For a Snowbird who owns, or about to buy, US real estate, the taxation of this property on a transfer by gift or on death by both Canada and the US often comes as a surprise. This double taxation arises because of the lack of symmetry between the taxing regimes of both countries. Canada imposes an income tax on the gain in the property upon a gift or upon an individual's death as it treats these transactions as "deemed dispositions" of the properties. the US, on the other hand, imposes a tax on the value of property owned by an individual transferred by gift during that person's lifetime or on death.
(a) Canadian Taxation on Death
Under the Act, all capital property owned by a taxpayer is deemed to have been disposed of immediately before death for proceeds of disposition equal to the fair market value of the property. Any inherent capital gain or loss on the property owned is included in the taxpayer's terminal return and is taxable according to the normal rules applicable to the taxation of an individual. It is this deemed disposition which creates a tax liability on death and which is often considered to be a "death" tax in Canada. If the capital property is transferred to a surviving spouse, or a qualifying spousal trust for the benefit of surviving spouse, provided the deceased and the surviving spouse were both Canadian residents at the time of death, there is a deferral of the realization of any taxable capital. It is, however, open to the executor to elect to have this rollover not apply.
(b) US Taxation on Death
In general terms, the US imposes an estate tax on the value of all property, owned by a non-resident individual and situated in the United States at the date of death. To ensure that the estate tax base is not eroded, the US system also includes gift tax and a generation skipping tax.
2. US Estate Tax Regime
The US imposes an estate tax on the transfer of assets i.e. the "taxable estate", at the death of an individual, who is either a US citizen, a non-citizen US resident or a non-resident alien owning property in the US. In general, regardless of citizenship or residency, the "taxable estate" is determined by subtracting permitted deductions from the "gross estate". For the non-resident alien, the "worldwide gross estate" is, however, relevant to determine the proportionate share of the deductions allowable in determining the US taxable estate. The items of inclusion, as well as the allowable deductions, can be affected by the estate/death tax treaty in effect between the United States and the country of origin. In addition, certain credits provided in the Treaty are also affected by the worldwide gross estate.
(b) Residency for Estate Tax Purposes
The residency nexus for income, and estate and gift tax purposes differs. Unlike the "residency" test for income tax purposes, the residency of a decedent for US estate and gift tax purposes is subjective and depends upon that individual's domicile at the time ofdeath. A person may be domiciled in the US if he or shelives in the US, for even a brief period of time, with no definite present intention of leaving in the future. Notwithstanding, domicile is presumed to continue in the foreign jurisdiction until it is established in the United States.
(c) Six Steps to Calculate Estate Tax Liability
Several Steps are involved in calculating the US federal estate tax liability of a non-resident alien.
1. Determine the fair market value of the decedent's US grossestate;
2. Determine the fair market value of the decedent's assets situated outside the US;
3. Identify and quantify the deductions allowable under the Tax Code;
Determine whether the decedent had made any US taxable gifts;
5. Calculate the tentative US estate tax payable as to the aggregate of the taxable estate and the adjusted taxable gifts;
6. Deduct any tax credits permitted from the tentative estatetax payable in order to determine the US estate tax payable.
(i) Woldwide Gross Estate
The worldwide gross estate includes the value "of all propertyreal or personal, tangible on intagible, wherever situated", to the extent of the decedent's interest in the property at the time of death. Moreover, it includes the value of all property transfered at any timeprior to death in which the decedent has retained an interest for his or her life.
(ii) US Gross Estate
Unless a treaty provides otherwise, the gross estate of a decedent non-resident alien shall be that part of his or her gross estate situated in the United States. The Code provides rules with respect to certain assets to determine the situs thereof.
A. Real Property
Real property is considered to have a situs where it is physically located.
B. Tangible Personal Property
The general rule is that the situs of tangible personal property is the location of the property at the time of decedent's death or at the time the property is transfered by gift. If a non-resident alien is "intransit" and has brought tangible personal property with him or her such as a car, this property is not considered to be situated in the US. It is not clear how long a person can be transit and still have their personal property fall within this exception.
C. Debt Obligations
The general rule is that a debt obligation of a US person or US governmental entity is owed to and held by a non-resident alien at death is considered US situs property. Exceptions to this rule for bank, savings and loan and insurance accounts are discussed below.
D. Corporate Shares
Generally, shares of a US domestic corporation is US situs property regardless of the location of the shares certificates.Shares of a foreign corporation is not US situs property.
E. Life Insurance
Proceeds from an insurance policy on the life of a non-residentalien is not US situs property regardless of the location of the insurance company paying the death benefit. However, if a non-resident alien dies owing a policy issued by a US insurance company on the life of another person, the life insuranceexclusion does not apply, and instead, the decedent's interest in that lifeinsurance policy is considered a debt obligation, which is US situs property.
F. Bank Accounts
Deposits maintained at a US domestic bank, unless they are connected with a trade or business within the United States are considerednot to be US situs property. However, the term "deposit" does not include cash in safe deposit box.
(iii) US Taxable Estate
The US taxable estate is determined by subtracting allowable deductions from US gross estate.
A. Debts, Funeral and Estate Administration Expenses and Taxes
Unless otherwise provided for by the treaty, a decedent's estate ispermitted to deduct a proportionate amount of the following:
- funeral expenses;
- estate administration expenses such as exucutor, legal accounting and probate fees;
- claims against the estate;
- unpaid mortgages and other liens;
- uncompensated losses that were incurred during the settlement of the estate and that arose from theft or from casualties, such as fires, storms or shipwrecks;
- the inheretance or estate tax imposed by a state of the United States on property situate within its borders;
- the income tax liabilityresulting from the capital gains taximposed as a result of s. 70(5) of the Act; and
- the actual amount deductible is determined by multiplying sum of the deductible expenses times the ratio of the US gross estateover the worldwide gross estate.
To claim a deduction, the worldwide gross estate must bedisclosed on the US estate tax return and the preparer must provideevidence of the payment of such expenses, liabilities and claims.
B. Marital Deduction
A merital deduction is permtted to the estate of a US resident orUS non-resident alien for US property to a "qualified domestic trust" ("QDOT"). This trust, established for the sole benefit of a non US citizen surviving spouse, must meet certain requirements established by the Code. If the requirements for QDOT are met, theestate tax in respect of such propertywill be deffered until the earlier of:
- the distribution of the principal of QDOT trust by the trustees to the non-US citizen surviving spouse (except for distributions that are "on account of hardship"). The tax on such distributionis due April 15 of the calendar year following the principaldistribution, except in the case of principal distributions duringthe calendar year in which the surviving spouse dies; or
- the death of the non-US citizen surviving spouse, the tax on the balance of the QDOT remaining at the surviving spouse'sdeath, together with the tax due on any principal distributions made during calendar year, is due nine (9) months after the date of such death.
The Tax rate applicable to principal distributions and upon the death of the surviving spouse, as to the property remaining in the QDOT, is the marginal estate tax rate of the estate of the first spouseto die and not marginal rates applicable to the estate of the surviving spouse.
The Code provides non-residents aliens with a full deduction forcharitable donations if:
- the donation is made to a corporate entity that is incorporated ororganized under the laws of a US jurisdiction and operated for religious, charitable scientific, literary or educational purposes, or
- the donation is made to a non-sorporate entity, such as a charitable trust, which uses the contribution or gift exclusively. within the US for these designated purposes.
If the donation meets either of these qualifications, the entire amountof the donation is deductable. However, as with the claiming of debts and expenses, to claim a charitable deductions, the value of the non-residentalien's worlwide estate must be disclosed.