The Smiths have been married for 40 years. Mr. Smith was born in Florida. Mrs. Smith was born in Saskatchewan. They met while they were in college and married within a year. While they could have settled down to a life of sunshine and oranges by staying in the U.S. they opted to move back to Saskatchewan.
The two have lived in Canada ever since. Mr. Smith goes back home to visit but he has been a Canadian resident for 40 years. Mr. and Mrs. Smith have made some money over the years, and managed to build up some wealth. Everything the couple owns is here.
The U.S. government has an interest in seeing Mr. Smith die. Not this year, however. Why? The U.S. government charges estate taxes against the wealth of its citizens when they pass away. That tax regime has been suspended for the 2010 calendar year. If Mr. Smith were to die this year, his estate would pay nothing in U.S. estate taxes. If he dies on Jan. 1 of next year, his estate will get hammered. The U.S. estate tax regime is scheduled to roar back into effect in 2011 with a 55 per cent tax rate and a $1,000,000 exemption.
What does that mean for Mr. Smith? He has assets of $3,000,000. If Mr. Smith dies in 2011, or in any later year, the first $1,000,000 of assets he owns will be free from tax by virtue of the exemption. The remaining $2,000,000 will be taxed at 55 per cent, leaving a total tax bill at death owed to the U.S. government in the order of $1,100,000.
That is a whopping big number. Mrs. Smith will definitely notice it when it goes missing. This is not a tax against income, or against capital gains, but against wealth. Everything Mr. Smith owns is swept into the net. It even includes the life insurance payout triggered at his death inside his company. That will annoy everyone as the life insurance was expected to allow his business partners to buy out his shares. The situation is worse if Mrs. Smith dies first. She has $3,000,000 of her own. If she dies first, and leaves everything outright to Mr. Smith, his net worth jumps to $6,000,000. If he then dies second, a full $5,000,000 will be taxed after the exemption is used. The tax would amount to $2,750,000.
You may be thinking this does not apply to you. Actually, it may. U.S. estate taxes apply to many people who are surprised to find out that they are caught up in the system. First, if you were born in the United States you might be a U.S. citizen without knowing it, even though you carry a Canadian passport. Second, even if you are not a U.S. citizen, you may be subject to U.S. estate taxes at death if you are what is called a "U.S. domiciliary." A U.S. domiciliary can include a person who simply lives in the United States for some time under a permanent resident visa, even after they leave. Holding a green card can be sufficient to sweep a person into the net.
Maybe none of those apply to you, but your family is not out of the woods until you ask yourself this question: Do any of your children live or work in the U.S.? If so, your family may have an issue. When the children die, their wealth will be taxed under the U.S. estate tax system, including anything you have left them along the way.
Can the taxes be avoided? You bet. The best strategy is to die this year. If that seems too extreme, there are a collection of other estate-planning strategies that can reduce or avoid the U.S. estate taxes. Special trusts are often used. The trusts keep the assets out of the U.S. tax system when family members die. You will need a specialized estate-planning adviser if this applies to you. Not everything works. Some do-it-yourselfers try to avoid the tax by making gifts while they are alive. That can inadvertently trigger hefty U.S. gift taxes.
The Smiths are fictional. The problems are real. Their story combines facts from the dozens of clients who consult me each year about U.S. estate planning problems.
John E. S. Poyser is a lawyer with the Wealth and Estate Law Group at the Winnipeg firm Inkster, Christie, Hughes LLP. Contact him at (204) 947-6801 or firstname.lastname@example.org