Cross Border Estate Planning: Gifting to US Resident Children

Canadian parents are no strangers to losing their kids to the US – some may leave Canada to study in the US never to return, while others are recruited by US companies and sponsored by them for immigration purposes.

Once becoming a US person, the child becomes subject to the dreaded US gift and estate tax regime.Click here for a review of these rules. While this may not have an immediate impact on a child whose assets are below the exemption amount of $5.34 million USD, the child may be impacted downstream once he or she has amassed some personal wealth and/or received an inheritance from mom/dad’s Canadian estate.

How can mom and dad, as Canadian resident taxpayers, structure their cross border estate planning to make gifts to US resident children and preserve their US child’s exemption amount?

The Dynasty Trust (commonly referred to as a lifetime trust, perpetual trust, or generation skipping transfer trust), is a structure that can assist in the cross border transfer of wealth from Canadian parents to US resident children or other beneficiaries. This type of trust is beneficial in that, if structured properly, will maintain the assets your child inherits from your estate, along with any growth of such assets, as separate from your child’s personal assets and therefore out of the reach of the US estate tax regime upon your child’s subsequent death. In other words, the inherited assets and any growth should not form part of your child’s estate for US estate tax purposes. In the absence of such a trust structure, the assets your child inherits, and any growth of such assets, would form part of your child’s estate and be subject to US estate tax when he or she subsequently passes away. This consequence can be avoided by the Dynasty Trust.

The Dynasty Trust would be structured as a US trust in that the grantor, trustee, and beneficiary are all US Persons. But, if mom and dad, as Canadian residents, direct under their Wills that the share to their US child be paid to the Dynasty Trust (instead of to the child), then the Dynasty Trust may be deemed to be a Canadian resident trust for tax purposes. This rule derives from section 94(3) of the Canadian Income Tax Act, and, as the section is relatively new, the jurisprudence on point is developing as interpretation issues arise.

One such issue is whether or not the Dynasty Trust would be deemed to be a Canadian resident trust if the Canadian estate of mom/dad is a “resident contributor” to the Dynasty Trust.

The Canada Revenue Agency (“CRA”) has issued conflicting interpretations on this issue. One interpretation is that mom and dad’s estate could not be a “resident contributor” because a deceased person does not exist and therefore cannot be a resident of any jurisdiction. A later interpretation painted a different picture. That is, that a Canadian resident contributor would in fact be a resident contributor, such that 94(3) would apply to the trust until the resident contributor ceases to exist.

If the answer is that an estate can be a resident contributor, section 94(3) will operate to deem the Dynasty Trust to be a Canadian resident trust, the consequences of which may include reporting obligations to the CRA, income and capital gains tax consequences, and potential withholdings on distributions. Moreover, the CRA may require the Dynasty Trust to pay tax on its income to Canada. However, where this is so, foreign tax credits ought to be applied in respect of any tax paid to the US Internal Revenue Service in order to avoid double taxation.

The good news is that if mom and dad’s estate is found to be a resident contributor, the deemed Canadian residency of the Dynasty Trust should only last as long as the Canadian resident contributor is in existence. So, for the change of residency to occur, the Canadian resident contributor must cease to exist – for example, if the Canadian contributor is an estate, the estate needs to be wound-up.

Once the Dynasty Trust has migrated to the US, it will be outside of the Canadian tax sphere and continue as a US trust which is in a position to grow, US estate tax favorably, for many years to come.

Although this area of the law is developing and is not certain, the Dynasty Trust continues to be a valuable cross border estate planning tool for Canadian taxpayers planning for their US resident children or other beneficiaries.