In circumstances where clients, who are Canadian residents, intend to equalize their estates amongst their children (“Equalization Intention”) where one or more of such children are “U.S. Persons” (a “U.S. Child”), estate planners need to consider whether that is possible and if so, how (“whether” and “how”, the “Questions”).  This is Part I of a three-Part blog series discussing a few considerations that tax and estate advisors may wish to consider in this regard, followed by planning strategies that may be implemented in circumstances with U.S. beneficiaries. Part II will be posted on May 24, 2024 and Part III on August 30, 2024. Note that it is not legal advice and to answer the Questions in practice, one must obtain U.S. tax advice.

Assume from this blog that a client (“Client”) intends for their estate planning to achieve the Equalization Intention and establish separation in assets amongst their children such that the children will be financially independent from one another.

The answer to the Questions is dependant on the set of facts, including on Client’s assets and the tax and estate planning strategies being implemented during lifetime or post-mortem. I would review Client’s assets as a first step. For example, what are Client’s assets, where and how are they held, and what is the liquidity profile? Part I of this blog series will discuss one asset category that may be considered as part of an analysis in answering the Questions, being corporate assets. Part II will discuss assets held in discretionary family trusts.

Corporate Assets

What if Client owns the common shares of a Canadian corporation and such shares are their primary asset? The life choice of a U.S Child to reside in the U.S. may have implications, including tax consequences impacting the Client’s estate planning. A couple of examples are below.

First, the U.S. has a complex series of corporate anti-deferral rules that apply when a U.S. taxpayer owns shares of a private non-U.S. corporation.  However, it would be important to determine whether, for example, income is active or passive for U.S. purposes. A discussion of these rules is beyond the scope of this post, however such categorization could make achieving the Equalization Intention difficult, if not impossible. One reason for this is that a common strategy to avoid double taxation involves creating a taxable dividend in the corporation, which may be able to be distributed to U.S. Child without incurring U.S. federal tax, provided inter alia that the dividend is from active assets.

Second, non-residents of Canada may not be able to receive capital dividends on a tax-free basis, as would be the case for Canadian residents. U.S. residents  will have fifteen percent (15%) withholding tax apply to the payment of a capital dividend. If tax efficiency also is a goal, likely Client’s executors would distribute a capital dividend only to those of their children who are residents of Canada and any taxable dividend to those their children resident of the U.S. If three (3) of the four (4) children are U.S. resident at the date of Client’s death, Canadian tax liabilities, including on account of withholding tax, may need to be factored into determining the Equalization Intention. In some cases, absolute equality among Client’s children may not be achievable. Alternatively, the executors may consider paying out a portion of any capital dividend as a taxable dividend to any U.S. Child, however this may not be ideal.

Such issues are examples of those to consider in whether and how the Equalization Intention can be achieved, within the context of a first step review, of Client’s assets. They also raise a host of other tax and estate planning considerations.