U.S. citizens living in Canada

Some tax & estate planning considerations during a U.S. election year
  

During a U.S. federal election year, any administration change can spell fiscal policy changes that can potentially impact your wealth planning. While we are not in the business of predicting election outcomes, we think it is prudent to highlight one area that may be sensitive to a shift in political power – the lifetime U.S. federal estate and gift tax exemption available to U.S. citizens.

We have outlined some key issues to help with any advance planning for U.S. citizens living in Canada, particularly those with an individual net worth of at least US$3.5 million.

U.S. federal estate and gift taxes

U.S. citizens are subject to the U.S. federal estate tax on the value of their worldwide estates owned at the time of death. The federal estate tax is computed on an individual basis at marginal rates, with a top rate of 40% applying on the value of taxable estates exceeding US$1 million.

Since the U.S. federal estate tax applies at death, U.S. citizens may gift their assets prior to death so that there is no estate remaining. As a backstop to this type of planning, the U.S. also has the federal gift tax that applies to tax transfers of assets made during life at the same rates as the federal estate tax.

In computing U.S. federal estate and gift tax, each U.S. citizen is able to claim a lifetime exemption to offset such taxes owing. Any amount of the exemption applied during a U.S. citizen’s lifetime against federal gift tax will reduce the amount available at death to apply against federal estate tax.

The following are key facts about the lifetime exemption:

  • Current exemption: US$11.58 million for 2020. Under current laws, this amount is indexed annually to inflation but will return to US$5 million (to be indexed for inflation) on January 1, 2026. U.S. citizens are allowed to take advantage of the approximate US$6 million difference in the exemption between now and 2026 by gifting assets without a claw-back of their remaining exemption amount in 2026.
  • The Democratic Party has proposed to decrease the exemption to US$3.5 million. This decrease could apply as early as January 1, 2021.

Planning

You should consider, with your professional tax and legal advisors, whether you should gift assets now to your heirs as part of your overall wealth planning in order to make use of the higher exemption amount that is available for 2020, should it decrease as early as 2021. This has the benefit of reducing the value of your estate, thereby reducing your federal estate tax exposure at death.

A step-by-step example

Your estate is worth US$10 million today and you have the full lifetime exemption amount of US$11.58 million available. If you were to die by December 31, 2020, you will not have any federal estate tax liability.

If the exemption is reduced from US$11.58 million to US$3.5 million on January 1, 2021, and you were to die in 2021, you will face a federal estate tax liability of US$2.6 million on the same US$10 million estate. This would be a significant erosion of your wealth.

You could plan for this risk by gifting up to US$6.5 million to your heirs in 2020 so that the value of your estate decreases from US$10 million to US$3.5 million before 2021. You will not pay the federal gift tax on the US$6.5 million gifted by virtue of using your available exemption of US$11.58 million in 2020, and you will still have a remaining exemption of US$3.5 million in 2021 to use against future federal estate and gift taxes.

Items to consider

  • Generally, gifts that are made to achieve this planning are irrevocable—you cannot get back the assets you gift. This planning is also on the assumption that political power shifts and the exemption decreases much earlier than 2026 as provided under current laws. Given these risks, this planning should only be done if you can afford to and you are comfortable with it.
  • As you are also a resident of Canada, any gifts you make will have to factor in Canadian income tax rules that may be applicable, such as the deemed disposition of transferred assets as well as the attribution rules. These rules can result in immediate Canadian income tax payable upon the gifting of assets to another individual, as well as future Canadian income tax payable through the attribution of future investment income and capital gains on the gifted assets back to you.
  • Planning should not be rushed and the proverbial “tax tail should not wag the wealth-planning dog.” You should seek professional tax and legal advice in order to facilitate the gifts in a way that achieves your overall wealth-planning objectives. Among some of the questions you may need to consider are the following: Should you gift large amounts to your heirs outright, or would it be better to put more structure around the gifts? Perhaps your heirs are also U.S. citizens who are subject to the federal estate tax and so gifting assets outright to them may end up increasing their tax burden? Are there certain assets that are more efficient to gift than others?

While we will not know if and when changes in U.S. estate and gift tax rules will occur until after the November 2020 election, it is important as a U.S. citizen living in Canada to understand any U.S. tax-policy proposals. This is a summary of one of the planning strategies that may be considered. It is important that you consult with your professional tax and legal advisors to determine whether this, or any other strategies, are appropriate in your circumstances. For further information, contact your Richardson GMP Investment Advisor.
 


Canadians subject to U.S. estate tax

It is not just U.S. citizens that are subject to the U.S. estate tax. The U.S. estate tax can also apply to non-U.S. citizens who own “U.S. situs assets” at death. Therefore, while the potential change in the lifetime exemption directly impacts U.S. citizens, it can also indirectly impact non-U.S. citizens who have a net worth exceeding the exemption amount available. If you are a non-U.S. citizen and are interested in learning more about your U.S. estate tax exposure, please ask your Richardson GMP Investment Advisor for a copy of our “U.S. Estate Tax for the Non-U.S. Citizen” education article.