U.S. vs Canadian Estate Taxation

Estate Taxation - Image of white and peach coloured houseThe U.S. and Canada have considerably different systems of taxation related to the estates of deceased persons.

Estates in Canada

For Canadian purposes, a Canadian resident, is deemed to have disposed of all property owned at the date of death at fair market value, thus triggering capital gains tax on any unrealized capital gains. Tax deferred items, such as Rasp’s are deemed to be disposed of at the same time, subject to certain rollovers available to the spouse of the deceased. The executor is permitted to file up to four separate income tax returns for the same decedent for the year of death for four separate classifications of income. The beneficiaries of the estate receive the property with a tax value equal to the fair market value used by the estate on the deemed disposition, and there is no system of estate taxation.

U.S. Estate Taxation of Residents and Citizens

The Economic Growth and Tax Relief Reconciliation Act of 2001 has effectively repealed the estate tax.

In the U.S., although estate tax is based on the value of the estate at the date of death (or the alternative valuation date which can be up to 6 months after the date of death), the estate tax in the period before elimination of the tax is subject to graduated tax at rates ranging from 18 to 40%,

Gift tax is levied on persons who transfer portions of their otherwise taxable estate to beneficiaries, by way of gift.  The tax may not be immediate, since taxable gifts over the lifetime of the grantor will reduce the estate tax exemption until it is depleted. For 2019, there is an annual exclusion of $15,000 per donee for gifts.

Each U.S. citizen or resident taxpayer is allowed an exemption against the gift and estate tax. The exemption amount shields a total transfer of $11.4 million per individual from tax in 2019. 

The estate tax system is designed to defer the major tax cost until the second of a married couple die, since transfers to a U.S. spouse are exempt from estate taxation (by the application of the marital credit).  Qualified trusts are also used to plan an orderly taxation of estates.  Severe complications may result in cases where a U.S. citizen is married to a non resident alien, since the U.S. citizen’s estate may be increased by a bequest from a non resident alien  spouse.  Specialized planning including the use of trusts is recommended in such cases.

The exemption against estate tax is reduced by taxable lifetime gifts (since 1932) exceeding the annual gift limit, (which is $14,000 for 2016) thus reducing the opportunity for distributing an estate during the lifetime of the decedent.

The beneficiary of an estate receives property at the fair market value used in the estate valuation, notwithstanding that no capital gains tax was paid by the estate on the value of the assets.

U.S. Estate Taxation of Nonresident Aliens

Prior to 1988 non-resident aliens of the U.S. were subject to estate taxation only on U.S. situs assets subject to a reduction of $60,000, but at tax rates that ranged from 6% to 18%, thus resulting in a tax rate more favorable than for U.S. citizens and residents.

The Death Tax Elimination Act signed on March 29, 2001 taxes only assets located in the U.S. and allows an exemption of the greater of $60,000 or the proportion of $175,000 that the U.S. situated assets represent of the entire estate. There is special relief from U.S. estate taxation for small Canadian estates with a total value under $1.2 million (in 2012).  In international estates, the marital credit is limited to spouses who are U.S. citizens.  Many U.S. citizens married to a non citizen spouse use U.S. Qualified Domestic Trusts (QDOT) to allow a deferral of tax on transfers on death.

Canadian Marital Credit

Paragraph 3 of Article XXIX B of the Treaty allows a special marital credit for transfers of property to a surviving spouse who is not a U.S. citizen, but a citizen of or resident of Canada.  To limit the provisions of this article to smaller estates, if certain conditions are met, this Treaty article allows for a marital deduction limited to the lesser of either the tax which would otherwise be payable on assets transferred to the spouse, or the amount of credits otherwise available.  In order to invoke this special “Canadian Marital Credit”, the trustee must waive the benefits of any marital deduction which would normally be available under U.S. law.

Foreign Tax Credits for Estates

Since the basis of taxation of estates is different in Canada and the United States, no foreign tax credit is permitted. However, Canadian capital gains taxes resulting from deemed dispositions on death are deductible from the gross estate for U.S. purposes.

This summary has been designed to provide a concise overview of the subjects addressed, and may not be complete. Reference should be made to original legislation prior to acting on any matter, and professional advice should also be obtained.