act doubled the current U.S. estate exemption at the time from $5 million (USD) to $10 million. This limit is indexed for inflation each year, and for 2022 the limit is set at $12,060,000. This increase in limit is set to expire on December 31, 2025, at which point the exemption amount will revert to the amounts applied prior to December 22, 2017, adjusted for inflation which would presently be $6,030,000. If the worldwide assets of the estate exceed the exemption limit in the year of your death, then your estate would be subject to US estate tax. If your worldwide assets are below the exemption threshold then the Canadian–U.S. Income Tax Treaty (the “Treaty”) may provide relief from the estate tax, although a filing requirement would still exist.
Treaty Relief
The Treaty allows Canadians a pro-rated unified tax credit based on your U.S. assets over the estate’s worldwide assets multiplied by the U.S. unified tax credit. The unified tax credit is essentially the U.S. estate tax that would be applicable on the U.S. exemption amount. For 2022, the unified tax credit is $4,769,800 based on the $12,060,000 exemption amount. Therefore, as long as the total worldwide assets are below the U.S. exemption, the prorated credit allowed under the Treaty will be enough to offset any U.S. estate tax liability.
For example, assume that Ms. A dies and on her death, she holds $1,000,000 USD of U.S. securities. Her Canadian assets including her home are worth $5,000,000 USD.
U.S. estate tax on $1,000,000
$345,800
Less: Unified Credit
$1,000K/6,000K*4,769,800
(794,966)
U.S. estate tax owing
0
For U.S. citizens or residents, transfers to a surviving spouse are a deduction in calculating the U.S. taxable estate. Under the Treaty, a non-refundable marital credit is available up to the amount of the maximum exemption if there is a transfer to a surviving Canadian spouse.
If the estate ends up having U.S. estate tax payable, the Treaty does allow the amount of U.S. tax payable to be claimed as a foreign tax credit on the final Canadian return of the deceased against the Canadian tax that would be payable in relation to the U.S. assets.
Filing Requirements
The U.S. estate tax return for a non-resident is form 706-NA. If you are required to file the return the deadline is nine months following the date of death; although, the return can be extended by filing an extension. It is important to note that even if no tax is owing, an estate tax return is required to claim the additional tax credits under the Treaty.
Your estate administrators may also want to obtain proof of Internal Revenue Service (“IRS”) clearance. This clearance is called a tax closing letter and effective October 28, 2021 the IRS has started applying a $67 USD fee to any estate that requests a closing letter. The closing letter can be helpful to an executor of an estate to substantiate that it has covered all the estate obligations prior to making any disbursements to beneficiaries. If U.S. stocks are being held, then in many instances the transfer agents may also require a closing letter from the IRS prior to transferring the U.S. investments.
Proposed Changes under the Biden Administration
The new U.S. administration has proposed changes to these estate rules which could have significant impact to both Canadian and American individuals in the coming years. In 2021, however, there were several draft bills; none of them were passed and the estate tax exemptions remain as outlined above. It is possible that there will be changes in the coming months and these exemption amounts may be lowered. This could impact those Canadians that own U.S. property.