U.S. estate tax rules clarified
Canadian Tax Alert – Global employer services, January 6, 2011
Since 2001, tax practitioners have been looking to the end of 2010 when the so-called “Bush tax cuts” were set to expire. A recent lack of clarity about the future of these tax changes has made U.S. estate-tax planning particularly challenging. However, following some last-minute negotiations in Washington, on December 17, 2010, U.S. President Obama signed into law tax changes providing some clarity to estate planners and executors. These more recent changes will expire on December 31, 2012.
The old rules: 2010
Without the recent legislative changes, 2010 was to be the year individuals were free of U.S. estate tax, with significantly higher estate tax rates (as high as 55%) coming into effect on January 1, 2011. Whereas in prior years a beneficiary could benefit from an increase in the basis of certain property passing from the decedent, 2010 implemented “modified” carryover basis rules which limited the increase in basis on property.
Under the “modified” carryover basis rules, an executor of a decedent who was a U.S. citizen or resident upon death in 2010 could apportion up to $1.3 million (all figures in U.S. dollars) of the fair market value of the assets on death as a basis increase to the assets inherited by the estate’s beneficiaries. In addition, a further $3 million of basis increase could be apportioned to property of a U.S. decedent passing to a U.S. surviving spouse. The discretionary nature of the allocation could certainly create some interesting discussions among the beneficiaries of a 2010 decedent’s estate.
The new rules: 2010 to 2012
The last-minute tax law changes provide retroactive implementation to January 1, 2010 of a U.S. estate tax for the calendar year 2010. The reintroduction provides for a full step-up in basis for most property passing to a beneficiary.
However, to help counterbalance the last-minute reintroduction of the U.S. estate tax rules, an optional estate tax system is being made available for deaths occurring in 2010. For calendar year 2010, an executor may make a special election for the estate to not be subject to U.S. estate tax; however, the assets of the estate will be subject to the “modified” carryover basis rules highlighted above.
With the potential retroactive application of the U.S. estate tax to a 2010 decedent, an estate executor must determine which of the two systems to select. The executor will need to balance the needs of each beneficiary as well as the estate as whole, and will need to look at both the relative size of the estate and the extent to which the estate’s assets had an accrued gain on death. The executor will also need to examine the interaction of the U.S. estate/income tax regime chosen with any foreign taxes arising from the death. For example, the Canada-U.S. tax treaty only provides relief for U.S. estate taxes incurred on death, and not on the carryover of basis inherited by a beneficiary.
For tax years 2010 to 2012, the U.S. estate tax rate will be set at a maximum 35% (down from the 2009 maximum rate of 45%), with an exemption amount of $5 million (up from the $3.5 million exemption in 2009) for U.S. citizen or resident decedents. A full step-up in basis will apply to most property owned by the decedent and passing to a beneficiary (except where an executor elects not to subject a 2010 estate to U.S. estate tax and thereby falls into the modified carryover basis rules).
Where the decedent is neither a resident nor a citizen of the U.S. (such as a Canadian holding U.S. real property), the modified basis carryover rules limit the amount of the basis increase to $60,000 (instead of $1.3 million). However, the rules applicable to property passing to a spouse are unclear, and as such it is uncertain whether property passing from a non-U.S. citizen may benefit from the ability to use the $3 million basis increase. Additional clarity will be required from the Internal Revenue Service.
For Canadians holding U.S. real property, the increased U.S. domestic exemption highlighted above will allow Canadian estate planners to minimize the U.S. estate tax impact, as their U.S. estate tax exemption will now be a prorated percentage of a higher exemption amount. However, careful consideration will be needed when contemplating the use of the carryover basis rules.
Planning beyond 2012
As most estate planners and advisors generally take both a short term and long term view to planning, there will continue to be uncertainty regarding the U.S. estate tax rates and exemptions in place after 2012. For now, taxpayers and their personal advisors should plan to meet frequently to review estate plans and be prepared for more changes as mid-2012 approaches.
For a complete discussion of the U.S. estate tax and other U.S. tax law changes contained within The Tax Relief, Unemployment Insurance Reauthorization, and Job Create Act of 2010, please read our document, Staying in Place: Congress Extends the Bush Tax Cuts.
This publication is produced by Deloitte & Touche LLP as an information service to clients and friends of the firm, and is not intended to substitute for competent professional advice. No action should be initiated without consulting your professional advisors. Your use of this document is at your own risk.