For many successful Canadian families, cross-border living has become a reality, especially when children or heirs decide to move to the United States for education, career, or lifestyle reasons. When this happens, the tax and estate implications can be significant and complex. This article explores the most common issues and planning strategies that arise when a Canadian-resident family member becomes a U.S. tax resident.
When a Canadian Heir Moves to the U.S.
Let’s consider a common example: A Canadian family owns a successful private business, OPCO Inc., valued at $10 million. The shares are split between the parent (50%) and two children (25% each). One of the children, let’s call him David, moves to the U.S. for work and severs his tax residency in Canada.
Although this may seem like a personal life decision, it has major financial and tax implications that affect David, the family, and the business structure itself.
The Canadian Departure Tax
When a Canadian resident leaves the country permanently, they are generally treated as having sold most of their assets – including private company shares – at fair market value, on paper, for tax purposes. This can trigger a large capital gains tax bill, even though no money has actually changed hands.
There are ways to postpone this tax, such as filing a special election and providing a financial guarantee to the Canada Revenue Agency. However, that deferral only lasts until the asset is eventually sold, and the paperwork and planning are complex.
Tax on Future Dividends
Once David becomes a U.S. resident, any dividends he receives from the Canadian company will face a Canadian withholding tax, typically 15%, before the funds reach him. He can usually claim a credit for this in the U.S. but depending on how income is structured and when it’s paid, there can be timing mismatches or limits to those credits.
If the shares in the business fall in value after David leaves Canada, he might not be able to claim that loss for Canadian tax purposes. This can lead to situations where income is taxed twice—once in Canada and again in the U.S.
Reducing the Tax Burden with Strategic Structuring
To minimize taxes and avoid unpleasant surprises, there are a few structures that families can consider before or after a beneficiary moves south:
Option A: Unlimited Liability Company (ULC)
If a Canadian business is converted into a ULC before the child becomes a U.S. resident, it can help align the tax rules in both countries. This approach gives the U.S.-resident child a higher tax “cost base,” meaning less tax would be payable on a future sale. But there’s a tradeoff: income from the business may be taxed right away in the U.S., even if no dividends are paid out.
Option B: U.S. Corporation “Blocker”
If the restructuring happens after the child moves, another strategy involves inserting a U.S. corporation between the child and the Canadian business. This can reduce Canadian withholding tax on dividends to 5%, and the U.S. corporation can defer some tax until it pays dividends to the child.
However, this structure can sometimes result in a higher total tax bill when all layers of taxation are considered. It also adds significant complexity to the ownership chain.
Option C: S Corporation
Another U.S. solution is to use an “S Corporation,” which acts as a flow-through entity for U.S. tax purposes. While this can reduce the Canadian withholding tax on dividends, it doesn’t provide much benefit if the Canadian tax is already fully creditable in the U.S.
Trust Planning with U.S. Beneficiaries
Now, let’s say the Canadian family holds the business shares inside a discretionary family trust. This is common in estate and tax planning. The trust owns all the voting and non-voting shares of the company, and the beneficiaries include both children and parents.
If David moves to the U.S., a few key things happen:
- His interest in the trust isn’t subject to Canadian departure tax.
- If the trust ever distributes assets to him, those distributions may be treated as taxable sales in Canada.
- Dividends paid to the trust and then to David will also face Canadian withholding tax.
The trust may also become subject to complicated U.S. tax rules designed to prevent deferring income tax that was earned years earlier. This can result in harsh penalties and higher effective tax rates.
Navigating the “21-Year Rule”
In Canada, family trusts are subject to a deemed sale of their assets every 21 years—essentially a forced realization of gains for tax purposes. If one of the beneficiaries is a non-resident like David, the trust has fewer options for rolling out assets without triggering immediate tax.
Strategies to address this include:
- Distributing assets to Canadian-resident corporate beneficiaries;
- Allowing trust property to “vest” in a beneficiary (i.e., become their legal entitlement); and/or
- Using a combination of distributions and corporate restructuring.
But tax authorities are increasingly skeptical of strategies designed to sidestep this rule. Careful legal and tax advice is essential.
U.S. Reporting and Ownership Rules
Once David becomes a U.S. taxpayer, he’ll be subject to extensive disclosure requirements for owning shares in non-U.S. corporations, trusts, or holding accounts. These include:
- Annual reports on foreign corporations and trusts;
- Detailed filings for foreign investment accounts; and
- Bank account reporting obligations for accounts outside the U.S.
Failure to comply can result in steep penalties, even if no tax is owed. These rules are complex, and the reporting burden can be high.
When Canadian Companies Become Problematic for U.S. Heirs
Canadian holding companies or operating businesses may be categorized by U.S. rules as “foreign investment companies” or “controlled foreign corporations.” These designations can trigger punitive tax treatment:
- Passive income earned inside a Canadian company may be taxed immediately in the U.S.
- Global intangible low-taxed income (GILTI) rules mean that even active business income may be taxed annually in the U.S.
- For individual shareholders, foreign tax credits may not fully offset U.S. tax, leading to total effective U.S. federal tax rates above 50%.
Certain planning options—such as converting the company to a ULC or making annual tax elections—can reduce these taxes, but they require careful timing and coordination.
Post-Mortem Cross-Border Planning
Suppose the parent of the family passes away while still owning the Canadian business or trust. What happens then?
- In Canada, the shares are treated as if sold at death, triggering capital gains tax.
- Distributions to U.S.-resident children can trigger Canadian withholding tax.
- U.S. estate tax may apply to U.S.-based assets or certain corporate shares.
To address this, planners often use a “pipeline strategy” to avoid double taxation, or restructure share classes before death to take advantage of corporate tax balances such as the capital dividend account (CDA) or refundable dividend tax on hand (RDTOH).
In some cases, using a mix of share redemptions and tax elections can produce better results, especially when one child is a non-resident.
U.S. Estate Tax and Basis Step-Up
For U.S. citizens or residents, estate tax applies to worldwide assets. But for Canadians with U.S. property (such as stocks in a U.S. company or a vacation home), U.S. estate tax may still apply even if they’re not U.S. citizens.
The U.S.-Canada Tax Treaty helps by offering a pro-rated exemption based on the proportion of U.S. assets to total estate value. This can eliminate estate tax in many cases but must be properly claimed.
The U.S. also offers a “step-up” in cost basis for inherited property. That means that if a beneficiary inherits an asset, the starting point for capital gains tax is the value on the date of death—not the original purchase price. This benefit isn’t always automatic and may require planning to ensure it applies, especially for foreign trusts.
Summary of Key Planning Strategies
| Issue | Action to Take |
|---|---|
| Child leaving Canada | Evaluate departure tax and filing elections |
| Ongoing business ownership | Consider ULC, U.S. blocker, or trust reorganization |
| Trust with U.S. beneficiary | Avoid taxable distributions; manage 21-year rule |
| Reporting obligations | Ensure U.S. filings are completed annually |
| Passive income companies | Consider restructuring to avoid U.S. penalty taxes |
| Inheritance planning | Use hybrid strategies to minimize double tax |
| U.S. estate tax exposure | Use treaty exemptions and trust planning |
| Post-death structuring | Preserve step-up and avoid estate inclusion |
Final Thoughts
As more Canadian families become cross-border in nature, traditional estate and tax planning methods often fall short. The transition of a child or heir to U.S. tax residency adds significant complexity but also opens new planning opportunities.
At Cardinal Point Wealth Management, our cross-border advisors specialize in helping families navigate this dual-world landscape. Whether you’re managing a family business, planning your estate, or responding to a family member’s relocation, we bring integrated U.S.-Canada financial, tax, and legal expertise to your team.
Let us help you build a cross-border plan that protects your wealth today and for generations to come. Contact a Cardinal Point cross-border financial advisor here.