High-net-worth individuals who have established U.S. revocable living trusts face unique challenges when moving to Canada. The tax rules in Canada and the U.S. differ significantly, and without careful planning, this move can result in double taxation and complex compliance issues. Here, we explore the key considerations and strategies for managing U.S. revocable trusts when immigrating to Canada.
Key Rules and Their Implications
Rule 1: Trust Residency
Upon moving to Canada, the trust will be considered a Canadian resident for tax purposes, if its control resides in Canada. This typically means that if the trustees are Canadian residents, the trust is considered to reside in Canada. For instance, if Bob and Margaret, U.S. citizens moving to Canada, become trustees, their trust will be deemed a Canadian resident. This dual residency status requires the trust to file income tax returns in both countries and report all income earned on trust property.
Rule 2: Cost Base Adjustments
For Canadian tax purposes, the cost base of the trust’s property will be equal to the fair market value at the time of immigration. This adjustment creates a different cost base for Canadian and U.S. tax purposes, which can complicate the calculation of gains or losses upon the sale of trust assets.
Rule 3: Reversionary Trust Rules
Under Canadian tax law, the reversionary trust rules [Subsection 75(2)] apply. This requires reporting the trust’s income or gains on contributed assets on the Canadian individual income tax returns of the contributors (Bob and Margaret). Consequently, they must report this income for both Canadian and U.S. tax purposes, necessitating the use of foreign tax credits to avoid double taxation.
Rule 4: Foreign Income Verification
Canadian tax rules mandate the filing of Form T1135, the Foreign Income Verification Statement, for foreign assets with a combined cost exceeding CAD $100,000. Many U.S. revocable trusts will need to comply with this filing requirement, and failure to do so incurs a significant annual penalty of CAD $2,500.
Rule 5: Estate Tax Considerations
For U.S. estate tax purposes, trust assets are still considered owned by the grantor upon their death. This means that U.S. estate tax may be payable on the value of trust assets at the time of the grantor’s death. In contrast, Canadian tax on these assets only arises upon their sale or on the trust’s 21st anniversary, potentially resulting in double taxation at different times and by different taxpayers.
Rule 6: Departure Tax
If the trust becomes non-resident in Canada when Bob and Margaret leave Canada, it may be subject to the Canadian deemed departure tax. This tax applies to the trust’s assets, even though personal assets held directly by Bob and Margaret might be exempt if they leave Canada within five years. The deemed departure tax can have significant financial implications, as it requires the trust to pay taxes on unrealized gains as if the assets were sold at fair market value. It’s essential for Bob and Margaret to plan carefully and seek professional advice to navigate these complex tax rules and minimize their overall tax liability during their transition.
Strategic Considerations
Revisiting Trustees and Control
To mitigate Canadian tax implications, consider appointing U.S. trustees who genuinely control the trust. This approach can help maintain the trust’s non-resident status in Canada. Regularly reviewing the trust’s operations and documentation to ensure compliance with U.S. control requirements is essential for preserving its tax-efficient status.
Trust Document Review and Amendments
Amending the trust document to limit the powers of Canadian residents and ensuring the trust meets the criteria for non-residency can prevent unintended Canadian tax consequences. Regular audits and consultations with cross-border tax specialists can help identify and address potential issues.
Potential Trust Unwinding
For long-term Canadian residents, unwinding the U.S. revocable trust may simplify tax compliance. Transferring assets directly to the grantors and updating their Wills can provide a straightforward solution. Engaging legal experts for proper asset transfer and estate planning is advisable.
Tax Planning for Trust Income
Careful planning around the timing and distribution of trust income can help optimize the tax position. Utilizing foreign tax credits and coordinating tax strategies between Canadian and U.S. tax advisors is crucial. Detailed record-keeping and proactive communication with advisors ensures effective implementation of tax strategies.
Conclusion
Moving a U.S. revocable living trust to Canada involves navigating complex tax landscapes in both countries. Understanding the implications of trust residency, cost base adjustments, reversionary trust rules, and potential departure tax is essential. Engaging with experienced cross-border tax planning professionals can help mitigate risks, optimize tax outcomes, and ensure compliance with both Canadian and U.S. tax regulations.