Death and Taxes and Taxes in Death – U.S. Estate Taxes
We’ve all heard the refrain before – death and taxes – these are two certainties we must all face as part of life. Believe it or not, you can also be taxed after death.
After your death, even if you are a Canadian citizen your estate may be subject to U.S estate taxes.
What is U.S. Estate Tax?
This is the tax imposed on the estate of a deceased person, such as property transferred under a will and certain other property that flows on death. This tax can apply to U.S. business assets, U.S. real estate property, U.S. stocks and other assets above a certain market value. I’ll provide more details on that in a bit.
U.S. estate tax is applied on a scale. These rates apply whether the individual is a U.S. citizen, a U.S. resident, or a non-resident ― the difference is that for non-residents who are not U.S. citizens only the value of property with a U.S. location or connection is included in calculations. Canadians investing in the U.S. should be concerned about this and read on to see if this tax might apply to their estate.
But I’m a Canadian citizen!?
Regardless if you’re a Canadian resident, even if you don’t live in the U.S. or you’re not married to a U.S. citizen, upon death your estate may be subject up to 40% U.S. estate tax after January 2013. (Recall Canada doesn’t have any estate tax.) As a Canadian citizen, when you die, our tax laws say you dispose of all your capital property and assets at fair market value, unless the assets are transferred to certain people. You may have some capital gains but you may also be able to take advantage of some tax deferrals. Let’s quickly use RRSPs as an example.
When Canadians die, RRSPs are deemed “disposed” and depending upon who is the beneficiary, the tax consequences from your RRSP can be deferred to your spouse or other financially dependent individual.
Back to U.S. estate taxes…
When Canadians die, they will be forced to pay U.S. estate taxes depending primarily upon:
- their worldwide assets, and
- how much of those worldwide assets are U.S. “situs” assets.
U.S. situs assets is a fancy term that includes the following stuff:
- Real estate property (e.g., condo in Florida) and other tangible property situated in the U.S.,
- U.S. securities, including those held in a discount brokerage account in Canada or outside Canada like:
- U.S. mutual funds including money market funds,
- U.S. securities including ETFs and stocks in an RRSP, RRIF, RESP or TFSA,
- Any business-related assets owned by a sole proprietor and used in a U.S. business activity,
- Some U.S. debt obligations.
Fortunately, the Canada-U.S. tax treaty provides Canadians with some exceptions from U.S. estate tax.
As of January 2013:
Generally speaking, this treaty allows Canadians to avoid U.S. estate tax if:
- The worldwide assets of the deceased estate value is less than $5.5 million USD
- U.S. situs assets of the deceased are less than $60,000 USD at the time of death regardless of worldwide assets.
You must satisfy both of these conditions to have U.S. estate tax exposure.
Updated for clarity as of January 2019:
- If the value of U.S. property you own upon your death exceeds US$60,000, your estate is required to file a U.S. estate tax return regardless of whether you’ll actually incur a U.S. estate tax liability.
- Starting January 1, 2018, the U.S. estate tax exemption is increased from US$5 million to $10 million, subject to a new “chained CPI” inflation-adjustment factor, which would make the exemption approximately US$11.4 million for 2019. These changes also increase the U.S. gift tax and GSTT exemptions.
- The increased exemptions will expire on December 31, 2025. At that time, the increased exemptions will revert back to the current $5 million exemption (indexed to inflation) beginning on January 1, 2026, unless additional legislation is enacted to extend or change them.
- The 40% maximum tax rate for U.S. estate remains the same for 2018 to 2025.
But also know…
In addition, under the Canada-U.S. tax treaty a foreign tax credit may be claimed in Canada with respect to U.S. estate taxes paid. The credit may only be claimed to offset Canadian income tax otherwise payable to those U.S. situs assets such as:
(a) capital gains tax triggered in Canada upon the death of the owner of U.S. situs assets, and
(b) RRSP/RRIF income inclusions where the RRSP/RRIF held U.S. situs assets.
The latter is very important to be aware of (and your lawyer and professional accountant will know what to do) since if this foreign tax credit is not applied for, the credit will not be applied and your estate may be forced to pay both U.S. estate tax and Canadian income tax on the U.S. situs assets. Double-taxation.
Needless to say this is a very complex tax subject and U.S. estate taxes can make investors’ heads spin. Furthermore, I just scratched the surface with this post today. So, to wrap up, some considerations for you for a complex but important subject:
- Make sure you have an up to date will with an executor named,
- Make sure you have beneficiaries identified for all your investment accounts which permit beneficiary designations,
- If you have a large worldwide estate, choose an executor who will strategically maximize your estate’s ability to claim a foreign tax credit in Canada for any U.S. estate tax required to be paid.
I want to thank Mark Goodfield and namely his colleague Katy Basi for providing some assistance on this blogpost. Katy Basi is a barrister and solicitor in the Toronto area, focusing on wills, estate planning and income tax law. While Katy is not qualified to practice U.S. law, she did review this post based on her current knowledge in this complex area.
@My Own Advisor
Thoughts? Yes. The definition of diversification isn’t open for interpretation :). It’s not willy-nilly like you seem to be doing. If you have Canadian stocks in company A, and you have U.S. healthcare stocks, and those stocks rise and fall together, then it’s clearly not diversification. You’re happy, thinking you’re diverse, but in reality it’s no different financially than if you had all 100% of your funds in one or the other. It only becomes diversification if you know that if the canadian stocks go down, that the U.S. healthcare either doesn’t react, or they go up. That’s diversification.
And if you don’t know if they react in tandem, then again, it’s not diversification. You seem to be falling prey to the common misconception that having different things make you diverse. It’s vital that your readers understand this distinction. There’s too many people that think they’re diverse because they own a bunch of different mutual funds.
Investopedia defines it this way:
A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio.
Diversification strives to smooth out unsystematic risk events in a portfolio so that the positive performance of some investments will neutralize the negative performance of others. Therefore, the benefits of diversification will hold only if the securities in the portfolio are not perfectly correlated.
So, your point about stocks rising and falling together, is not diversification – we agree. Stocks that have a lower risk or beta however than other stocks, is by definition diversification.
As long as we’re talking about just stocks and only stocks, then there is not much diversification since you are not expecting one stocks by and large to outperform the other. Certainly an indexer thinks this way.
If however, you’re owning stocks, bonds, real estate and other asset classes, then different asset classes should expect to have different return expectations.
Glenn, the best diversification is with assets such as bonds, real estate, cash, and commodities, but international stock markets still have some value. I noticed recently that while the US market has increased quite a bit over the last few years, the TSX has stayed pretty flat. That’s why I’m putting a bit more into Canadian stocks these days. Maybe the diversification works better over a period of a few years than a few days.
I think diversification definitely works well over a few years. That said, I haven’t been happy with the performance of emerging markets of late…but I suspect they will come back.
Hi there. I’m glad Sarah required further clarification on U.S. Estate taxes because like her, I was (am) totally confused. Your footnote helped somewhat, but just to put the matter to rest, can I assume the following? At the time of death,
1 – If your total worldwide assets are less than the threshold of U.S. $5.25 million, and,
2 – You hold in excess of U.S. $60,000 in situs assets (U.S. E.T.F’s)
Then you are liable for U.S. Estate taxes?
My understanding is:
Condition # 1: you’re OVER $5.25 M USD and
Condition # 2: you hold OVER $60,000 U.S. situs assets, then you’re doomed to pay U.S. Estate Taxes.
If you only meet ONE condition, you escape!
The thing investors should be aware of, the $5.25 M USD threshold is likely to come down, maybe even to $1 M USD in the years to come. That put many more Canadians to a predicament. The $1 M USD value includes your principal residence.
@My Own Advisor
Mark said: ‘In the name of diversification, I definitely think holding U.S. stocks or ETFs is worth it, especially pre-retirement when you’re focused more on growth vs. income. ”
In the name of correcting misunderstandings due to name-calling, it’s only diversification if the U.S stocks are uncorrelated or negatively correlated with your current holdings. Too many people buy something ‘different’ and call it diversification. If you buy Canadian stocks and U.S. stocks in the name of diversification, but the two stock markets rise and fall in tandem, then you’re not at all diversified. This is only another variance of people who hold multiple mutual funds in the name of diversification (that’s not diversification).
In other words, don’t ‘think’ about it. Dig out the numbers, and find out if U.S. stocks are negatively or uncorrelated with your current holdings. And if they are, you’re diversified (though perhaps improperly). If they are correlated, then you’re not diversified at all.
To put it in real terms, people diversify with the goal of sheltering themselves from large downturns. But if what they’re holding is actually correlated in terms of returns – they rise and fall together – then when the crash comes, everything goes down – they weren’t sheltered.
(If I recall from my readings, U.S. stocks may have a small uncorrelated component with Canadian stocks. But if I also recall from my readings, international holdings were really only a secondary and minor diversification technique. The real diversification technique is still a mix of asset types – equities (however you mix it), cash, bonds, and real estate.)
Fair comment Glenn.
In the name of diversification I meant; for example, I hold no CDN stocks in the healthcare space but instead, I invest in US stocks in the healthcare sector. This, to me, is diversification.
This is not to say you cannot be more diversified: own bonds, real estate, etc. since the correlation is much greater when you compare stocks vs. bonds vs. RE. I do not see the term “diversification” as having only one definition.
When I think of how you mix stuff up, different asset types, that’s asset allocation.
I’m a bit confused…you state:
“Generally speaking, this treaty allows Canadians to be exempt from U.S. estate tax if after January 2013:
The worldwide assets of the deceased are less than $5.25 million USD (only in certain circumstances involving spouses can this amount be doubled).
U.S. situs assets of the deceased are less than $60,000 USD at the time of death, regardless of worldwide assets”
Wouldn’t this mean that you only have to worry about US estate taxes if your worldwide assets are more than $5.25 million AND your US assets are greater than $60,000USD? Would you not be exempt otherwise based on what you’ve written??
Also, you don’t even have to file US income taxes if your US holdings are less than $100,000, so that would seem to support this…no?
*sigh* so confusing!
Sorry, I didn’t mean to confuse. The essense is this…if you die and
a) The total value of your estate is >$5.25 M USD AND
b) Your estate includes the minimum of $60 K USD…
You’re on the hook for U.S. estate taxes.
In the case you meet only one condition, you’re off the hook.
The $5.25 M threshold is likely to come down over the years, as the U.S. attempts to tackle its national debt. This is going to hurt many Canadians, since your estate includes your primary residence, even if only in Canada.
Wow! This sure as heck puts a crimp in all of the other advantages of holding U.S. E.T.F’s. I am in the position of holding in excess of the U.S. $60,000 in U.S. E.T.F’s and was seriously considering adding to this. However, is it really worth it based on the new 40% U.S. Estate taxes?
Also, does the foreign tax credit for Canadians cancel out in it’s entirety the U.S. 40% Estate Tax?
Crazy I know, which is why I wanted to start wrapping my head around the issue. It definitely puts a damper on owning a bunch of U.S. stocks and ETFs. I hold in excess of that value as well, but I don’t intend to hold that much when I retire. Maybe about $50,000 or so for the very reason of U.S. Estate Taxes.
In the name of diversification, I definitely think holding U.S. stocks or ETFs is worth it, especially pre-retirement when you’re focused more on growth vs. income.
My understanding of the issue this – the foreign tax credit does not void the 40% estate tax entirely.
You can reduce your estate tax liability by claiming a tax credit, referred to as the unified credit, equal to the greater of either $13,000 or $2,045,800 (the estate tax on $5.25 million for 2013) multiplied by the value of your U.S. assets divided by your worldwide assets. For example, if your U.S. home accounts for 15 per cent of the value of your worldwide estate you would be entitled to a unified credit of $306,870 ($2,045,800 x 15%).
Read more here as it relates to RE specifically:
An investment solution using ETFs can be this: Canadian-domiciled ETFs that hold US stocks are not considered “situs” assets. Take iShares XSP for an example.
A footnote to my previous comment…
You are exempt from U.S. Estate Taxes if you meet only ONE condition above.
If you hold > $60,000 USD at time of death, and DO NOT meet the worldwide asset threshold (whatever it is of the day, currently $5.24 M USD) then you don’t need to pay U.S. Estate Taxes. Your executor however should be filing some forms with the IRS in the U.S. though.
My point is still valid…if as an investor you intend to hold > $60,000 USD in U.S. ETFs and U.S. stocks, you need to understand the implications as they pertain to your estate. I wanted to write a post about this, so I can clarify the issue for myself and others. I hope it helped?
I wasn’t aware of this either. There are definitely a lot of bizarre things between Canada and the U.S.
For example, (to my understanding) if American companies ship to Canada, they are supposed to remit and collect GST. And if they don’t the Canadian gov’t has the ability to reach out and touch the American company. Yeah I know, unbelievable, and few do this. But Amazon is one example – I believe that’s one reason they opened a shipping location in Canada.
And if you’re advertising in the U.S., but targetted at Canadians, then again with the GST. For example if you advertised on a U.S. website via a U.S. company, but the advertising is geo-targetted at Canadians, then you need to pay GST on that sale. This area is a bit bizarre with a variety of permutations, I’ve actually had to speak to rev. canada on this before.
Geez Glenn, I’ve learned something too. Wouldn’t a flat North American corporate tax solve many of these issues and each country could have a VAT as much as they would like?
Wow, I had no idea. My grandparents didn’t have any investments outside of real estate and of course their RRSPs/Pensions. I don’t think they were taxed by the US. This is good information!
Yeah, you really need to watch the U.S. holdings as far as investments go. U.S. estate taxes can take a significant toll, even for Canadians.