U.S. tax reform measures were signed into law by President Trump on December 22, 2017, culminating a whirlwind legislative process at the end of 2017 which resulted in the Tax Cuts and Jobs Act (the “Tax Act”), the most significant changes to U.S. tax law in over three decades. These changes, in particular those relating to personal taxation, will impact many individuals and families with U.S. connections.
The Tax Act reduces U.S. personal income tax rates. The top bracket is now 37%, in contrast to the prior 39.6% and applies to individuals with income of $500,001 or more. In comparison, the top marginal tax rate in 2018 for an Ontario taxpayer is 53.53% and applies to individuals with income of $220,000 or more. U.S and Canadian tax rates are on opposite trajectories – ours increasing and the U.S.’s decreasing. The question of the day: is the Canadian policy approach sustainable given our reliance on and interconnectivity with the U.S.?
The Tax Act doubles the tax exemption for gift, estate and generation-skipping tax (” Transfer Taxes “) for U.S. Persons. In 2018, a U.S. Person will now have an exemption of approximately $11.2 million USD, indexed for inflation. For a married U.S. couple, this will mean a total exemption of approximately $22.4 million USD, indexed for inflation. This huge exemption amount for Transfer Taxes means that at least for the time being, for U.S. Persons, estate tax will be paid by only the very few. These changes to U.S. estate tax follow a general trend in many countries in the last several decades to reduce or eliminate estate and inheritance tax.
You are a U.S. Person for Transfer Tax purposes if you are a U.S. citizen, including a dual citizen of the U.S. and another country, or if you are domiciled in the U.S. It is possible to be a U.S. citizen without being aware of your status. For example, you may be a U.S. citizen if you were born in Canada to one or more U.S. citizen parents, even if you have never resided in the U.S. There are also other types of “accidental” U.S. citizens, including children born in U.S. hospitals. You may also be a U.S. Person if you have moved to the U.S. to work and have a U.S. domicile because you intend to permanently reside in the U.S.
But the estate tax has not been permanently repealed – there is a “sunset” and pending future legislative changes, the estate tax will revert on January 1, 2026 to $5 million USD adjusted, for inflation, which at 1.5% per year would equate to about $6.5 million USD in 2026.
For a U.S. Person, estate tax is based on the value of his or her worldwide estate. For a non-U.S. Person, estate tax is based on the value of his or her U.S. situs property. There is a $60,000 USD estate tax exemption for a deceased person who is not a U.S. person which continues and remains unchanged. As well, under the Canada-U.S. Tax Treaty, Canadians get further possible relief since the Treaty allows a credit against U.S. estate tax based on the proportion of a deceased person’s U.S situs assets to his or her worldwide assets multiplied by the exemption a U.S. person would have. If a deceased Canadian has a worldwide estate with 10% U.S. situs assets, the credit will increase from $549,000 to approximately $1.12M USD (10% of $11.2M). Good news indeed!
The Tax Act is now effective as of January 1, 2018. Canadians with U.S. connections should review their individual estate planning and seek professional advice to ensure it is still appropriate. In particular, if they are a U.S. Person and if their estate planning includes a will which contains formulas based on the amount of the U.S. exemption, it should be reviewed to consider whether the plan of distribution still reflects their intentions.
Given that there has not been a permanent repeal of U.S. estate tax, what the future holds is uncertain. Ensuring there is flexibility in the estate plan so that it can be revised and updated as circumstances change will be of key importance.
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.