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By Elena Hanson
Special to the Financial Independence Hub
How can the estate of your American aunt, who lived in the United States and visited Canada only three times, be considered a resident of Canada? And how can the Canada Revenue Agency tax her estate income while the IRS may or may not be able to collect tax on anything? It gets even more interesting if she held her assets in a living trust or held majority ownership in a private corporation.
I came across this exact scenario and it shows what can happen when moving a trust across the border.
In 2003, Tom and his wife Rose settled their trust. They were both U.S. citizens and residents as well as the beneficiaries and trustees of their trust. Both passed away within months of each other in 2017. Tom died first.
When Rose died, their trust was the beneficiary of annuities and an Individual Retirement Account (IRA), and also consisted of
- investments in marketable securities,
- a corporation owning 50% of a condo,
- the other 50% of the same condo,
- and some personal property.
Prior to their deaths, Tom and Rose resigned as Trustee, and their niece Anne became the sole Trustee of the U.S. Trust. She also became one of four beneficiaries of the estate upon their passing. Nothing too complex, so far. Right? Except that Anne and the three other beneficiaries happen to be Canadian citizens and residents who never lived in the U.S. or filed U.S. taxes.
What exactly does this mean? Are there tax implications of the trust moving to Canada? The short answer is, yes. Let’s have a quick look at what those implications might be.
First, from the perspective of the Internal Revenue Code (IRC), when Anne became Trustee of the trust in February 2017, the trust moved to Canada but retained something known as “grantor trust status in the U.S.” When Rose died in May 2017, the trust then became a non-resident and no longer held grantor trust status for U.S. tax purposes.
What’s so great about grantor trust status? Typically, moving a trust from the U.S. to Canada would result in U.S. tax on the appreciation of trust assets. Because the trust maintained its grantor status after it was moved to Canada, the trust assets were not treated as sold.
That’s the good news, but here’s the straight goods on how the U.S. tax regime treats the disposed assets held within the trust:
- For the corporation, the sale of the condo results in a small capital gain based on the fair market value from the time of Rose’s death to the time it was sold by the corporation and such gain is subject to U.S. tax. Because the corporation primarily involved real-property interest, its liquidations is subject to a 15% withholding tax known as FIRPTA tax.
- The marketable securities are not subject to U.S. capital gains tax as the trust is a U.S. non-resident, 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% withholding tax does apply and any capital gains are subject to U.S. FIRPTA tax. As the Trustee, Anne must file a U.S. non-resident trust return to the IRS, report the gain on the sale of the property, and claim back the full amount, or portion, of the FIRPTA tax.
- When U.S. annuities are received by a non-US person., they are subject to a 30% tax if the annuities are paid out as a lump sum. The tax rate can be reduced to 15% if periodic payments are taken by Canadian residents. The same rule applies the IRA. Unfortunately, each of the beneficiaries are subject to U.S. tax on their portion of the distribution and will have to 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.
Fortunately, insurance death benefits are tax-free, but now let’s look at the tax treatment by Canadian authorities. When Anne took on the role of Trustee, the trust became a Canadian resident for Canadian tax purposes. The cost of the most assets held by the trust was adjusted to the fair market value on the date the trust moved to Canada, except for the IRA and annuities.
More income of the trust will be 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 the time of disposition. However, since U.S tax was also paid on the property disposition within the corporation prior to the liquidation, there may be a foreign tax credit available to offset the Canadian tax.
- This is also true for a capital gain realized on the sale of the condo, and income distributions from the annuities and the IRA. Any Canadian taxes triggered when these assets were sold or distributed can be offset by foreign tax credits on the U.S. taxes already paid. But be aware as to who reports on what as some of the incomes and credits are recognized by the trust while others are recognized by individuals.
- The marketable securities are only subject to Canadian tax on the gains that accrue after the trust moved, therefore, there is no risk of double taxation on this portion of the trust.
To untangle all this, it’s important to get the advice of professional, cross-border tax advisors – and not just to start drafting those returns and applying credits. Things can get very complicated in terms of grantor status and residency of the trust, not to mention the risks for double taxation and manual reviews required by the IRS and CRA. The best advice is to know what your risks are and to find a professional you can trust.
Elena Hanson is the Founder and Managing Director of Hanson Crossborder Tax Inc. She is currently doing a podcast series with Darren Coleman, a wealth management advisor with Raymond James, called Two Way Traffic which is about cross-border tax and financial issues.
