u.s.-canadian tax and estate planning for dual...

U.S.-Canadian Tax and Estate Planning for Dual

ResidentsReconciling U.S. and Canadian Law on Trusts, Deemed Dispositions on Death, Situs Wills, and Wealth Transfers

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WEDNESDAY, NOVEMBER 18, 2020

Presenting a live 90-minute webinar with interactive Q&A

David A. Altro, Managing Partner, Altro LLP, Montreal, Quebec

Bradley R. Thompson, Partner, Altro LLP, Ontario & New York

Samantha Y.F. Wu, Partner, Altro LLP, Toronto

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U.S.-Canadian Tax and Estate Planning for Cross-Border Taxpayers

Reconciling U.S. and Canadian Laws on Estate Planning Strategies, Deemed Dispositions on Death, and Wealth Transfers

November 18, 2020

MONTRÉAL / TORONTO / CALGARY / VANCOUVER / FT. LAUDERDALE / ORLANDO / NAPLES / PHOENIX / PALM SPRINGS

6

INTRODUCTION

• David A. Altro, B.A., LL.L., J.D., D.D.N., TEP.

• Managing Partner, Florida Lawyer, Canadian Legal Advisor and Quebec Notary

• Education:

• University of Montreal, 1989, D.D.N.

• Nova Southeastern University, 1984, J.D.

• University of Montreal, 1979, LL.L.

• Concordia University, 1976, B.A.

• Bar Admissions: Florida (1984), Quebec (1980-1989), Chambre des Notaires (1989)

• Bradley Richard Thompson, B.A., M.A., B.C.L., LL.B., LL.M (US Tax)

• Partner, Ontario and New York Attorney

• Education:

• LL.M. (in US Tax) from New York University School of Law (2008)

• B.C.L and LL.B with distinction from the McGill University Faculty of Law (2004)

• M.A. (in economics) (2001)

• B.A. (First Class Honours) (2000)

• Bar Admissions: New York (2005), Ontario (2009)

• Samantha Y.F. Wu, B.A., J.D.

• Partner, Ontario & New York Attorney

• Education:

• J.D., Benjamin N. Cardozo School of Law, Yeshiva University (2010)

• B.A. (Psychology) University of British Columbia (2007)

• Bar Admissions: New York (2011), Ontario (2015)

KEY CONCEPTS


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KEY CONCEPTS OF CROSS-BORDER PLANNING

• Taxation regimes for US citizens vs. Canadian residents

• Canadian residents and taxpayers owning U.S. assets;

• Americans living in Canada;

• Canadian deemed residency rules.

• Balancing Multi-Jurisdictional Probate Proceedings

• Situs Wills and Powers of Attorney documents

• Probate and trust planning

• The U.S. Estate Tax and the Canadian Deemed Disposition on Death

• Avoidance of Double Taxation

• Identifying types of tax triggered and treatment on either side of the border

• The U.S.-Canadian Tax Treaty

• Residency tie-breaker rules

• Foreign tax credit (FTC) Rules;

• Sourcing – Canada versus US;

• Article XXIV resourcing

PROBATE AND ESTATE TAXES


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CROSS-BORDER ESTATE PLANNING – U.S. ESTATE TAX RULES

• U.S. Estate Tax as Applied to the Canadian Resident

1. Value of the U.S. situs properties – does the gross value exceed $60,000 USD?

• Obligation to file a U.S. Estate Tax Return

2. Value of the worldwide properties – does the value of the worldwide estate exceed the applicable exclusion

amount in effect in the year of death?

• Leaving to a Canadian-Resident Spouse

• Marital Deduction (26 U.S. Code Sec. 2056) – transfers between spouses at tax free, in life or in death. However,

this deduction is only available if the surviving spouse is a U.S. citizen.

• Marital Credit – under the Treaty, Canadian residents are allowed a pro-rata portion of the credit allowed for U.S.

citizens, based on the value of their U.S. assets in proportion to their worldwide assets. This credit is referred to

as the Unified Credit.

• The prorated unified credit is calculated by taking the value of the taxable estate, divided by the value of the

decedent’s worldwide estate, and multiplying it by the unified credit for the applicable year.

• Long-term planning issues when leaving to a dual-citizen spouse or dual-citizen children/grandchildren

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CROSS-BORDER ESTATE PLANNING

The Canadian-Deemed Disposition Rules

• In lieu of a value-based death/estate tax, the Canadian Revenue Agency (CRA) treats the decedent as of he/she sold

all of his/her assets right before he/she died.

• This is referred to as a Deemed Disposition, as the decedent is deemed to have disposed of his/her properties even

though there is no actual sale. The tax that is calculated and levied in the hands of the deceased is a capital gains

tax.

• Capital gains tax is calculated on the difference between the deemed proceeds of disposition (typically fair market

value of the asset) and the asset’s adjusted cost basis.

• How is capital gains in Canada taxed?

• 50% inclusion rate, then taxed as income in the hands of the taxpayer at his/her graduated income tax rate.

• Leaving to a Canadian-Resident Spouse

• ITA Subsection 70(6) - A rollover is available on assets transferred from the deceased to his/her spouse or

common-law partner.

• The surviving spouse or common law partner must be a Canadian resident.

• The gift must be outright, or in a qualifying Canadian spousal trust.

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CREDIT FOR TAXES AT DEATH – ARTICLES XXIX B(6) AND (7)

• Under Articles XXIX B(6) and (7) of the Treaty there is a credit available in both the US and Canada,

respectively, for the “death tax” paid in the other country in respect of property in that country,

which can reduce the taxes in the residence country.

• Example: second-to-die non-citizen non-resident of the US, tax resident of Canada for purposes of

Article IV of the Treaty. At time of passing WW estate value of USD$15,000,000, of which USD$1.5

million relates to a US vacation home purchased in 2017 for USD$1.4 million and a portfolio of US

publicly traded equities worth USD$800,000 with a basis of $600,000.

• US estate tax of approximately USD$164,828

• Canadian tax on deemed disposition of CAD equivalent of USD$182,000

• **Full utilization of FTC for US estate tax – will not always be the case depending on mix of

appreciated US situs assets, FX gains, etc.

• US estate taxes not otherwise allowable as a credit or a deduction in terminal Canadian tax return

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CROSS-BORDER ESTATE PLANNING – TRUST PLANNING

Trusts remain an excellent estate planning tool for probate-avoidance and asset preservation.

• Trust Residency Rules

• Canadian – Central management and control

• U.S. – the Court Test and the Control Test.

• Revocable Trusts/Grantor Trusts

• Usage of a living trust for Canadians owning U.S. situs properties;

• Canadian characterization of revocable grantor trusts

• Canadian principal residence exemption (PRE) and trust planning

• After 2016, only certain types of trusts are able to claim the PRE for taxation years that begin after 2016.

Eligible Trusts fall into one of three categories:

• (1) Alter Ego Trusts, Joint Partnership Trusts, spousal trusts, or trusts established for the sole benefit of the

settlor during his/her lifetime;

• (2) Testamentary trusts that are qualifying disability trusts; and

• (3) Inter vivos or testamentary trusts where a specified beneficiary is a minor child of the settlor and the

beneficiary’s parents are both deceased.

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• U.S. Citizens and Canadian Trusts – U.S. taxation of a foreign trust

• U.S. taxation of a foreign trust depends on whether the trust is a grantor or non-grantor trust.

• Foreign grantor trusts

• Where a U.S. person transfers property to a foreign trust directly or indirectly, and the trust has a U.S.

beneficiary, the grantor is treated as the owner of the trust property.

– The word “Transfer” and the requirement that the trust has a US beneficiary is not straight-forward.

• Grantor trust rules are similar to the Canadian reversionary trust rules – income of a Canadian discretionary

trust that is considered a grantor trust would attribute to the U.S. owner for U.S. tax purposes. This may

create double taxation, as for Canadian purposes, the income of the trust is often taxed in the hands of the

beneficiaries.

• Foreign non-grantor trusts

• Generally taxed as non-resident alien individuals (only on U.S. sourced income).

• The trusts get a deduction for the proportion of their distributable net income that are distributed to the

beneficiaries, and the U.S. beneficiaries include the distributed amounts of income in their income. If

Canadian tax has been paid on non-US income, FTC is likely available for U.S. tax purposes.

• They have the ability to accumulate income to the extent that the income is not distributed to the U.S.

beneficiaries. However, this would trigger punitive throwback tax rules, which in general terms, tax and

interest charges are applied to “throw back” the income into the accumulation years.

• Most Canadian discretionary family trusts would distribute their income currently and typically will not

accumulate income.

• Require additional reporting requirements and incur penalties for non-compliance.

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• Testamentary Trusts in Wills/Trusts

• What is a qualifying Canadian Spousal Trust?

• (1) Income to the spousal trust must be distributed to the surviving spouse on an annual or

more frequent basis; and (2) No other beneficiaries can enjoy the benefit of the trust assets for

as long as the surviving spouse is alive.

• Using A/B Exclusion/Inclusion Trusts or the Qualified Domestic Trust for a Canadian-resident,

dual-citizen surviving spouse.

– Scenario 1 – Spouse 1 is Canadian only, and Spouse 2 is a dual citizen. Both are Canadian

residents.

– Scenario 2 – Spouse 1 is a dual citizen, Spouse 2 is Canadian only. Both are Canadian

residents.

– Scenario 3 – Both spouses are dual citizens living in Canada.

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CROSS-BORDER SPOUSAL TRUSTS – TRAPS/OPPORTUNITIES

• Article XXIX B(5) of the Treaty – testamentary

• Relief from deemed disposition for US residents – principally applicable for “taxable Canadian property”

• Potential for US-resident testamentary spousal trust with competent authority agreement

• Part XII.2 tax

• Can apply in contexts in which Canadian real estate is owned by a trust with non-resident beneficiaries

• Purpose/policy is to not permit certain incomes/gains to be allocated to non-residents and to be subject to

Part XIII tax (Canadian withholding) rather than Part I tax

• Can also apply to inter vivos spousal trusts on the right facts

17

CROSS-BORDER ESTATE PLANNING – PROBATE PLANNING

• Multi-Jurisdictional Probate and Incapacity Issues

• Time and cost

• Potential issues with probating the original Will in multiple jurisdictions, and reconciling the differences in

execution formalities.

• Usage of the situs Will.

• Probate rules in Canada (Ontario)

• In Ontario, probate is not legally mandated. However, for certain types of assets, probate is almost always

required as third-parties will typically call for probate before transferring them to the beneficiaries.

• Once probate is triggered, all assets are subject to probate.

• Application of the Estate Administration Tax (E.A.T.) – in the aggregate, it is approximately 1.5% of the fair

market value of the probate-able estate.

• Some probate planning available in certain provinces, such as the opportunity to carve out a Primary and a

Secondary Estate.

18

CROSS-BORDER ESTATE PLANNING – GIFT TAX

• Gift Tax Rules

• U.S. lifetime gift tax exclusion and the estate tax

• Lifetime gifts to a US citizen and resident spouse qualifies for the unlimited marital deduction.

• Gift tax as applied to non-citizen Canadian residents:

• Lifetime gift tax exclusion is not available to non-citizens of the US.

• For donors who are non-US persons, US gift tax only applies to the extent that they gift US situs property that

qualifies as US tangible property, which are property that are physically located in the US, i.e. real estate,

boats, cars, jewelry, and cash. If applicable, non-US persons will report such taxable gifts by filing a Form 709

– United States Gift (and Generation Skipping Transfer) Tax Return to the IRS.

• Any gift above the annual gift tax exemption is subject to gift tax rates up to 40%, which is taxed in the hand

of the Donor.

• There is no tax on gifts in Canada in either the hand of the donor nor the donee. However, there is a tax

consequence when the gift consists of capital property. The transfer of ownership of a capital asset (i.e. an

asset that has accrued gain) is considered to be a disposition for Canadian tax purposes.

– Example: Donor gifts Donee a gift of real estate that has a fair market value of $200,000, and the cost

basis of the real estate is $100,000. For tax purposes, a disposition occurs, triggering capital gains tax in

the hands of the Donor on the $100,000 of unrealized appreciation. The Donee acquires the gifted

property at an adjusted cost basis of $200,000.

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CROSS-BORDER ESTATE PLANNING – LIFE INSURANCE

• Canadian taxation of “exempt” life insurance

• Valuation at death

• US taxation of life insurance

• Corporate ownership

• “capital dividend account” and “capital dividends”

• US treatment – estate tax and income tax

• Use of Canadian-resident ILITs

Canadian Family Corporation

Patriarch/MatriarchFamily

discretionary trust

Voting fixed-value prefs

Non-voting commons

Corporately-owned life insurance

20

ESTATE FREEZE

• Common Canadian estate tax-planning technique, well

accepted (within limits) by the Canadian tax authority

• An “estate freeze” is an estate and tax planning

technique undertaken with the objective of transferring

the future growth in asset value to another taxpayer

while converting the current value of the asset to a

fixed amount for the original owner (the “freeze”).

Typically, the downstream freeze is in favor of the

taxpayer’s children or grandchildren, or a younger

spouse/common-law partner.

• Canada accepts valuation theory – no value shift

• But see Kieboom, Romkey, Krauss (partnership),

• Price adjustment clauses

• Add a US component – all persons are US citizens,

patriarch/matriarch are US citizen, children are US persons

• 351(e) – non-qualified preferreds

• PFIC/CFC implications

• Trust throw-back rules

• Gift/estate tax implications – §§ 2036, 2038, 2701, etc.

• § 368(a)(1)(E) – family-owned corporations, §447(d)(2)(C)(i), TCJA

• Stock dividend - § 305; Canadian definition of amount

(hi/lo stock div)

• Freeze with a ULC?

Canadian Family Corporation

Patriarch/Matriarch Family discretionary trust

Voting fixed-value prefs Non-voting

commons

CROSS-BORDER IMPLEMENTATION


22

CROSS-BORDER PARTNERSHIPS AND CORPORATE STRUCTURES

• Choice of entity / entity classification

• Canada “two-step” analysis

• US so-called “check-the-box” regulations

• Canadian entities: corporation, unlimited liability corporation, partnership

• US entities: corporation, partnership (LP, LLP, LLLP), statutory/business trust, LLC, etc.

• Canadian perspective: corporation or partnership, absent certain financing or other structures

typically seeking consistent treatment in Canada and the US

• Article IV of the Treaty – LLC, LLP, LLLP; but s-corporations

• US perspective: blocker or flow-through (eligible entity)

• Classification of actual legal joint venture (IRC § 7701(a)(2) vs. Bow Valley Husky (Bermuda),

Continental Bank; PLR 201305006)

23

INBOUND TO US STRUCTURES

Canadian Holding Corp.

US Operating Corp.

USA

Canada

US business assets or rental real estate

Canadian shareholders (non-USCs)

Canadian LP

US LP

US rental real estate

Canadian partners (non-USCs)

Canadian Operating Corp.

US branch


Canadian Holding Corp.

CTB partnership

US business assets or rental real estate


24

INBOUND TO CANADA STRUCTURES

US Holding Corp.

Canadian

Operating Corp.

USA

Canada

Canadian business assets or rental real estate

US shareholders

US LP

Canadian LP

Canadian rental real estate

US shareholders

US Operating Corp.

Canadian branch

US shareholders

S-corp

ULC

Canadian business assets or rental real estate

US shareholders

25

TREATY-SPECIFIC RULES AND PARTICULAR CASES

• Article XXIV of the Treaty

1. […] In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a citizen or resident of the United States, or to a company electing to be treated as a domestic corporation, as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada; […]

3. For the purposes of this Article:(a) profits, income or gains (other than gains to which paragraph 5 of Article XIII (Gains) applies) of a resident of a Contracting State which may be taxed in the other Contracting State in accordance with the Convention (without regard to paragraph 2 of Article XXIX (Miscellaneous Rules)) shall be deemed to arise in that other State;

• Common pre-TCJA structure – s-corp owning ULC to carry on

Canadian business

• Business income: resourcing rule likely not required –

862/864

• Difficult cases: capital gains, ancillary income

ULC

S-corp

USA

Canada

• Canadian operating business

• Canadian real estate• Investments• Ancillary US activities

26

David A. Altro

B.A., LL.L., J.D., D.D.N., FLC, TEP

[email protected]

Bradley R. Thompson

B.A., M.A., B.C.L., LL.B., LL.M.

[email protected]

Samantha Y.F. Wu

B.A., J.D.

[email protected]

(416) 477-8150www.altrolaw.com

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