US Estate Planning: An Introduction to US Estate Tax

What Is US Estate Tax?

The Internal Revenue Service (IRS) imposes estate taxes on US citizens, US residents, and some non-residents. Estate tax is calculated using an individual’s worldwide estate. One’s total US estate tax liability is subject to applicable exclusions, credits, and deductions.

What Is the US Estate and Gift Tax Exemption?

In 2020, the federal estate and gift tax exemption is $11.58 million USD per individual and a combined $23.16 million USD for couples, meaning individuals can leave almost $12 million USD to heirs and couples can leave approximately $23 million USD to heirs without being subject to the US federal estate and gift tax. Although the current exemption amount is historically generous, it is projected to revert to pre-Trump levels on January 1, 2026.

Who Is Subject to US Estate Tax?

The term “US Person” is often used to describe US citizens and green card holders, who are all caught by the US estate and gift tax net, no matter where in the world they live. For example, both US citizens born in foreign countries to US citizen parents and Canadian-born-and-raised professionals who have acquired a green card are considered to be US Persons. All US Persons are subject to estate tax and must also file an annual tax return and related forms, regardless of their country of residence. 

Non-resident aliens who hold US situs assets are also subject to US estate tax. A non-resident alien is defined as an individual who does not hold a green card and who is neither a resident nor a citizen of the US.

Which Property Is Subject to US Estate Tax?

Generally, the following US situs property is subject to federal estate tax: 

• Real estate or tangible property physically located in the US;
• capital stock of a US corporation (private or public); and
• debt obligations (e.g., bonds, debentures, and loan instruments) issued by a US domestic corporation or trust.

Property Interest is a key concept thoroughly described in the Internal Revenue Code (IRC), sections 2033 to 2042. In essence, many types of property interest are included in one’s gross estate, such as transfers with a retained reversionary interest, joint property, and life insurance proceeds.

How Is US Estate Tax Calculated?

The gross estate (fair market value, or FMV) of a deceased’s worldwide assets for federal estate tax purposes is roughly comparable to gross income under the federal income tax. Just as all items of income subject to income tax must be included when calculating one’s income tax liability, all the property and property rights that are subject to estate tax must be included when calculating one’s gross estate for US estate tax purposes. After identifying and summarizing each item in the gross estate, deductions are subtracted; the remainder is the amount used to calculate the estate tax.

Note that the resulting gross estate for tax purposes may not necessarily be the same as the probate estate. For instance, life insurance proceeds paid to named beneficiaries, trust property, and joint ownership property with rights of survivorship will not be captured by the probate estate but will be part of the gross estate for US federal estate tax.

How Do You Reduce Your US Estate Tax Liability?

It is only all too common to find that adult children have been included on title to US property under a joint tenancy with right of survivorship; regrettably, this can create gifting issues. Alternatively, Canadians are often advised to set up a revocable living trust to hold US property, which works well within the US, but unfortunately creates many issues on the Canadian side. A Cross Border Irrevocable Trust may be a better option for Canadians.

For US estate tax purposes, life insurance policies on the life of a deceased are included in the value of the deceased’s gross estate if he or she held any incidents of ownership in the policy (i.e., owned the policy, held an option to acquire the policy, or had the right to control the policy directly, or, for example, through a corporation that owned the policy in which the owner held 50 percent or more of the shares).

Additionally, a policy on the life of a third-party is treated as US property and is valued at its cash surrender value at the date of the owner’s death.

Holding life insurance policies in an irrevocable life insurance trust ensures that insurance proceeds are not included in a deceased’s taxable estate.

Several deductions are available to reduce the value of an individual’s worldwide estate. Examples of deductions include funeral expenses, outstanding debts secured against US situs assets, estate taxes paid to a US state, and gifts at death to a registered charity. Solely available to married individuals, the estate tax marital deduction can be an effective tool for estate planning. 

Despite the Republican tax reform enacted in December 2017, the federal estate tax remains a formidable source of estate shrinkage. A great deal of estate planning centres around strategies to reduce this final liability.

If you are a US Person living in Canada, a non-resident alien with US situs assets, or a Canadian resident aiming to become a US Person without exposing your worldwide estate to the IRS, a cross-border professional can help you with you with an optimized estate plan.

This short summary is part one of a series aimed at demystifying US estate planning. For additional resources, please find below a list of useful links:

• Snowbirds, here’s how to avoid probate on US sunbelt properties, The Globe and Mail, October 2019
• If your child lives in the US it may be time to revise your will, The Globe and Mail, June 2019
• Essential planning considerations for Canadians selling US property, MCA Blog, June 2019