Crossborder death: An administrative nightmare for survivors
Moving a trust across the Canada-U.S. border is complicated. In 2003 Tom and his wife Rose settled their living trust. They were U.S. resident-citizens, and initial beneficiaries and trustees of the trust. Both passed away within months of each other in 2017.
When survivor Rose died the trust was the beneficiary of annuities and an IRA, and consisted of investments in marketable securities, a corporation owning 50 per cent of a condo, the other 50 per cent of the same condo and other personal property.
The couple’s niece Anne, a Canadian resident, became trustee of the trust after their resignation. However, Anne was not only a new sole successor trustee of the U.S. trust but one of four beneficiaries of the estate. The three other beneficiaries were also Canadian resident-citizens who never lived in the U.S. or possessed U.S. tax identification.
Here is the nightmare for the trustee, successor trustee and beneficiaries. Along with tax implications of the trust ceasing to be controlled by a U.S. person, we must examine things from both a U.S. and Canadian perspective.
From the perspective of the Internal Revenue Code (IRC), when Anne became trustee of the trust in February 2017, the trust emigrated from the U.S. to Canada while retaining its grantor trust status. When Rose died, the trust became a non-resident, non-grantor trust for U.S. tax purposes.
Typically, the emigration results in U.S. tax on appreciation of trust assets. Because the trust maintained its grantor status after emigration, it wasn’t subject to the gain-recognition provision. Also, termination of the grantor status is normally considered a transfer that triggers the gain recognition. Since the transfer was the result of a death and below a certain dollar limit, there is an exception to this rule. But what about U.S. tax treatment of the disposed assets?
- For the corporation, disposition of the condo results in a small capital gain based on the fair market value from the time of Rose’s death to when the corporation was liquidated, with any gains subject to U.S. tax. And because the corporation primarily involved real-property interest, its liquidation is subject to a 15 per cent withholding tax (Foreign Investment in Real Property Tax Act, or FIRPTA, tax).
- The marketable securities are not subject to U.S. capital gains tax since the trust is a U.S. nonresident, and any gains are considered foreign source income.
- Like the corporation, the condo sale results in little to no capital gains as it sold shortly after death. However, the 15 per cent withholding tax does apply and any capital gains are subject to FIRPTA tax. Anne must file a U.S. non-resident trust return to the Internal Revenue Service
(IRS), report the gain on the property sale and claim back the full amount, or portion, of FIRPTA tax.
- U.S. annuities received by a non-resident of the U.S. are subject to a 30 per cent tax if received as a lump sum. If periodic payments are taken, the tax rate can be reduced to 15 per cent. This is the same for the individual retirement account (IRA) that is part of the trust. But each of the four beneficiaries is subject to U.S. tax and must obtain a U.S. tax ID. They may also have to file a U.S. tax return if the withholding tax is not administered at a proper rate at source.
- Insurance death benefits are tax-free.
Now let’s look at Canadian tax treatment. When Anne became trustee, the trust became a Canadian resident for Canadian tax purposes. Most assets held by the trust obtained a new cost basis equal to the fair market value on the date of migration, except for IRA and annuity.
Overall, parts of the trust taxable in the U.S. are also taxable in Canada:
- The corporation is considered a controlled foreign affiliate of the trust and its liquidation results in Canadian tax on the gain at time of disposition. However, since U.S. tax was also paid on the same disposition, a foreign tax credit is available to offset the Canadian tax for as long as there is a match to the tax rates and the gain amount.
- This is also true for capital gains realized on disposition of the condo, liquidation of the annuities and distributions from the IRA. Any Canadian taxes triggered in the disposition of these assets can be offset by foreign tax credits on U.S. taxes already paid. Be aware of who reports on what since some of the incomes and credits are recognized by the trust, others by individuals.
- The marketable securities are only subject to Canadian tax on the gains that accrue after immigration, therefore, there is no risk of double taxation on this portion of the trust.
After untangling everything tax accountants can start drafting those returns and apply credits. But things get complicated around grantor status, residency of the trust and risk for double taxation. They get even murkier when the IRS and CRA manually complete their respective reviews. All the more reason to consult a professional crossborder tax adviser.
This article was originally published on April 24 2020 by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc