The U.S. Vacation Home

& U.S. Offshore

Voluntary Disclosure

Cheyenne J.H. Reese, LLM

Legacy Tax and Trust Lawyers

May 24th, 2012

U.S. Estate Tax

Imposed on transfers of property on death

Rate of tax above $500,000 is 35%

For U.S. citizens and residents, imposed on worldwide taxable estate

For non-citizen non-residents, imposed on “U.S. taxable estate”

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U.S. Estate Tax (cont’d)

Residency based on “domicile”

Physical presence with intention to remain permanently or no current intention to leave

Assume for purposes of our discussion that we have a Canadian domiciliary who is not a U.S. citizen (an “NRA”) purchasing a vacation home located in the U.S.

For U.S. citizens and residents exemption now at $5,120,000 (adjusted for inflation)

For NRA, $60,000 is exempt

2013?

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Deductions Against Estate Tax

Unlimited Marital Deduction

Applies to outright transfers to a U.S. citizen (“legally married”) spouse and certain qualifying transfers in trust for a U.S. spouse

Charitable Deduction

Funeral and other Testamentary Expenses

Outstanding Debts and Liabilities

NRA will only get portion of deductions equal to U.S. Assets

Worldwide Assets

Full disclosure of Worldwide Assets required

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Estate Taxation of

Non-Resident Aliens

Applies to U.S. situs property, which includes:

Real property located in the United States;

Shares in a U.S. corporation; and

Tangible personal property located in the United States

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Estate Taxation of

Non-Resident Aliens (cont’d)

Marital Deduction Property passing to a U.S. citizen spouse Applies to transfers to a non-U.S. citizen spouse

through a “qualified domestic trust” (QDOT) • Trust must satisfy terminable interest rule, • Have at least 1 U.S. trustee, • U.S. trustee must have right to withhold estate tax on

distributions of corpus, and • Security requirements must be satisfied

Only defers the tax Tax is applied on the appreciated value at the

surviving spouse’s death

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NRA’s Treaty Credit

$13,000 credit, shelters $60,000

Article XXIX B alternative credit

Available to every Canadian resident (other than a U.S. citizen)

Entitled to a proportionate unified credit equal to:

U.S. Assets x $1,772,800 (2012)

Worldwide Assets

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NRA’s Treaty Credit

Example. Deceased Canadian citizen and resident owned the following assets: U.S. $

Insurance Proceeds 1,000,000

RRSP 1,000,000

House 1,000,000

Canadian Investments 1,500,000

U.S. Condominium 2,000,000

Total 6,500,000

Estate would be entitled to an Applicable Credit of $545,477, as follows:

$2,000,000 x $1,772,800 = $545,477

$6,500,000

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Calculation of NRA’s Estate Tax

Same graduated tax rates as for U.S. citizen

Example (cont’d)

U.S. Taxable Estate $2,000,000

Tentative U.S. Estate Tax $680,800

Less: Applicable Credit ($545,477)

Equals: Net Tax $135,323

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Calculation of NRA’s Estate Tax

Extra Marital Credit

• Calculated same as Treaty Credit

• Outright to Canadian Spouse or in qualifying trust for Canadian Spouse

• Better than QDOT because savings (up to $1,772,800) vs deferral

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Calculation of NRA’s Estate Tax

With extra credit

Example (cont’d)

U.S. Taxable Estate $2,000,000

Tentative U.S. Estate Tax $680,800

Less: Applicable Credit ($545,477) Less: Treaty Credit ($545,477)

Equals: Net Tax nil

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Treaty Credit

Canadian credit for U.S. estate tax paid at death

Applied against any income, profits or gains from any U.S. situs property

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U.S. Gift Tax for U.S. Citizens

Imposed on transfers of property during lifetime

Imposed at the same graduated rates as the estate tax

Imposed on transfers on a cumulative basis

For U.S. citizens and residents, Applicable Credit (maximum $5,120,000) applies to gift tax and reduces exemption at death

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U.S. Gift Tax for U.S. Citizens (cont’d)

Annual Exclusion – each year an individual is entitled to gift up to $13,000 to each of any number of donees

Increased to $139,000 for gifts to non-citizen spouse Direct payments of medical and tuition expenses are

generally excluded from taxable gifts, regardless of amount

Marital Exclusion – unlimited deduction for gifts to a U.S. citizen spouse only

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U.S. Gift Taxation of NRAs

U.S. Gift Tax Liability for NRA

Gifts of U.S. real estate or tangible personal property located in U.S.

• Gift of vacation property itself; or

• Gift of cash to buy vacation property

35% top gift tax rate

Treaty credit is not available to offset tax on gifts by an NRA

No foreign tax credit for Canadian capital gains tax and vice versa

• Canada treats gifts as disposition at fair market value

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U.S. Gift Taxation of NRAs

Treaty credit is not available to offset tax on gifts by an NRA

No foreign tax credit for Canadian capital gains tax and vice versa

• Canada treats gifts as disposition at fair market value

$13,000 annual exclusion is available

Deduction for gift to NRA spouse is limited to $139,000 (2012) per year

Gifts to U.S. citizen spouse qualify

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Planning for Canadian NRA Owning U.S.

Situs Property Generally

The Tools

Treaty Credit

Treaty Marital Credit

Lifetime Annual Exclusions ($13,000 and $139,000)

Unlimited Marital Deduction to U.S. citizen spouses

No gift or estate tax on certain intangibles

QDOT

Charitable exemption

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Possible Solutions

Canadian Corporation

Cannot use a Canadian corporation for vacation home because of “shareholder benefit” problem for Canadian income tax purposes

Higher corporate U.S. tax on sale

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Possible Solutions (cont’d)

Canadian Trust

Properly drafted trust holds U.S. Vacation property (to avoid estate tax)

Settlor cannot retain any interest

Typical Canadian family trust will not work (U.S. income tax and estate tax issues)

Trust to be funded prior to locating property (to avoid gift tax)

Watch out for mismatch of foreign tax credits on rental income and sale

Watch out for 21 year deemed disposition

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Possible Solutions (cont’d)

Non-Recourse Debt

Recourse only against Real Property

Netted against value of Real Property

Must be bona fide

Difficult to procure for NRA

Not often seen in practice

Asset Allocation and Wills

One spouse holds U.S. assets and other spouse holds balance

Testamentary Trusts with independent Trustee or Ascertainable Standard for distributions

Consider Gift Tax and Canadian Attribution Issues

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Possible Solutions (cont’d)

Life Insurance

Consider ownership of policy

Best used in tandem with Asset Allocation and Wills

Insurance Trust may be appropriate

QDOT with Charitable Gift

U.S. Vacation Property is held in QDOT for survivor

• Deferral of U.S. Estate Tax

Charitable Deduction for U.S. real property gifted to U.S. or Canadian charity

If no QDOT, no Charitable Deduction for gift to Canadian charity but available if to U.S. charity

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Possible Solutions (cont’d)

Hybrid Entity

Limited Partnership in Canada

Check the Box; treat as Corporation for U.S. purposes

Corporate Tax vs. Personal Tax

Complex Tax Reporting

Can be used for all U.S. assets

Law not 100% clear on situs

Do Nothing

Powers of Attorney to Facilitate Sale

Play the odds (e.g. plan to sell before death)

In many cases exposure is small; do the math first

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OVDI

2009 and 2011 Programs closed

January 2012 new Program opened

Fixed penalty structure (27.5% / 5%)

8 years of returns (tax and informational)

Guidance not issued

Canadian-specific issues (including RRSP, RESP, TFSA)

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Conclusion

Careful Estate Planning creates significant U.S. tax savings.

Thank You.

Cheyenne J.H. Reese Legacy Tax + Trust Lawyers

604.631.1251 creese@legacylawyers.com