Navigating cross-border tax traps: Estate planning for Canadians with U.S. connections
The tax advisor’s role in Canadian estate planning has become more important than ever as tax rules grow increasingly complex. Add a U.S. person into the mix and the complexity seems to not just double, but triple or quadruple. This disproportionate complexity is primarily caused by two issues:
- U.S. citizens are taxable on worldwide income no matter where they reside,1 and
- Canada has a capital gains tax on death, while the U.S. has an estate tax levied on the fair market value of a decedent’s worldwide estate.2
Whether it is a U.S. citizen resident in Canada or a U.S. beneficiary of an otherwise Canadian estate, aligning Canadian and U.S. tax laws to achieve a person’s non‑tax estate planning objectives can be daunting. The guidance of a cross‑border tax advisor in the estate planning process is imperative for impacted Canadians.
Here, we highlight a few key issues and the strategies we have employed to help clients bridge the gap between Canadian and U.S. tax systems, avoid double taxation and achieve their non‑tax estate planning objectives. We focus on some unique cross‑border tax challenges faced by (1) U.S. citizens resident in Canada and (2) non‑U.S. citizens resident in Canada with either a U.S. citizen spouse or beneficiaries.
U.S. citizens resident in Canada
U.S. estate tax
The U.S. imposes a unified estate and gift tax of up to 40 per cent of the fair market value of the taxable estate and certain lifetime gifts of a U.S. citizen. Currently, the lifetime estate and gift tax exemption is $13.99 million USD for 2025, so it will not be an issue for everyone. For some taxpayers, however, the impact could be substantial.
Furthermore, in 2026, the lifetime exemption is set to revert back to approximately $7 million USD.3 As such, there are likely many taxpayers who may be in the clear based on the current exemption, but will have to revisit their U.S. estate tax exposure if the lifetime exemption returns to the much lower amount in 2026. Taxpayers in this situation may wish to consider significant gifting strategies now to “lock in” the current higher lifetime exemption.
If a taxpayer expects to have a U.S. estate tax liability upon their passing, careful planning is advised to ensure it is creditable against Canadian taxes at death (or vice versa) under the Canada‑U.S. Tax Treaty to eliminate or reduce potential double taxation.
Controlled Foreign Corporations (CFCs)
We have highlighted in past articles the potentially punitive Global Intangible Low Taxed Income (GILTI) and Subpart F regimes applicable to U.S. citizens resident in Canada who control CFCs.4, 5 While we do not repeat technical details of the U.S. income tax and compliance issues here, we stress they can be quite significant and burdensome. CFCs can be particularly challenging when executing Canadian post‑mortem tax planning (common Canadian planning designed to eliminate double tax at death). If CFC status can be avoided, or if its associated tax problems can be mitigated as part of an estate plan, it should be seriously considered.
Estate freeze for a U.S. citizen resident in Canada
Canadians often employ estate freezes as a means of transferring future growth in assets to the next generation. When the freezor is a U.S. citizen resident in Canada, navigating the impact of the complicated U.S. income and estate tax regimes can be challenging.6 Careful attention must be given to both Canadian and U.S. income tax provisions to ensure the transaction does not trigger a taxable event on either side of the border. However, when orchestrated properly, they can not only work, but may have some U.S. tax benefits by utilizing the freezor’s U.S. lifetime gift tax exemption.
For U.S. income tax purposes, while the company would likely remain a CFC after the transaction, the double tax exposure posed by the GILTI and Subpart F regimes may be reduced if there are non‑U.S. owners of the growth shares. Finally, there may also be advantageous foreign tax crediting in relation to any U.S. estate tax levied on other Canadian assets in the estate.
Alter‑Ego Trusts (AETs)
AETs are common in Canadian estate planning and can serve as a will substitute, with benefits ranging from reduced probate fees, planning for incapacity, seamless transition of assets and minimizing the risk of will contestation. A Canadian, age 65 or older, would transfer assets tax‑free to the AET and maintain exclusive entitlement to its assets and income during their lifetime. Upon their death, the AET would pay the Canadian tax on any unrealized gains on its assets, not the individual decedent.
During the settlor’s lifetime, it is likely an AET would be considered a foreign grantor trust (FGT) for U.S. income tax purposes and its income would ultimately be taxed to the grantor/settlor for both U.S. and Canadian tax purposes, with foreign tax credits claimed to minimize double tax. The associated annual U.S. tax compliance with FGTs can result in increased tax preparation fees.
The U.S. estate tax implications of AETs can be more problematic and must also be considered. The decedent would likely include the AET assets in their gross estate for U.S. estate tax purposes. If the AET holds U.S. situs assets upon which U.S. estate tax is payable, the Canada‑U.S. Tax Treaty does not appear to provide relief for the AET to claim a foreign tax credit for the U.S. estate tax liable by the individual decedent (not the AET) on those assets. As a result, the potential for double tax exists.
Joint Partner Trusts (JPTs)
JPTs serve a similar purpose as AETs and have similar Canadian tax implications. They differ in that the trust assets and income must exclusively be for the benefit of the taxpayer and their spouse, until the death of the second spouse. There is no deemed disposition to the trust at the death of the first spouse and the tax is deferred until the death of the surviving spouse.
The potential U.S. income and estate tax problems noted for AETs above may also apply to a JPT and must be considered if either spouse is a U.S. citizen. The IRS would likely view the JPT as two separate FGTs with respect to each spouse’s individual contributions, causing accounting headaches when preparing the U.S. citizen’s U.S. tax return. Canadian tax compliance may also be complex due to similar Canadian tax rules attributing the trust’s income based on who contributed the income generating assets.
Renouncing U.S. citizenship
For U.S. citizens in Canada grappling with these complex cross‑border tax problems, renouncing U.S. citizenship could be one way to cut the Gordian knot. Renunciation is a major decision and will not be a viable solution for many due to non‑tax reasons. The U.S. also has a complex expatriation tax regime that must also be considered.7
Non‑U.S. citizens resident in Canada with either a U.S. citizen spouse or‑beneficiaries
Many of the above issues also apply when a non‑U.S. person is planning on leaving assets to a U.S. surviving spouse or other U.S. beneficiaries. However, there are more opportunities to plan around some of the impending U.S. tax problems before the U.S. beneficiaries have inherited an interest in the assets. Families with Canadian estate plans should revisit those plans if U.S. beneficiaries are involved and take extra care if the estate includes Canadian entities such as trusts, partnerships or corporations.
Bypass spousal trusts
Canadians who are non‑U.S. persons wanting to leave assets to a U.S. citizen spouse should consider implementing a bypass trust in their will. The Canadian death taxes on assets left to a spouse or qualifying spousal trust can be deferred to the death of the surviving spouse.
However, assets left to a spouse or spousal trust typically form part of the surviving spouse’s gross estate, entering the U.S. estate tax net. If the spousal trust places certain limitations on the surviving spouse’s invasion powers over the trust capital, the spousal trust may qualify as a bypass trust for U.S. estate tax purposes, meaning its assets may be excluded from the surviving spouse’s gross estate upon their death.
Notwithstanding the U.S. estate tax result, where a U.S. surviving spouse indirectly inherits corporate assets through a spousal trust – i.e., the CFC and foreign non‑grantor trust (FNGT) rules – the potential U.S. income tax issues must be considered. Pre‑mortem planning solutions involving Unlimited Liability Companies (ULCs), discussed below, may help alleviate some of these problems.
Estate freeze with U.S. beneficiaries
We previously discussed the U.S. tax considerations at play when a U.S. citizen resident of Canada shareholder freezes their interest in a Canadian corporation. For non‑U.S. citizen shareholders looking to transition ownership to the next generation, it is important to identify whether any members of the future generation are U.S. persons.
Where family trust beneficiaries are U.S. persons, they may have just gained an indirect interest in a CFC via the trust – or potentially a Passive Foreign Investment Company (PFIC) – which has similar negative tax problems we do not discuss here. Furthermore, future trust distributions to U.S. beneficiaries could be considered distributions from a FNGT and subject to a draconian U.S. throwback tax.
Generally, trust agreements may be drafted in such a way as to avoid FNGT status, resulting in the non‑U.S. freezor being treated as the owner of the trust for U.S. income tax purposes during their lifetime. As such, during the lifetime of the non‑U.S. freezor, the U.S. beneficiaries would no longer be subject to the aforementioned U.S. throwback tax on trust distributions. The IRS would also not “look through” to the underlying trust assets to determine if the U.S. beneficiaries have an indirect interest in a CFC or PFIC.
If there is an opportunity to avoid CFC or PFIC status as part of the Canadian business owner’s structure during their lifetime, this can help avoid unwanted U.S. tax issues for U.S. family members and beneficiaries.
Are ULCs a silver bullet?
ULCs can play a powerful part in pre‑mortem planning before U.S. beneficiaries take ownership of a Canadian corporation, but the lack of liability protection may result in these entities not being appropriate in all scenarios. Converting a traditional Canadian corporation to a ULC before the U.S. beneficiaries have obtained an interest in the corporation (directly or indirectly) can have significant benefits.
For U.S. tax purposes, the ULC’s internal assets would receive a cost basis revaluation to their fair market value at the time of conversion. The ULC would likely be considered disregarded for U.S. tax purposes once the U.S. beneficiaries inherit ownership,8 avoiding CFC status. This opens the door to many useful post‑mortem Canadian tax planning options that may have been challenging, had the heirs instead inherited a CFC with low basis internal assets, as any gains inside a CFC would likely have been subject to the dreaded Subpart F or GILTI regimes.
ULCs and U.S. estate tax
The previously discussed U.S. estate and gift tax regime applicable to U.S. citizens could also apply to non‑U.S. persons if they own U.S. situs assets of more than $60,000 USD. A Treaty credit can also help further reduce U.S. estate tax for non‑U.S. persons.9
If a non‑U.S. citizen Canadian business owner holds U.S. situs assets within a Canadian corporation, the conversion to a ULC can lead to U.S. estate tax exposure (and potentially U.S. income tax issues, depending on type of U.S. situs asset). Any underlying U.S. situs assets held in a Canadian limited corporation are generally not considered part of the individual shareholder’s gross estate under this regime, so are effectively “blocked” from U.S. estate tax exposure. However, if the U.S. situs assets are owned by a ULC, those assets would be considered owned by the shareholder and includible in the shareholder’s gross estate (as the ULC is usually treated as disregarded for U.S. tax purposes). There may be more enhanced strategies available to avoid this outcome.
AETs and JPTs with U.S. remainder beneficiaries
We previously outlined some U.S. tax issues for AETs and JPTs established by a U.S. citizen resident in Canada. Even if a settlor is not a U.S. person, U.S. tax implications of these trusts must be considered if the remainder beneficiaries of the AET or JPT are U.S. persons.
For Canadian tax purposes, the remainder beneficiary will receive a full step up in their cost basis of all AET/JPT assets to fair market value upon death of the settlor/surviving spouse. However, it is a separate exercise to determine whether this would be the case for U.S. tax purposes as well.
For example, the IRS view that the JPT is essentially two separate trusts with respect to each individual spouse could result in there being no step up in basis for U.S. tax purposes of some of the JPT assets upon death of the surviving spouse. This Canada‑U.S. tax basis misalignment could be problematic for a U.S. remainder beneficiary and result in double tax.
Should beneficiaries renounce their U.S. citizenship?
U.S. citizen surviving spouses or beneficiaries may be surprised to learn how problematic their U.S. citizenship can be when it comes to cross‑border tax and estate planning. Renouncing U.S. citizenship before inheriting assets can often simplify things, but it is an important decision and unsuitable for many. If renouncing is considered, as mentioned above, the impact of the U.S. expatriation regime should be reviewed.
Seek advice
Amid this complexity are solutions to help impacted taxpayers. The right solution for a given taxpayer will be highly dependent on their specific circumstances. Implementing any of these strategies is very complicated and should not be pursued without the assistance of a qualified cross‑border tax advisor.
1 The U.S. imposes worldwide income taxation on its citizens, but also lawful permanent residents (i.e., Green Card Holders) and certain other individuals based on their days of presence in the U.S. While this article focuses on U.S. citizens, certain non‑U.S. citizens may also be subject to some of these provisions.
2 Similar to U.S. income tax, the U.S. imposes worldwide estate and gift taxation on certain non‑U.S. citizens as well, provided they are “domiciled” in the U.S.
3 The Tax Cuts and Jobs Act (TCJA) of 2017 doubled the lifetime estate and gift tax exemption, but this automatically expires in 2026. The lifetime exemption will revert back to $5 million USD in 2026, indexed for inflation, expected to be approximately $7 million USD. There is speculation President Trump and the Republican Party would attempt to make permanent the increased lifetime estate and gift tax exemption.
5 Who is more GILTI, Biden or Trump? | Baker Tilly Canada | Chartered Professional Accountants
6 he primary U.S. tax issues associated with a Canadian freeze are potential gift tax and a potential realization transaction.
8 Note that, should there be more than one owner of the ULC, it would likely be classified as a foreign partnership for U.S. tax purposes, which can add complexity.
9 The Canada‑U.S. Tax Treaty entitles a non‑U.S. person to a prorated lifetime exemption. The Treaty also provides for a marital credit, which can effectively double the prorated Treaty credit, to the extent U.S. situs assets are left to a Canadian or U.S. spouse or certain spousal trusts.
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