U.S. Estate Tax Planning

June 2008

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Foreign high net worth individuals owning U.S. assets, such as U.S. real estate or U.S stocks, can face important U.S. estate tax issues and liability upon their death. The United States imposes estate tax on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. In addition, it also imposes estate tax on the estate of a non-resident in certain circumstances.

Under the Internal Revenue Code of the United States ("IRC"), a U. S. resident for the estate tax purposes is subject to U.S. estate tax upon his death, on the fair market value of assets worldwide. A non-resident is subject to U.S. estate tax upon his death, only on the fair market value of property that is situated in the United States, which includes U.S. real property. The U.S. estate tax currently ranges from 18% to 46%, which maximum rate will be reduced to 45% in 2009.

It should be noted that in 2010, the US estate tax is scheduled to be repealed. However, unless further legislative action is taken by the US government, the US estate tax will only be repealed for the year 2010 and will thereafter be reinstated, as it existed before the changes made in 2002.

The Internal Revenue Code does not define the term "resident" for estate tax purposes, as it does for income tax purposes. The distinction between a resident and non-resident for U.S. estate tax purposes is important because a U.S. resident is liable to U.S. estate tax on his worldwide assets, whereas a non-resident is liable to U.S. estate tax only on his assets situated in the United States.

The concept of residence is not the same for U.S. estate tax purposes as for income tax purposes.  The determination of residence for estate tax purposes is not based on green card entitlement or the number of days present in the United States but rather on the common-law test of domicile.  Under common law, a person is domiciled in the United States if he lives there with no definite present intention of moving therefrom.  The place of domicile will be determined based on the facts and circumstances of the individual's lifestyle and long-term domiciliary intention.  It is therefore possible for an individual to be a U.S. resident  for  U.S. income tax  purposes while being a non-resident for U.S. estate tax and gift tax purposes.

A unified credit of $2,000,000 is available to a U.S. citizen of resident, which will be increased to $3,500,000 in 2009. It should be noted that the above unified credit is only available to a resident of the United States. Under the IRC, a non-resident is only entitled to a unified credit of $13,000, representing a $60,000 exemption.

Consequently, any non-resident buying or owning US assets over $60,000 should carefully consider the U.S. estate tax implications and potential liability as well as possible planning solutions to minimize such exposure.

CANADA-U.S. TAX TREATY
The Canada U. S. Tax Treaty provides special relieving provisions regarding US estate tax applicable to a resident of Canada. Essentially, Canadian residents can benefit from the same exemption available to a U. S. citizen (i.e. $2,000,000), but only on a pro-rata amount, based on their U.S. taxable estate over their worldwide taxable estate.
For example, if a Canadian resident's U.S. estate represents 15% of his worldwide estate, his equivalent exemption will be limited to US $300, 000 (15% of US $2 million).  If his U.S. assets are worth US $1million and his worldwide estate is US $6.5 million, his U.S. estate tax liability would be US $225,000 should he die, in 2008. Assuming 5% inflation, such liability will have tripled to US $775,000 in fifteen years.

ESTATE TAX PLANNING
Canadian resident individuals purchasing or owning significant U. S. real estate properties may consider various planning techniques to reduce or eliminate their exposure to U.S. estate tax. For example, they may acquire U.S. real estate through a non-U.S. corporation. However, there could be important U.S. and foreign issues and risks in doing this, such as the higher corporate tax rate on the sale of the property and shareholder benefit issues.
Other more sophisticated techniques involve the use of non-U.S. entities, such as foreign trusts, partnerships, limited liability companies or other hybrid entities to convert U.S. property into non-U.S. intangible property for U.S. estate tax purposes. Usually, these structures involve substantial costs, practical difficulties and issues as well as greater risk of attack by the U.S. tax authorities. In all circumstances, a complete cost\benefit\risk analysis is required and professional advice should be obtained before implementing such a structure.