While President Barack Obama’s new tax proposals may never see the light of day, given the Republican majorities in both the House and Senate, they have generated discussion among cross-border tax practitioners. Dual citizens living in Canada or Canadians who own U.S. properties may wonder whether they need to reopen their estate plans in case the proposals, referred to by the White House as an attempt to close the “trust-fund loophole,” ever come into law.
Canada and the U.S. have historically taken quite a different approach to taxation upon death. In Canada, there is a deemed disposition at fair market value of all your capital property (other than your principal residence), as of the date of death and you pay capital-gains tax on any accrued gains on your final tax return.
The U.S., however, has an estate tax that taxes the fair market value of a U.S. person’s estate above a certain dollar-level exemption (US$5.43 million). Whether or not there was an accrued gain on that property at death is irrelevant.
To illustrate, let’s assume Cathy, a Canadian resident, dies with a portfolio of stocks worth $500,000 that have a tax cost of only $100,000. When Cathy dies, she would pay up to 25% capital-gains tax on the $400,000 accrued gain as of the date of the death.
If, on the other hand, she was a U.S. citizen, and not a resident of Canada upon death, she would not pay any U.S. income tax, since the U.S. doesn’t currently tax appreciated property at death, nor would she pay any U.S. estate tax since her estate was below the exemption of US$5.43 million. Cathy’s heirs would inherit the portfolio with a stepped-up cost basis of $500,000, allowing the $400,000 accrued gain to permanently escape taxation.
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