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The Two Certainties: Death and (Foreign) Taxes

A failure to take into account taxes on death can often defeat an estate plan. It can result in a smaller estate being available for distribution and it can also result in some beneficiaries bearing a disproportionate amount of the estate’s tax burden. While most estate plans take into account domestic taxes arising on death, such as income tax and probate tax, foreign taxes, however, are too often ignored even though a dollar of tax paid to a foreign government is no different than one paid to a domestic government.

Obtaining foreign tax advice is sometimes avoided due to the associated costs or perceived added complexity. While such advice increases estate planning costs, the result typically produces a significant tax savings and helps ensure that your estate planning objectives are not adversely impacted. As well, most of the complexity is dealt with behind the scenes by your advisors.

In some cases, you and your advisors may be unaware that a foreign tax issue exists. Where one of the three following scenarios exists, further investigation is often recommended. 

The first scenario is where you are a citizen or resident of another country. U.S. citizens living in Canada, for example, are subject to U.S. estate tax on their worldwide estates, regardless of whether or not they ever resided in the U.S. Somewhat similarly, persons living in Canada who were resident in the U.K. for at least 17 of the last 20 years prior to their death are subject to U.K. inheritance tax on their worldwide estate.

The second scenario is where you own property, usually real estate but sometimes also personal property (e.g., shares and other investments, personal effects), in another country. Under this scenario, you may never have been a resident or citizen of the other country. For example, non-residents of Italy are subject to Italian inheritance tax on all assets located in Italy.

The last scenario is where a beneficiary of your estate is a resident of another country. In Ireland, for example, tax applies where an Irish beneficiary receives a gift under a will, regardless of whether the deceased had any ties to Ireland. Under this scenario, it is often the beneficiary, and not your estate, that is subject to tax. As a result, your objective of treating all beneficiaries equally may be defeated without proper planning. Even where a country does not tax beneficiaries on inheritances, foreign tax issues may still arise in the future if the beneficiary is a citizen or resident of a country that taxes based on citizenship or residency (i.e., the first scenario).

There are various strategies that can be used to defer and/or avoid foreign taxes on your death. The end result of these strategies may be a few additional provisions in your will, a second will dealing with just your foreign assets, or a restructuring of the form of asset ownership (for example, transferring certain assets to a trust or corporation). In some cases, though, it will not be necessary to implement any strategy, at least not immediately, as many countries exempt a certain a portion of estates from tax and/or provide preferential tax treatment to gifts by will to certain beneficiaries, specifically spouses. In order to determine the best strategy (including doing nothing), a foreign advisor in the relevant country should be included in the estate planning process.

Foreign taxes are not always a certainty if you have foreign connections, but they can become a certainty when proper planning is not undertaken. Where one of the above scenarios exists, you should consider whether foreign taxes may result on your death and, if so, what options are available to minimize such taxes. Once known, you will be in a better situation to assess whether it makes sense to proceed with any additional planning.

Please join us for our next blog post when we discuss using letters of wishes in your estate plan.

The comments offered in this article are meant to be general in nature, are limited to the law of Ontario, Canada, and are not intended to provide legal or tax advice on any individual situation. In particular, they are not intended to provide U.S. legal or tax advice. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate to your personal circumstances.