Benjamin Franklin once said: “In this world, nothing can be said to be certain except death and taxes.”
He was right. Yet, even though death and taxes are two constants, the type and amount of tax to paid upon a person’s death can differ dramatically based on a person’s province of residence and estate planning.
In fact, residency and estate planning can have a very big impact on a person’s final estate tax owed, particularly since a variety of taxes may be imposed by different taxing jurisdictions. If you understand the implications of inheritance taxes (known in Canada as probate tax), estate taxes and estate planning, you can certainly reduce the impact these taxes have on the legacy you live to your beneficiaries.
Country of residence at time of death is key
Most developed nations impose at least one type of tax on the estate of the deceased. An estate is all of a deceased person’s assets. This includes property, rights and other tangible interests. When charged to the estate, this tax is based on the value of a deceased person’s estate, including all property, rights, assets and other tangible interests. In Canada, the deceased person’s estate owes this tax. In other countries, the tax is imposed on the beneficiary, or the person who receives the assets of the deceased. This tax is sometimes called an inheritance tax or succession duty.
A person’s citizenship, residence and the place where the asset is located may play a role in determining what kind of tax must be paid. It also determines how much estate tax needs to be paid.
For example, in Canada, Australia, New Zealand and Denmark, the estate will owe capital gains tax on all property owned at the time a person died. In Canada, the personal residence of the deceased owes this capital gains tax but is also exempt from the tax based on the principal residence exemption.
In comparison, the Internal Revenue Service, the American tax department, doesn’t offer an exemption on the capital gains of a principal residence (for homes over a certain threshold). Instead, the IRS imposes a tax on a deceased person’s estate. However, the U.S. tax code offers taxpayers a massive exemption — $11.4 million USD in 2019 — which means that only the wealthy end up paying estate taxes.
In Japan, Chile, and many European countries, an inheritance tax or succession duty is charged. It is based on the items and property that a beneficiary receives from the person who died. Here, too, there is an exemption on the amount of inheritance tax paid. Only those gifts and properties inherited which exceed the value of the exemption are taxed.
Overlap of tax laws makes estate planning a critical step to protect your beneficiaries
Determining and paying the estate tax or inheritance tax may seem simple but each country (and jurisdiction) will expect their share which makes the possible overlap of taxes owed possible — and sometimes result in the same asset being taxed multiple times by different taxing jurisdictions.
For example, if a person living in Canada dies and leaves all of his property to someone living in Japan, the beneficiary will need to tackle taxes in Canada and in Japan. The Canadian capital gains tax may be imposed on the estate as a result of the Canadian resident’s death. In addition to this, the person’s beneficiary in Japan will have to pay the inheritance tax on the value fo the inheritance.
These examples show the importance of dealing with multiple taxation issues using estate planning especially if it involves beneficiaries in countries that impose an inheritance tax. A person would need to consider who will bear the tax burden once he or she dies. They also need to consider just how it will affect the beneficiaries.
Let’s illustrate how big a difference this can make. If a person designates that the taxes are to be paid by the estate, all the beneficiaries would receive the same net amount. This includes beneficiaries who are living in places that impose an inheritance tax. If the beneficiaries pay the taxes, those who are living in places where there is an inheritance tax would end up receiving significantly less. These taxes can go as high as 55% in some jurisdictions. Whereas those who reside in places which do not impose such a tax would receive more.
How to minimize taxes through estate planning
While there is no way to completely avoid multiple taxes after death, proper estate planning can make a major difference in minimizing the estate’s or a beneficiary’s tax exposure.
For example, Canadians may be able to protect properties from additional U.S. estate taxes by placing assets in a trust. This is an arrangement where a property is transferred by one person to another for the benefit of a third person. In the U.S., there are exemptions associated with placing assets in a trust. This can greatly reduce estate taxes that would need to be paid.
Another way to minimize the effect of multiple taxation on death is by using a “blocker” corporation. A Canadian who has beneficiaries in the U.S. may direct his or her assets located in the U.S. to be held through a foreign corporation. This is referred to as a “blocker” corporation. With this estate planning strategy, the assets held by the foreign corporation is considered to not be based in the U.S. Therefore, it would not be included in the person’s U.S. taxable estate. The foreign corporation acts as a blocker which shields the Canadian’s U.S.-based assets from U.S. estate taxes.
A simpler method to try and deal with the impact of multiple taxation is by purchasing life insurance. The U.S. tax code considers life insurance on a foreigner who is not living in the U.S. as not situated in the country. As a result, it is not included as part of a foreigner’s taxable U.S. estate. This life insurance — in the amount of the expected estate tax for the person’s assets based in the U.S. — will provide his or her beneficiaries with the funds necessary to cover the U.S. estate taxes.
Smart estate planning strategies take the beneficiaries’ place of residence into account
Proper planning is also used to minimize the effect of multiple taxation in other countries.
In France, for example, some types of life insurance vehicles are used to hold investments so that it will not be subjected to an inheritance tax. But in England, trusts are used in some situations by persons not living in the U.K. to shield them against inheritance taxes.
Without proper planning, a person’s estate can be significantly affected by multiple taxes on death. To avoid multiple taxation you must assess each potential beneficiary’s tax implications. The possible effect on the estate would be a good starting point for proper planning.
As you can see, there are many factors to consider when it comes to dealing with the issue of multiple taxation on death. These factors may also differ from one individual to another, depending on their personal circumstances. With Canadian families branching out all over the world, it is very important to understand just how impactful multiple taxation on death can be. It is vital to seek professional help to properly handle the issue.