There are notable instances where having a non-U.S. citizen spouse results in complications when it comes to tax and estate planning. For example, there is no estate tax marital deduction when the done spouse in not a U.S. citizen unless a QDOT, a form of qualified domestic trust, is used. This QDOT structure is not an ideal planning structure in many situations.
However, there are certain situations where having a non-citizen allows for tax planning opportunities that are not available to couples where both individuals are U.S. citizens. In this article, we will discuss one such scenario. This scenario and the case facts have been simplified to focus on potential benefits of using this gifting strategy. If this were an actual client situation, there would be additional facts to consider, and each case should be evaluated on its own facts and circumstances.
The case facts are as follows, using the fictitious names of “Janet” and “John” for the two spouses.
Janet and John are a married couple from Texas who are moving to Alberta, Canada on July 1, 2021. They expect to remain there for the foreseeable future, and feel it is likely that they will retire in Canada.
Janet is a U.S. citizen and John is a Canadian citizen who has been living in the U.S. for the last 10 years. He has held a Permanent Resident Card (“Green Card”) for the last five years.
Janet has a large brokerage account that contains numerous positions with significant unrealized capital gains. The value of this account is USD$3,000,000, and total unrealized gains are USD$1,000,000.
While John has some retirement assets, he does not own a brokerage account.
Janet’s net worth is below the current estate and gift tax exemption.
John is expected to earn significantly less taxable income on an annual basis compared to Janet in the future.
Before we dive into the gifting strategy, it is necessary to have a brief refresher on certain points related to the Canadian taxation of brokerage accounts.
Canadian Taxation of Brokerage Accounts Upon Becoming a Canadian Tax Resident
In a previous article of ours https://cardinalpointwealth.com/2018/10/08/residents-of-canada-what-are-the-canadian-and-u-s-tax-ramifications-when-being-forced-to-liquidate-a-u-s-brokerage-account/ we outline some of the Canadian income tax implications of becoming a Canadian resident. Here is a summary of certain facts that are most important for this discussion:
There is a deemed disposition of assets immediately prior to becoming a Canadian resident.
There is a deemed reacquisition of those same assets at the time you become a Canadian resident. The cost basis of these assets for Canadian tax purposes would equal their fair market value on that date.
Each spouse is required to file their own individual tax return in Canada.
For the purposes of our discussion, it is also important to note that Canada has income attribution rules that are applicable in various scenarios, one of which relates to gifts between spouses. A detailed explanation of these rules is beyond the scope of this article, but here is summary of certain relevant points:
If a Canadian resident were to gift assets from their brokerage account to their Canadian resident spouse, future capital gain, interest, and dividend income would attribute back to them.
This is designed to curtail shifting income to a lower income spouse.
Taxation of Janet’s Brokerage Account Without Additional Planning
As mentioned above, for Canadian tax purposes, Janet will be deemed to sell the assets within her brokerage account immediately prior to becoming a Canadian resident. She is then deemed to reacquire them. As such, for Canadian tax purposes, she will then have a brokerage account with a value and cost basis of USD$3,000,000. She has managed to avoid Canadian taxation on the unrealized gains.
However, she maintains the USD$2,000,000 cost basis for U.S. tax purposes, and she would still report USD$1,000,000 of capital gains on her U.S. tax return if she were to sell the assets. She has not avoided future U.S. taxation on the unrealized gains.
Her net worth for U.S. estate and gift tax purposes remains the same.
Goals of the Gifting Strategy
There are three potential goals related to this strategy. The first goal is the main driver of the strategy for most individuals, while the two other goals may be applicable in certain situations. They are as follows:
Avoid taxation of unrealized gains in both countries.
Do the above in a manner that avoids Canadian income tax attribution and allows for income splitting. This goal is more important for scenarios where the U.S. citizen is expected to be in a much higher Canadian tax bracket compared to the non-citizen spouse.
Reduce the net worth of the U.S. citizen spouse. For example, if the U.S. citizen was considering renouncing U.S. citizenship in the future, gifting assets could potentially be a means of reducing their net worth to avoid punitive expatriation tax rules. A full discussion of renouncing U.S. citizenship is outside the scope of this article.
Summary of the Gifting Strategy
Prior to July 1, 2021, Janet gifts John the assets contained in her brokerage account. Since she is below the U.S. estate and gift tax exemption amount, although she will be required to file a gift tax return, she will pay not pay gift tax.
Janet and John will relocate to Canada on July 1, 2021 and will become Canadian tax residents.
John will renounce his Green Card status and as such will expatriate shortly after moving to Canada by one of a couple methods. He will become a non-resident for U.S. tax purposes.
John will own his own brokerage account that will contain the assets that were gifted to him. This account will have a fair market value and cost basis of USD$3,000,000 for Canadian tax purposes.
Future capital gains realized within this account will not be subject to U.S. income tax, since John will no longer be considered a tax resident of the U.S.
The value of Janet’s estate has been reduced by USD$3,000,000.
The unrealized gains of USD$1,000,000 will avoid taxation in both countries.
Income splitting will be achieved.
Since Janet was not a Canadian resident at the time of the gift, the gift will not be subject to the Canadian attribution rules.
Income realized within the account in the future will be taxable to John at his lower marginal tax rates.
Additional Comments on the Gifting Strategy
If income splitting is an objective, the gift should take place prior to Canadian residency. In Janet and John’s situation, it was beneficial to shift income to John and as such it was important for the gift to take place prior to the move. For two high income earning spouses, income splitting will be less of a concern.
A detailed analysis of the expatriation rules for Green Card holders is beyond the scope of this analysis, but here are a few clarifying details. For more information on the expatriate process please contact Cardinal Point or another qualified service provider.
John was able to avoid covered expatriate tax status because he was not considered a long-term resident. He owned his Green Card for less than 8 of the last 15 years.
If John had owned his Green Card for at least 8 of the last 15 years, further analysis would be required to determine the appropriateness of this strategy.
John could expatriate by filling out the required paperwork and handing in/mailing his Green Card to the proper authorities, or by filing a U.S. non-resident tax return with the proper treaty disclosure.
This strategy would be equally effective if the non-citizen spouse had a visa instead of a Green Card.
What if both Spouses hold Green Cards?
This strategy would have a different focus if both spouses held Green Cards.
The gifting would not be required to avoid taxation of unrealized capital gains if both spouses are able to avoid covered expatriate status when they become non-residents of the U.S.
However, it still may be worth gifting assets for income splitting purposes.
If one spouse can avoid covered expatriate status, then it might be worth gifting assets to that spouse in order taxation of unrealized gains.
It is very possible that neither individual is considered a U.S. resident for estate and gift purposed. A detailed analysis would be required to make this determination. However, if this was the case, then gift tax considerations could be ignored. This would allow more flexibility in gifting for very high net worth individuals.
The Cardinal Point Advantage
This article highlights the complexity and intricacy of planning for mixed citizenship marriages, and the importance of tax planning prior to relocating to another country. When a U.S. citizen and their non-U.S. citizen spouse relocate to Canada, this gifting strategy potentially allows for significant tax savings on unrealized gains, for income splitting, and for an estate planning opportunity. As mentioned earlier, the example used in in this article was simplified to focus on the strategy and its intended results. The appropriateness of this strategy depends upon the case facts of each individual situation. We highly recommend that you consult experts such as those employed by Cardinal Point prior to your relocation to Canada, and when considering whether this strategy is appropriate for you.
Cardinal Point has a unique team of cross-border tax, estate, financial planning, and investment management experts. Not only can we assist with planning for your move, we also have the registrations and ability to manage investment portfolios that include accounts in Canada and the United States. We have the expertise to ensure that our clients can maintain retirement assets in their country of origin, and to transition other assets from one country to another in a tax-efficient manner. Our clients receive tax planning as a part of their overall financial plan.
