U.S. Trusts May Lose Their Way North of the Border

U.S. Revocable Trusts and How Moving to Canada Can Throw a Wrench Into Your U.S. Estate Plan

Revocable trusts are fairly common estate planning tools for U.S. persons who live in the U.S. A typical structure for a U.S. revocable living trust is where the grantor, trustee and beneficiary are the same individual. This article discusses U.S. revocable trusts with this typical structure.

Revocable trusts can aid in avoiding probate, provide an easy vehicle for incapacity planning, and help provide more control over the distribution of assets after death. These trusts are generally considered “disregarded/flow-through entities” by the IRS meaning all income, deductions, and tax credits are reported on the grantor’s U.S. tax return and the trust is not subject to separate income tax filing obligations, resulting in a low cost to maintain the trust over time. Estate planning upside without much cost – sounds great from a U.S. tax filing perspective!

So what happens when someone who maintains a U.S. revocable trust moves to Canada? If the soon-to-be Canuck is the trustee of the U.S. revocable trust, the Canada Revenue Agency (CRA) will consider the trust a Canadian resident for tax purposes and treat the trust as a separate entity from the grantor. This means that the trust would be required to file its own income tax return in Canada, separate from the Canadian and U.S. personal income tax returns. This difference in tax treatment creates the potential for double taxation, taxation that often cannot be fully offset using foreign tax credits, as well as onerous and costly tax filing obligations.

Below we highlight the key issues related to maintaining a U.S. revocable trust as a Canadian tax filer.

Key Issues Faced By U.S. Revocable Trusts With Canadian Resident Grantors/Trustees

1. Additional Tax Filing Requirements

As we noted, the requirement to file additional Canadian income tax returns for the U.S. revocable trust every year would come with additional administrative work and higher annual tax filing costs if you are utilizing the services of an accountant. These tax filing costs can add up when considering the additional tax forms such as Form T1135, the Foreign Income Verification Statement, for foreign assets with a combined cost of CAD$100,000 or more.

2. Different U.S. and Canadian Cost Bases

For Canadian tax purposes, the cost base of the property owned within the U.S. revocable trust would be the fair market value at the time of immigration. This creates a situation where there could be different cost bases for Canadian the U.S. tax purposes and can make investment management and income and tax planning decisions much more difficult. Tracking two different cost bases over time is hard enough but deciding if and when to sell an asset with two different cost bases within a portfolio of assets can be far more difficult.

3. Canada’s 21-Year Trust Rule and Double Taxation at Death

Canadian capital gains tax on assets held within a U.S. revocable trust only arises when these assets are sold or upon the trust’s 21^st anniversary. For U.S. estate tax purposes, the trust would be considered an asset of the grantor at death and could trigger U.S. estate tax. This difference in tax treatment could open the door to double-taxation.

4. The ‘Reversionary Trust Rule’ Reduces Available Foreign Tax Credits

The Canadian ‘reversionary trust rule’, which covers U.S. revocable trusts, requires that all income generated in the trust be reported on the grantor’s Canadian and U.S. personal tax returns. Any foreign taxes paid by a ‘reversionary trust’ do not flow through to the grantor for U.S. foreign tax credit purposes. This lack of foreign tax credit eligibility could result in additional taxes payable.

5. Potential Problems Maintaining a U.S. Revocable Trust While a Canadian Resident

Many U.S. financial institutions cannot oversee a taxable investment account on behalf of a Canadian resident, even if they are a U.S. citizen, therefore the U.S. financial institution often requires that the account be transferred out or closed. Depending on the assets held within the trust, the grantor may be forced to liquidate assets upon leaving the U.S. as some U.S. assets cannot be held at Canadian financial institutions.

Ways to Avoid Complications Related to U.S. Revocable Trusts While Living in Canada

• Dissolve the trust, avoiding all the problems above. Dissolving the trust prior to moving to Canada, transferring assets to grantors and updating the grantors’ personal wills simplifies tax reporting and maximizes foreign tax credits available. This can be done on a tax-free basis for US tax purposes.

• If the trust cannot be easily and inexpensively dissolved (perhaps you are already a Canadian resident with two cost bases), is needed for broader estate planning reasons, or there are material unrealized capital gains, consider appointing U.S. trustees to avoid the trust becoming resident of Canada. Finding appropriate trustees at a reasonable cost may be difficult, depending on the size of the trust, and ongoing monitoring of tax compliance will be necessary.

• Along the lines of the above, in some cases, it is possible for amendments to be made to the trust document to limit the power of the Canadian resident trustees so that the trust is not considered a resident of Canada by the CRA. This can be complex and requires tax attorney expertise.

• If you opt to maintain a Canadian resident U.S. revocable trust, adopt a planning first mentality. Planning to optimize when and where to realize income can help limit lifetime taxation. This can be onerous for the trustee as well as his or her tax and/or legal advisors and come with high tax and/or legal costs. It is important to undergo a cost-benefit analysis to determine if maintaining a Canadian resident U.S. revocable trust is prudent.

CONCLUSION

A Canadian resident maintaining a U.S. revocable trust can cause a number of headaches and come with material costs. To avoid double-taxation, it often makes sense to not use U.S. revocable trusts while residing in Canada.

It is important to note that we are not tax nor legal experts and every situation is unique. We do not provide official tax advice, and all information provided above is for discussion purposes only. Any Canadian resident who is the grantor of a U.S. revocable trust or anyone planning on moving to Canada who is the grantor of a U.S. revocable trust should consult with a cross-border tax accountant to review the trust documents and develop a plan about what to do with the trust before or after becoming a Canadian resident.