Ask the Spud: Am I Vulnerable to US Estate Taxes?

Q: I am ready to follow the Couch Potato and would like to use the US-listed Vanguard ETFs that you recommend in your model portfolios. But when I checked with my accountant, he warned me that I could face US estate taxes when I die. Is this true? — Karl W.

It’s possible, yes. Canadians with a high net worth and significant holdings in US assets (including ETFs listed on an American exchange) may be subject to estate taxes levied by the Internal Revenue Service. This tax can be up to 35%.

Before we go any further, let me remind you that I am not a tax expert, and it is essential that you consult an accountant or other qualified advisor if you think you may be in this situation. It’s also crucial to understand that US estate tax laws have changed several times in recent years (most recently in December 2010) and will likely change again after the presidential election next year: the current law is only valid until the end of 2012. It’s your responsibility to stay on top of these changes.

With that out of the way, here’s the situation today. Canadian residents who die before the end of 2012 are subject to US estate taxes if they meet both of the following criteria:

  • The total value of their estate is at least $5 million (USD). This means all of their worldwide assets, including their home, any recreational or rental properties, their investment portfolio, and certain life insurance policies.
  • Their estate includes a minimum of $60,000 in US situs assets. This term refers to any property that is situated in the US, including real estate and securities such US-listed stocks or ETFs. (US bank deposits, however, are excluded.) Note, however, that Canadian-domiciled mutual funds and ETFs that hold US stocks are not considered US situs assets. For example, the iShares S&P 500 Index Fund (IVV), listed on the New York Stock Exchange, is a US situs asset, but the TSX-listed iShares S&P 500 Index Fund (XSP) is not.

Does that mean me?

Let’s say you die next year with a $5 million (USD) estate, which includes $50,000 in a US-listed ETF and no other US situs assets. In this case, you meet the first condition, but not the second, so you would not be subject to estate taxes.

However, if you have a $6 million estate, including a condo in Florida as well as some US-listed ETFs, then you may be subject to the tax on those US situs assets, because their total value exceeds $60,000. The calculation is quite complicated, and it depends on the proportion of US situs assets in your overall estate. For examples of how the estate tax is calculated, see this helpful document from BDO Canada and this page at TaxTips.

If your estate is valued at less than $5 million, but you have US situs assets over $60,000, then you won’t be subject to the tax under the current law. However, your executor should still file IRS Form 706-NA within nine months of your death.

The bottom line is that Canadian investors of modest means do not have to worry about holding US-listed ETFs. However, if you have significant wealth, then you need to keep on top of US estate tax laws. As it happens, if no new law is enacted, the exemption will drop from $5 million to just $1 million in 2013, and the maximum tax rate will be 55%.

If you’re in your golden years and you think you’re vulnerable to US estate taxes, it may be prudent to use Canadian-listed ETFs for your foreign equity holdings. The higher MERs will be well worth it if they save you from the IRS.

The information in this post should in no way be considered tax advice tailored to specific individuals. Always consult a qualified advisor before making any investment decision for tax purposes.

17 Responses to Ask the Spud: Am I Vulnerable to US Estate Taxes?

  1. Dean December 9, 2011 at 12:16 am #

    Good info Dan. I thought that holding half my portfolio in Cdn. securities and half in US securities would be prudent, given my retirement plans. But the tax implications may prove otherwise. I’ll have to contact my tax lawyer for some clarification on this matter. Thanks for the useful advice as always. 🙂

  2. Canadian Couch Potato December 9, 2011 at 8:42 am #

    @Dean: Thanks—and please feel welcome to report back if you learn anything new!

  3. marc ryan December 9, 2011 at 12:26 pm #

    RE: Canadian exposure to US Estate taxes-
    This subject regularly comes up, and I always make the same observation. Canadians with direct US assets, for instance a Florida condo, do indeed seem to have a real exposure since upon death their estate is likely to have to make a US estate tax filing in which their estate will need to reveal all of their US assets, including what I call indirect US assets such US stocks, bonds and ETF’s held in their canadian brokerage account(s). However Canadians with no direct US assets are likely to not face the same issue. I invite all your readers to check with their Canadian broker, and ask if the broker will require US estate and income tax clearance when he or she dies at a time when there are US stocks, bonds and ETF’s in his Canadian account(s). My expectation: they will be told no such requirement exists, so as a practical matter there should not be any US estate tax exposure. If you do ask your broker, please advise us of your broker’s response by posting a follow-up comment here.
    A final caveat: one cannot exclude the possibility that in the future the IRS will try to blackmail Canadian brokers that are part of Canadian financial groups who do business in the USA to mstart snitching on their Canadian clients. However, I suspect that Canadian financial groups would strongly resist since, if they caved in, many of their clients would switch to stand-alone Canadian brokers.
    Marc Ryan

  4. Andrew F December 9, 2011 at 3:24 pm #

    What about assets held in a holding corp at the time of death? The corporation lives on, so I presume there are no US estate issues?

  5. Canadian Couch Potato December 9, 2011 at 3:36 pm #

    @Andrew F: That strategy is discussed in the BDO Canada document that I linked in the post. Here’s what it says:

    If a Canadian corporation holds the U.S. property, there
    should not be a disposition of the property
    for estate tax purposes on death. However,
    it should be noted that you may pay more
    combined Canadian and U.S. income tax on
    investment income and on the eventual
    capital gain by using a corporation. In
    addition, this strategy is not an effective way
    to hold personal-use U.S. real property, as
    this creates a Canadian personal tax cost to
    the owner of the corporation through the
    assessment of a benefit.

  6. Rick December 10, 2011 at 9:30 am #

    Can you please add and track a model portfolio using the new Vanguard ETFs. How does the following look:
    VSB 40%
    VCE 20%
    VEF 20%
    VUS 20%

  7. Canadian Couch Potato December 10, 2011 at 11:47 am #

    @Rick: The portfolio looks great. However, I don’t expect to be updating my model portfolios for a year or so.

    VUS and VEF use currency hedging, which I prefer to avoid: I will continue to recommend VTI and VXUS (or VEA/VWO) for foreign equities. VCE and VAB are certainly excellent choices for Canadian equities and bonds, and I may update the model portfolios with these at some point, but I’m resisting the urge to make changes every time new products are launched.

  8. Maxwell C. December 11, 2011 at 4:47 pm #

    A whole YEAR? I was expecting something like every month!

  9. Que November 15, 2012 at 3:00 pm #

    Hello Dan,

    You always find very creative ideas towards your Blog, and don’t have a lot of repetition, but have you considered doing updates on some topics that deserve another post, like this one? As new ideas and methods to deal with obstacles like this tax come out of the wood work, it would be nice to talk about them, especially as your readers age and grow their US exposure.

    Also, since this current law is only valid until the end of 2012, have you thought about doing a follow up post in the new year with any new changes?

    Always appreciated.

    Thanks,
    Que

  10. Canadian Couch Potato November 15, 2012 at 3:06 pm #

    @Que: Thanks for the comment. I will definitely report on any changes to the estate tax rules that come about in the new year.

  11. Matt February 17, 2013 at 9:08 pm #

    Dan, can you comment on the new US estate tax rules passed in Jan 2013?

    If I’m reading things correctly, US estate taxes kick in once your worldwide assets are greater than $ 5.25 million for 2013, indexed for inflation annually.

    And then your rate of taxation depends on the value of the US assets you own, minus the unified credit granted by US-Canada tax treaties?

    I guess the only thing that trips me up is ‘worldwide assets’. You mention that it includes the value of your home, recreational properties, investments and certain life insurance policies… who exactly is tallying this up when you die? What if certain assets are held in two names, like a husband and wife owning a house? How does the US government know if I own a cottage?

    Thanks for any comments!
    matt

  12. Canadian Couch Potato February 18, 2013 at 7:47 am #

    @Matt: I have not looked carefully into the new rules and don’t want to offer advice where I’m not qualified. If you think you may be vulnerable to US estate taxes you should definitely consult a tax specialist.

  13. Prasanna September 14, 2013 at 8:06 pm #

    Hi Dan:
    If I hold US based ETF’s directly from a American exchange that cost over $100,000, do I have to file a T1135, (specified foreign property) even though a T5 or a T3 maybe issued by the Canadian Broker?

    Many thanks
    Prasanna
    Maple,ON

  14. Canadian Couch Potato September 15, 2013 at 10:07 am #

    @Prasanna: This article should help:
    http://www.advisor.ca/tax/tax-news/is-updated-t1135-cause-for-celebration-121472

  15. Prasanna September 15, 2013 at 9:57 pm #

    Glad to see that RRSP..etc are exempted. thanks for the link.
    Best,
    Prasanna

  16. Jon March 20, 2014 at 10:59 pm #

    Hello CCP,
    If I held a US listed ETF such as VTI in a professional corporation, do you know if I would get taxed by both Canadian and US governments? What if I held VUN instead?

  17. Canadian Couch Potato March 21, 2014 at 12:35 am #

    @Jon: You would be subject to the usual withholding tax on dividends, but you would not pay US income taxes. The same would be the case for VUN. See our white paper for more information:
    http://canadiancouchpotato.com/2014/02/20/the-true-cost-of-foreign-withholding-taxes/

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