Cross-border insurance planning is tricky but understanding the basics can go a long way in assisting clients. This short article will review some of the key questions to consider in order to avoid potential pitfalls in life insurance planning.

Who is the Owner, the Insured and the Beneficiary

In the context of personal insurance planning, it is important to appreciate that there are always three (3) parties involved; the owner, the insured and the beneficiary(ies). For U.S. gift tax purposes, if there are three different parties involved, there is the risk of inadvertently triggering gift tax by the owner at the insured’s death.

For example, the wife may be the owner of the policy, the husband is the insured and the children are the beneficiaries (i.e. three parties involved). In this scenario, the wife may be deemed to have made a gift of the proceeds of the policy to the children on the death of husband; based on the Goodman[1] case.

Tip: identify the parties involved early.

Know Your Client & The Insurance Policy

First, is the Canadian resident also a U.S. citizen? This is relevant as it will determine the tax implications on the death of the insured.

If the owner of the life insurance policy is a U.S. citizen, the insurance proceeds will form part of the gross estate for U.S. estate tax purposes. If the insurance proceeds are significant, it may increase the value of the estate over the personal estate tax exemption thus, triggering U.S. estate tax.

If the owner of the life insurance policy is a Canadian resident who has no link to the U.S., the life insurance policy shall not be considered U.S. situs property but, could still form part of the decedent’s worldwide estate for U.S. estate tax purposes if the deceased has “incidents of ownership” of the policy within three (3) years prior to death. The main Incidents of ownership may be (but are not exclusive):

• Any ownership interest in the insurance policy;
• Reserving the right to amend or change the beneficiary(ies) under the insurance policy;
• Reserving the right to borrow against the insurance policy.

If the policy meets the above criteria and the Canadian resident holds U.S. situs assets on their death (for example, U.S. real estate or U.S. stocks), estate advisors need to look at the specifics of the life insurance policy to properly assess the U.S. taxable estate implications.

If the Canadian resident wishes to sever all incidents of ownership, it is important to note there is a 3-year lookback where the proceeds of the life insurance will be included in the taxable estate for U.S. estate tax purposes.

Is the Insurance Issuer a U.S. Company or Canadian Company?

It is also relevant to look at the insurance issuer. Why? If the Canadian resident owns an insurance policy issued by a U.S. insurance company, the U.S. will consider the insurance to be a U.S. situs asset and its value will form part of the deceased’s gross estate for U.S. estate tax purposes. This might occur where the insured immigrated to Canada from the U.S. and has maintained his U.S. insurance policy.

If the Canadian resident is a U.S. citizen and owns an insurance policy issued by a Canadian insurance company, in addition to the U.S. estate tax implications noted above, they need to beware of the potential application of the U.S. excise tax. Also, there is likely an obligation on the U.S. citizen to report the accrual cash value and there may be U.S. tax implications.  Lastly, the U.S. citizen may have to report the insurance as part of his or her FATCA reporting.

Conclusion

A comprehensive estate plan requires a delicate balance of thoughtful decisions, strategic implementation and in some instances, life insurance may be a key component of the plan. In the context of cross-border estate planning, advisors need to review the specifics of the life insurance to properly assess its potential tax implications; the Canadian and U.S. tax implications, as well as any relief from the Canada-U.S. Tax Treaty.

[1] Goodman v. Commissioner, 156 F.2d 218 (2nd Cir. 1946).