What are the tax implications if you are a beneficiary of a U.S. estate? Rarely do we consider the implications of a Canadian resident inheriting from a U.S. estate.

From a Canadian Tax Perspective

The general rule is the Canadian beneficiary shall receive their inheritance tax-free since the U.S. estate is deemed to have acquired the assets at fair market value (i.e. cost-base step-up).

Further, if the executor is a resident of the U.S., any income earned by the U.S. estate should not be taxable to the Canadian beneficiary on the basis that the estate is considered a non-resident taxpayer. That said, if the estate distributes the income to the Canadian beneficiary, the latter will be subject to Canadian tax on the income received and there will likely be some withholding tax in the U.S. The beneficiary will need to seek clarification from the executor.

The distinction between the Canadian beneficiary receiving money or property from the U.S. estate is important. If the Canadian beneficiary receives cash as his or her inheritance (not income), then there are likely no tax issues. However, if the Canadian beneficiary inherits U.S. property (such as real estate) from the U.S. estate, the beneficiary likely has Canadian tax reporting requirements, notably, submitting Form T1135. The beneficiary must also seek the fair market value of the property received in order to establish the cost base of the property.

The above demonstrates the importance of the beneficiary to seek information and clarification from the U.S. executor. Navigating through the Canadian tax rules can be complex, especially in the context of a Canadian beneficiary of a foreign estate.

Are you Inheriting from an Estate or a Trust?

In the U.S., the use of trusts as an estate planning vehicle, and to avoid probate, is fairly common. The advantages of using a trust are that the assets held by the trust never form part of the estate and thus, probate is avoided and the administration of the trust may be more expedient.

For the Canadian beneficiary, it is important to enquire whether he’s receiving from the estate or from a trust created by the deceased. There are important distinctions when receiving from a U.S. trust, as opposed to an estate, and this may be problematic for the beneficiary for different reasons. Here are examples of what the beneficiary needs to consider:

• Property held in a U.S. trust will not receive a cost-base step-up for Canadian tax purposes. Such could result in a mismatch since the U.S. will recognize a property cost-base step-up. Such a discrepancy could result in a capital gain triggered for Canadian tax purposes on the distribution to the Canadian beneficiary.
• The foreign tax credit may not be available to offset potential U.S. taxes paid or withheld at source because the trust is treated as a separate taxpayer; this may result in double-tax to the Canadian beneficiary.

If the distribution is received from a U.S. trust rather than an Estate, the Canadian beneficiary should also seek tax advice as to whether Form T1142 is required; it likely is.

U.S. trust law and Canadian trust law are different and as a result, the Canadian beneficiary will need to retain a knowledgeable cross-border advisor to appreciate these discrepancies and the beneficial rights.

Conclusion

It would be ideal if the beneficiary was involved in the estate planning but in most cases, it is a fait accompli leaving the beneficiary to untangle this web of complexities. Therefore, a client who learns of being a beneficiary of a U.S. estate should consider the cross-border tax issues and the tax compliance that may ensue and seek professional assistance.