Sophie Lalonde, Founder at 3D Financial, and Shlomi Steve Levy, partner at Levy Salis LLP, bring you a special collaborative article. In this article, they delve into the intricate world of cross-border inheritance, focusing on Canadians with U.S. beneficiaries. Explore the nuanced tax, legal, and financial challenges in this informative piece. To know more about these issues, read the article below.
Embarking upon the path of cross-border inheritance, especially from Canada to the U.S., reveals a myriad of nuances and tax implications worth exploring. With multifaceted complexities in play, we can distill this exploration into three primary components for Canadians dealing with U.S. beneficiaries:
- Choosing a Power of Attorney
- Understanding Reporting and Tax Obligations for the U.S. Beneficiary
- Examining Subsequent U.S. Estate Tax Exposure for U.S. Beneficiary
1. Power of Attorney: Navigating Jurisdictional and Practical Challenges
When a Canadian designates an American as a Power of Attorney (POA), several issues may arise, including:
- Jurisdictional Issues: Ensuring the POA document complies with laws in both Canada and the U.S. and defining which laws will govern the relationship.
- Tax Implications: Acknowledging potential tax consequences for both parties and seeking professional advice.
- Distance and Communication: Managing affairs across borders and establishing effective communication channels.
- Cultural and Legal Variances: Navigating differences that might impact POA document execution and interpretation.
- Financial Institutions’ Requirements: Ensuring the POA adheres to financial institution guidelines in both countries.
It’s pivotal to engage professional guidance to ensure that the POA aligns with all legal compliances and meets everyone’s needs.
2. Reporting and Tax Obligations: Navigating Compliance and Avoiding Penalties
U.S. beneficiaries must adhere to stringent reporting obligations. Although the U.S. doesn’t directly tax Canadian inheritances, it demands detailed reporting via forms, notably Form 3520. A failure to submit can result in a penalty of up to 35% of the inherited assets. However, inheritances under $100,000 USD are exempt from this requirement.
3. Financial Intricacies: Inheriting Securities and Addressing Currency Risks
Upon death in Canada, securities’ Adjusted Cost Base (ACB) ‘steps up’ to the market value, which becomes the new ACB for the U.S. beneficiary, thereby settling capital gains until the decedent’s death at the estate level in Canada.
However, complexities arise when handling specific investments like mutual funds or Real Estate Investment Trusts (REITs), which can be classified as a Passive Foreign Investment Company (PFIC) in the U.S., potentially triggering adverse tax outcomes. Furthermore, Canadian mutual funds cannot typically be held by American residents due to regulatory issues.
Beneficiaries must also acknowledge currency risks, considering the exchange rate fluctuations between the Canadian Dollar (CAD) and the U.S. Dollar (USD).
4. Legacy Planning: The Role of the Dynasty Trust in Safeguarding Future Generations
Considering the potential of U.S. estate tax on beneficiaries’ assets should they subsequently pass away, employing a Dynasty Trust becomes crucial. This trust perpetuates wealth across generations within a tax-advantaged environment, safeguarding against gift tax, estate tax, and generation-skipping transfer tax as long as assets remain within the trust. Importantly, it allows for wealth preservation through unlimited generations, provided that it is structured aptly.
In light of the 2017 Tax Cuts and Jobs Act, the federal estate tax exemption is set at $12.92 million, allowing you to allocate up to this amount into a Dynasty Trust without incurring estate taxes or generation-skipping transfer tax, thereby ensuring prolonged asset protection. This strategy may be particularly astute at present, as there are rumors that the exemption may be reduced to $5 million, adjusted for inflation, in 2026.
Navigating through the convolutions of cross-border inheritance necessitates meticulous planning and an adept understanding of the legal and financial landscapes across both jurisdictions. It is imperative to consult professional advice to adeptly navigate through the particularities of cross-border inheritance and investments.
The comments offered in this article are meant to be general in nature and are not intended to provide legal advice regarding any individual situation. Before taking any action involving your individual situation, you should seek legal advice to ensure it is appropriate for your circumstances.
About the author
Shlomi Steve Levy is a Partner of Levy Salis LLP and is a member of the Quebec Bar, the Law Society of Ontario (L3), the Society of Trust and Estate Practitioners, and the Canadian Bar Association.
With more than 25 years in the financial industry, Sophie has achieved levels of expertise far beyond the industry standard. Not only is she one of Canada’s foremost financial planning experts, she is also one of very few cross border financial planning specialists.