As a Canadian, you may not be worried about estate tax because Canada has no such thing. But if you have assets in the United States, you better read up as you could be subject to the U.S. estate tax and inheritance tax under certain circumstances. And with U.S. President Joe Biden’s tax proposals making headlines, you might want to chart out a plan with your tax advisor on estate planning too.
In this article, we will see when is the U.S. estate tax levied? Who pays it, and how Biden’s tax proposal would impact estate tax calculation?
All you need to know about the U.S. estate tax 2021
An estate includes all types of assets, like cash and securities, real estate, insurance, trusts, annuities, and business interests. The U.S. Internal Revenue Service (IRS) charges estate tax when a person dies and his/her assets are transferred to the heir. The estate tax is calculated on the fair value of the asset. The fair market value is arrived at after deducting mortgages, other debts, estate administration expenses, and qualified charities.
The U.S. estate tax is levied when the fair market value of the assets at the time of inheritance is above US$11.7 million. This exemption is per person, which means married couples can claim a US$23.4 million exemption. That’s a lot of money. Hence, very few wealthy people are subject to the estate tax. And if the estate is transferred to the surviving spouse, there is no estate tax, irrespective of the size of the estate. But when the surviving spouse who inherited the estate also dies, the beneficiaries are subject to estate tax.
If your inherited estate is above the US$11.7 million exemption, you will have to pay estate tax. This tax graduates from 18% to 40%, depending on the fair value of the asset above the threshold.
Joe Biden’s estate tax proposal
But Biden has proposed to restore the U.S. estate tax exemption to US$3.5 million from US$11.7 million. That would bring more estate under the tax ambit. Biden has also proposed to increase the maximum estate tax rate to 45%. In addition to estate tax, Biden proposed to levy a capital gain tax (CGT) of up to 39.6% on a gain exceeding $1 million at the time of inheritance.
To add to the tax bill, Biden has proposed to repeal the step-up in basis. At present, the heir inherits the asset at fair market value. That value becomes the cost basis to calculate capital gain on the asset, which is a step up from the actual cost. But Biden has proposed to consider the original cost as the basis to calculate capital gain. After deducting 39.6% CGT and 3.8% investment tax, the estate tax is calculated on the remainder of the asset.
When do Canadians pay the U.S. estate tax?
The U.S. estate tax is applicable even to Canadians that have U.S. assets like real estate, stocks or savings accounts. Rest other things remain unchanged. As a Canadian, you do not pay any estate tax for your Canadian assets, but you pay tax if your worldwide assets’ fair market value surpasses US$11.7 million. If the U.S. asset is transferred to the surviving spouse, there is no estate tax.
Although Canada does not have a separate estate tax, they have to add 50% of net capital gains on assets to their taxable income. Canadians may claim a foreign tax credit for U.S. estate tax under certain circumstances to avoid double taxation.
There are many ways to avoid the U.S. estate tax, do not accumulate too many assets or gift/sell them before you die. You can’t predict death in many cases, leaving this method unfit. There are other viable alternatives like setting up an Irrevocable Life Insurance Trust (ILIT) or a Qualified Domestic Trust (QDOT), holding U.S. situs assets in a Canadian corporation or a Canadian trust, and many more.
Not all options may be feasible for you. Sit with your tax advisor and understand the options that are appropriate for your financial situation. Biden’s tax proposals have a long way to become legislation. So stay updated with the news and plan with your tax advisor.
Contact the tax professionals at McCay Duff LLP in Ottawa to discuss how partnering with us can help save you time, anxiety, and money when it comes to your taxes. Our tax advisors provide expertise in all aspects of corporate tax, Canadian and U.S. personal tax, and ensure compliance with tax laws while minimizing your tax obligations. To learn more about how McCay Duff LLP can assist you or your business, please contact us online, or by telephone at 613-236-2367, or toll-free at 1-800-267-6551.