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Canada-US Cross-Border Will Planning August 2006 Nadja Ibrahim

Canada-US Cross-Border Will Planning August 2006 Nadja Ibrahim. AGENDA. 1. U.S. Estate Tax Regime 2. Insurance 3. Will Planning: US citizen spouse US citizen decedent US beneficiary 4. Charitable Deduction Planning 5. Inheritance Trust Planning. US Estate Tax Regime.

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Canada-US Cross-Border Will Planning August 2006 Nadja Ibrahim

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  1. Canada-US Cross-Border Will PlanningAugust 2006Nadja Ibrahim

  2. AGENDA • 1. U.S. Estate Tax Regime • 2. Insurance • 3. Will Planning: • US citizen spouse • US citizen decedent • US beneficiary 4. Charitable Deduction Planning 5. Inheritance Trust Planning

  3. US Estate Tax Regime • U.S. citizens or residents (including dual citizens): • Taxed on FMV of worldwide estate at death • If assets < US$2 million  No U.S. estate tax • Unified credit available = $780,800 • Non-resident aliens (“NRA”): • Taxed on FMV of U.S. situs property owned at death • If worldwide estate < US$2 million  No U.S. estate tax; otherwise, • If U.S. assets < US$60,000  no U.S. estate tax • May be increased under the Canada-U.S. Treaty

  4. US Estate Tax Regime • Enhanced Unified Credit / Exemption • Allows for a pro-rated amount of the unified credit available to a U.S. person, calculated as follows: • Unified Credit ($780,800) X US assets/worldwide assets • Unified credit is never less than $13,000 provided for under US domestic tax law

  5. Year (US$) Exemption (US$) 2002 $1 million 2003 $1 million 2004 $1.5 million 2005 $1.5 million 2006 $2 million 2007 $2 million 2008 $2 million 2009 $3.5 million 2010 N/A (repealed) 2011 & after $1 million Unified Credit Highest (US$) Estate Tax Rate $345,800 50% $345,800 49% $555,800 48% $555,800 47% $780,800 46% $780,800 45% $780,800 45% $1,455,800 45% N/A 0% $345,800 55% US Estate Tax Regime

  6. Insurance Common Mistake • Owning life insurance personally can have adverse US estate tax consequences. • “Incidents of ownership”, include the following: • right to change beneficiaries or their shares • right to surrender the policy for cash or to cancel it • right to borrow against the policy reserve • right to pledge the policy as collateral • right to assign the policy or cancel an assignment

  7. Insurance • Implications of having incidents of ownership: • US citizens are subject to US estate tax on the proceeds of life insurance which they own/have incidents of ownership, or if their estate is the beneficiary of the life insurance policy. • Value of insurance proceeds added to worldwide estate of Canadian which reduces tax credit allowed under Treaty • US person could create trust and contribute premiums to trust • Trust is owner of insurance policy • Family members are the beneficiaries • US person is not a trustee • Trust must be structured from both estate and gift tax perspective

  8. US Citizen Spouse Will Planning • Mr. Brown - Canadian resident and citizen • Significant wealth, all assets left to Mrs. Brown on death • Mrs. Brown – Canadian resident and US citizen • On Mr. Brown’s death: • No US estate tax (unless significant US assets) • On Mrs. Brown’s death: • Will be subject to US estate tax on the value of her worldwide estate (including assets from Mr. Brown) • Current estate tax exemption is $2 million USD. • Watch insurance

  9. US Citizen SpouseWill Planning • Canadian spouse trust • Migration clause (possible move to US) • Structured to keep assets out of Mrs. Brown’s estate • No general power of appointment. Can’t appoint assets to • Herself • Her creditors • Her estate • Her estate’s creditors • Canadian spousal rollover applies

  10. US Citizen SpouseWill Planning • Mrs. Brown – Trust terms: • Entitled to all income, including capital gains, to avoid adverse US throw-back rules • Discretionary capital entitlement • 5 and 5 power • Right to demand greater of $5,000 and 5% of trust capital once a year • Can be a trustee • Subject to an ascertainable standard restriction (health, support, maintenance and education). • Can’t participate in decisions to distribute to herself above the standard

  11. US Citizen DecedentWill Planning • Mr. Brown • Canadian resident, US citizen • Significant wealth • Assets pass to Mrs. Brown on his death • Mrs. Brown • Canadian resident, Canadian citizen • On death of Mr. Brown • No marital deduction for outright transfer to non-US citizen spouse (but marital credit under Treaty) • US estate tax liability on worldwide assets • May need to trigger Canadian tax to get FTC

  12. US Citizen DecedentWill Planning SOLUTION 1 Mr. Brown’s Will: • Transfer to spouse/spouse trust • Qualifies for Canadian income tax rollover • Qualifies for marital credit – combined with unified credit shelters approx. $3.7 million USD from estate tax • Keep in mind amount of insurance owned by Mr. Brown – may increase estate value beyond $3.7 million USD. • If significant US assets ensure spousal trust created to avoid US estate tax exposure for surviving spouse on the US assets

  13. US Citizen DecedentWill Planning SOLUTION 2 – For Estates over $3.7 million USD • Qualified Domestic Trust (QDOT) for US purposes • Eligible for the marital deduction • Estate tax deferred until death of Mrs. Brown • Terms of QDOT: • Spouse entitled to all income • No one other than spouse can take capital during lifetime of spouse • At least one trustee must be a US citizen • If assets >$US 2 million • Provide security (bond or letter of credit) OR • US financial institution must be a trustee • Evaluate benefits of deferral • assess whether Canadian tax liability sufficient to offset US estate tax

  14. US BeneficiaryWill Planning • Create special trust for US beneficiary to ensure assets do not form part of beneficiary’s estate for US estate tax purposes. • US beneficiaries are taxed on distributions from a Canadian trust. The US calculation is complicated and often involves an interest component – pay income/gains from trust annually. • US beneficiary needs to file Form 3520 if he/she receives any distribution from the Canadian trust. Form 3520 needs to be filed even if the distribution is non-taxable. • Penalty for failure to file Form 3520 is 35% of the value of the distribution received by the beneficiary.

  15. US BeneficiaryWill Planning • US anti-deferral rules: • Rules may apply when a Trust or Estate owns shares in a Canadian company and there is a US beneficiary – usually applies if Canadian investment holding company involved. • Rules require the beneficiary to include his/her share of the company’s income on the beneficiary’s US income tax return, regardless of whether an amount is actually received. • Income is taxed to the beneficiary at regular tax rates. • Evaluate whether US beneficiary’s entitlement may be satisfied with assets other than company shares.

  16. Charitable Deduction Planning • Planning is available for a Canadian resident who wishes to make a charitable bequest and owns US property (say, US securities), which will be subject to US estate tax on death • US provides deduction for donation of US property to US domestic charity • Canada-US Treaty provides for charitable deduction for bequests to Canadian registered charity • If Canadian property is donated the deduction is prorated. • If US property donated there is a dollar for dollar deduction • Particularly attractive given new legislation which eliminates Canadian capital gains on donation of securities to charity.

  17. Charitable Deduction Planning Example: • Canadian resident taxpayer died in 2006 (never a U.S. citizen) • No spouse • Total worldwide assets = US$3,500,000 • Includes U.S. securities = US$400,000 • Charitable bequest in will = US$100,000 • Taxpayer provides in will that bequests to charity should be satisfied with US securities. • Charitable deduction planning will eliminate or reduce US estate tax payable.

  18. Charitable Deduction Planning

  19. Inheritance Trust PlanningClient Scenario • Sally – Canadian resident, US citizen • Sally’s mother – US resident and US citizen • Mother is quite elderly and Sally expects to inherit significant wealth from mother’s estate. • Client’s Question: How should I receive the inheritance?

  20. Inheritance Trust PlanningStructure Beneficiaries: - Sally Sally’s mother (US) (only contributor) NRT Trustees: • Sally and U.S. resident • Sally’s mother establishes US domestic trust under will for benefit of Sally: • Beneficiary’s interest is discretionary • Beneficiary given limited power of appointment • Trust assets invested

  21. Inheritance Trust PlanningIncome Tax Opportunity • Reduced income tax rates on investment income • 15% on qualified dividend income • 15% rate on long-term capital gains • State tax • Limits US estate tax exposure for US citizen beneficiary • subject to Generation Skipping Tax Limit in the US • Canadian non resident trusts rules do not apply • 21 year rule does not apply

  22. RRSPs and US Estate Tax • US assets held in RRSP are subject to US estate tax • Elimination of foreign content rule in RRSPs may see increase in US estate tax exposure • Canada allows a foreign tax credit for US estate tax paid against Canadian taxes arising on US property on death due to the Treaty • CRA has indicated that Treaty relief does not apply to RRSPs. • Can apply to Competent Authority if the result is double tax – should be allowed since IRS has allowed such a credit. • Problem likely to be resolved as a result of current Treaty negotiations.

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