Bar News - March 16, 2016
Elder, Estate Planning & Probate Law: So, Your Clients Have Assets in Canada, Eh?
By: Patricia M. McGrath and Michelle Arruda
Even if Donald Trump builds a wall, some of our clients will own or acquire assets in foreign jurisdictions, frequently in our neighbor to the north – Canada. When working with such a client, estate planners must be aware of certain Canadian tax and non-tax issues.
The typical estate planning “client” is a married couple, both US citizens. Occasionally, they own real estate in other states, and the value of their estate exceeds the federal estate tax “applicable exclusion amount.” Working with that married couple, we bring to bear our knowledge of US and state tax laws, and expertise concerning avoiding probate.
Our advice typically includes funding revocable trusts, for the following “probate avoidance” reasons: maintaining privacy, swifter “estate” settlement, and reduced settlement costs. A revocable trust is especially important when a client owns real estate in multiple states; if the real estate is not titled in the trust, multiple probate administrations may be required.
Minimizing estate taxes may involve establishing continuing trusts after the first spouse’s death. Even if estate tax planning is not needed, keeping property in trust after death may be advisable for various protective reasons.
Now consider that the married couple owns or is acquiring Canadian real estate and a Canadian bank account. Is our usual advice sound? Is there anything further to consider?
A starting point is to consider the Canadian tax that applies when real estate is transferred to or owned by a trust. A second consideration is the provincial law governing the ownership and death time disposition of real estate. Finally, consider the US reporting of foreign accounts.
Canada does not have a transfer tax system comparable to the United States. Instead, Canada treats a gratuitous transfer during life or at death as if the owner had disposed of – sold – the property at its fair market value immediately prior to the transfer (See generally section 38 of the Income Tax Act of Canada (ITA); ITA Section 70(5)). The owner is then taxed on 50 percent of the unrealized capital gain (ITA Section 38(a)). At the top marginal rate of 33 percent, the effective rate of the Canadian capital gain tax is 16.5 percent.
Importantly, this “deemed disposition” tax applies to a lifetime transfer to a revocable trust. Moreover, under Canadian tax law, with certain exceptions, a trust is deemed to have disposed of its capital assets every 21 years, essentially making long-term trusts unviable (ITA Section 104(4)(b-c)).
At death, married Canadian decedents can benefit from a tax-free rollover of the Canadian property to the surviving spouse and to certain testamentary QTIP-type spousal trusts (ITA Section 70(6)). Canadian tax law does not confer this benefit, however, on nonresidents.
Fortunately, the United States-Canada Income Tax Convention (the “treaty”) provides some tax relief. First, a US decedent leaving Canadian property to a surviving spouse or to certain spousal trusts can defer the deemed disposition tax until the surviving spouse’s death, because the treaty treats the decedent and his spouse as if they were Canadian residents (Article XXIXB of the treaty). Second, the decedent’s estate may obtain a credit against the decedent’s US estate tax for the Canadian deemed disposition tax at death (Article XXIXB). This is a federal tax treaty, however, so it does not mitigate any state estate tax liability. Also, tax relief is not available for lifetime transfers.
Accordingly, for the couple who already owns their Canadian real estate, the usual “fund your trust” advice has a cost; transferring the real estate to the trust will trigger the Canadian capital gain tax, and the later death of the donor could trigger the tax on the additional unrealized gain at that time. The first tax can be avoided, of course, if the couple originally acquires the property in the name of the trust, but not the second tax, unless the death-time beneficiary is the surviving spouse or a spousal trust, in which case rollover relief may be available. However, when the property ultimately is distributed from the trust to a non-Canadian beneficiary, then the deemed disposition rules will apply. Moreover, depending on the terms of the trust, while the property is held in trust, there could be a deemed disposition every 21 years.
Is this couple better off holding title to the Canadian property in their own names? If so, they should be strongly advised to execute wills that comply with Canadian provincial law. Financial powers of attorney that comply with local law also are advisable, in the event the Canadian property needs to be sold or otherwise managed during a period of incapacity.
Moreover, note that the separate Canadian provinces govern the legal aspects of property ownership. For example, Quebec generally is a civil law system rather than the English common law system. As such, it does not recognize joint tenancy with right of survivorship, and a surviving joint-tenant spouse will not take sole title by operation of law. Without further recognized directions, the surviving spouse will unexpectedly become subject to local intestacy rules.
Finally, if the couple establishes that Canadian bank account, they may have multiple US reporting obligations. Under the Foreign Bank and Accounting (FBAR) rules, a “U.S. person” (including a US citizen or resident and a trust created under US laws) holding any financial interest in, or authority over, a financial account in a foreign country generally must report the account on Financial Crimes Enforcement Network (FinCEN) Form 114, if the value of all foreign accounts exceeds $10,000 (31 CFR Section 1010.350), and must note the existence of the account on his or her US income tax return.
There are substantial penalties for even negligent failure to comply with these reporting requirements. There also are Foreign Account Tax Compliance Act (FATCA) reporting requirements, requiring any taxpayer with an interest in a “specified foreign financial asset” to attach Form 8938 to his or her income tax return for any year in which (for single filers) the aggregate value of all such assets is greater than $50,000 on the last day of the taxable year or $75,000 at any time during such year (IRC Section 6038D).
In sum, when dealing with a client with Canadian assets, there are tax and non-tax considerations that may necessitate advice different from advice typically given to solely US-based clients. In particular, holding real estate in a revocable trust may not be optimal. As a result, the client may need a Canadian will and power of attorney. Moreover, the client should be informed of US reporting requirements for Canadian financial accounts. The best advice, of course, is to consult with local Canadian counsel.
Patricia McGrath is a shareholder at Devine Millimet & Branch, focusing on employee benefits and estate planning.
Michelle Arruda is a shareholder at Devine Millimet & Branch, whose practice includes estate planning and trust and estate administration.