Estate-plan pitfalls for the 1 million Americans living in Canada

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About 1 million citizens of the United States live in Canada, and for those who plan to stay, finding expert estate planning advice on both sides of the border is needed to avoid nasty surprises.

Tax and estate rules differ from country to country, and commonplace financial instruments in the U.S. are treated differently in Canada.

“One of the things [Americans] have to think about is whether their generic U.S. estate plan works in Canada. The answer is likely not. It will have to be redone,” says cross-border tax lawyer Max Reed, principal, Polaris Tax Council in Vancouver.

While the most financially significant differences between the two jurisdictions relate to taxes on estates, differences exist in the paperwork as well, says Reed. Prior estate plans and power-of-attorney documents may not be valid in the new jurisdiction.

For instance, he says, he has American clients living in British Columbia who hold real estate in North Carolina. Wills in B.C. need two signatures, while wills in North Carolina require two signatures and must be notarized.

In multi-jurisdictional estate planning, “you need to have advice in each jurisdiction in which you have real property in particular, or significant assets more generally,” Reed says. “Then you layer on the taxes on top of that – two tax regimes. It gets very complicated very quickly.”

If the person owns real estate in both jurisdictions, having wills in each country would be advisable, he says.

There are fundamental differences in taxation between the U.S. and Canada, and that applies to estate taxes as well.

Michael Pereira, who works with KPMG Family Office and Global Mobility Services on cross-border tax and related matters, says the U.S. tax system is based on citizenship status regardless of where you live, so residency is not a determining factor in terms of exposure to transfer taxes such as gift and estate taxes.

Canada has a residency-based tax system, so you have to consider rules for both countries that arise on death, adds Pereira.

The U.S. has an estate tax with an exclusion amount of just under US$12.1 million for 2023, he says. That applies to worldwide assets, including those in Canada. While most Americans don’t reach that bar, it is a consideration for the high-net-worth individual.

The principles of taxation are quite different in each country, Pereira says. In Canada, tax is based on accrued gains; in the U.S. it’s on value.

“If you’re a Canadian and you die with $100 million in the bank, you wouldn’t have any tax owing, ignoring probate. From an income tax perspective, there would be no tax to you in Canada because you only own cash,” Pereira says.

“If you’re an American citizen living in Canada, you would get a credit on your U.S. estate tax for any Canadian taxes paid on death. But that amount could be significantly less than the U.S. estate tax, which is taxed on value, and the highest rate is 40 per cent. For Canadians, when you’re realizing gains on death, in most provinces the most tax is 27 per cent on capital gain. So there’s a rate differential.”

U.S. immigrants sometimes get a shock when they come to Canada and find their financial plan may have negative consequences, Reed says.

“Revocable living trusts are a very standard estate planning document [in the U.S.], and all it really does is avoid probate. … In California, everyone who has over a million bucks has one of these things.”

The U.S. income tax system disregards this type of trust in income tax terms, says Reed, but the Canadian tax and legal system has a different view of revocable living trusts. In Canada the trust is a separate taxpayer, and 21 years after the setup of the trust there is a tax sale of the assets that applies in Canada.

Another common instrument in the U.S. is the limited liability corporation (LLC).

“It’s taxed one way in the U.S. and another way in Canada, and that causes Canadian problems for the people who are immigrating,” says Reed. “For the high-net-worth set, oftentimes they’ll have private investments, funds and real estate formed in LLCs, and those will need to be redone.”

Pereira says some Canadian investments can be headaches for beneficiaries in the U.S.

If a Canadian resident passes away and owns shares in a Canadian corporation, and the corporation falls within certain U.S. anti-deferral rules, it can have implications for the beneficiary’s taxes.

“One of the most onerous U.S. anti-deferral tax rules relates to passive foreign investment companies. … Successful entrepreneurs in Canada have developed businesses and gone on and sold those businesses and then they typically have a holding company and that holding company turns into an investment company. If that person passes away and there’s a U.S. beneficiary, passive foreign investment company rules can result in an onerous tax outcome,” says Pereira.

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“If they hold these passive foreign investment companies for a long time they can end up with U.S. effective tax rates of 70 or 80 per cent.”

He says one fix to mitigate that risk to U.S. beneficiaries is the use of an unlimited liability company in the Canadian context. Three provinces – B.C., Alberta and Nova Scotia – have unlimited liability company legislation.

“They get out of these onerous foreign corporation anti-deferral rules,” says Pereira.

Pereira says the best course of action is always to plan ahead to avoid adverse tax outcomes.

“If you’re an American planning on moving to Canada, it’s important to get that cross-border advice before coming to Canada. Go through your holdings and assets, look at your family dynamics and understand what may need to be done. There’s pre-move planning and post-move planning.”

Reid adds that there’s nothing intuitive about the differences in policies between the two countries, which is another reason to get expert advice.

“In the cross-border space,” Reed says, “there are a lot of arbitrary rules that aren’t based in logic or principle.”

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