One of the most talked-about tax issues south of the border is the future of the U. S. estate tax. The current regime is set to expire at the end of this year.
The issue is of critical importance to two groups of Canadians: U. S. citizens living in Canada and Canadians who own "U. S. situs property."
In Canada, upon death, there is a deemed disposition of your property at fair market value. The resulting increase in value from the date of purchase to the date of death is taxable as a capital gain on your final tax return.
The U. S. system works differently. Instead of a deemed disposition with a potential tax liability upon death, the U. S. imposes an estate tax levied on the fair market value of all property owned on the date of death.
The U. S. estate tax applies to all U. S. citizens, even those living outside of the United States, as well as to non-U. S. citizens who die owning U. S. situs property, such as U. S. real estate or stocks in U. S. companies.
For 2009, estate tax rates begin at 18%, but rise to 45% once the taxable estate is over US$1.5-million.
U. S. citizens have an exemption for the first US$3.5-million of the estate. But noncitizens, including Canadians who own U. S. assets, are only entitled to a pro-rated exemption under the Canada-U. S. tax treaty. The exemption is equal to US$3.5-million multiplied by the ratio of U. S. property to your worldwide estate.
That means if your worldwide estate, including your Canadian home, is under US$3.5-million, you need not worry about U. S. estate taxes --at least for now.
However, the U. S. estate tax could be repealed for next year. The status of the estate tax has been in limbo since the entire system was revamped in 2001. Before the reform, the top rate was 55% and the exemption was only US$675,000. Over the past nine years, the rates have fallen and the exemption has risen.
But given the dire state of the U. S. economy, no one thinks that this will continue. Some possible options include:
Do nothing. The U. S. estate tax will disappear in 2010 and automatically return in 2011 with a US$1-million exemption and a top rate of 55%. But this could be a politically risky move. The U. S. Tax Policy Center has estimated that with a US$1-million exemption, approximately 46,000 estates would owe estate tax each year compared with only 6,400 per year by keeping the exemption at its current level.
Another option is to keep the 2009 rates, which max out at 45% with the current exemption of US$3.5-million. U. S. President Barack Obama has recommended that the exemption be indexed to inflation.
A Senate proposal is being considered that would cap the top rate at 35%, with an exemption of US$5-million.
Stay tuned as more details come out in September.