In circumstances where clients who are Canadian residents intend to equalize their estates amongst their children (“Equalization Intention”), when 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 article examines a few considerations that tax and estate advisors may wish to consider in this regard, looking at the asset categories of corporate assets and discretionary family trusts. Note that this is not legal advice and to answer the Questions in practice, one must obtain U.S. tax advice.

Assume for our purposes here 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 dependent 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 the Client’s assets as a first step. For example, what are the Client’s assets, where and how are they held, and what is the liquidity profile?

Corporate Assets

What if the 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 a 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, it is likely the 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 of their children who are residents of the U.S. If three (3) of the four (4) children are U.S. residents at the date of the 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 the 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.

Trust Assets

What if the Client’s family’s wealth primarily is held in discretionary family trusts and the Client considers assets held in such trusts essentially their personal assets, available to be considered as part of the Client’s estate planning to achieve the Equalization Intention?

Note that it may be undesirable to treat such trusts as an extension of the Client’s assets, as funds held in such trusts are not the Client’s assets and there are risks associated with treating a discretionary family trust like a will, which it is not. Further reasoning is beyond the scope of this article; however, I will move forward in discussing a circumstance whereas part of the plan to achieve the Equalization Intention, assets held in family trusts are being considered as available for equalization purposes.

Assume the Client’s children form part of the class of discretionary beneficiaries of the trusts. In considering the Questions, my preliminary review may include considering:

1. Are there restrictions on dispositions in the terms of the Trust Deed such that you cannot distribute to a non-resident of Canada?
1. If “yes,” what other assets are available to the Client and their family to equalize the U.S. Child? Are those assets sufficient for the equalization? This raises a risk of inequality.
2. If “no,” is it even desirable to make distributions to the U.S. Child? For example, if the assets comprising the trust fund have unrealized capital gains, in distributing some to the U.S. Child, you may not get the rollover out of the trust that you could obtain through a distribution to a Canadian resident beneficiary, thereby triggering potentially significant income tax consequences.
2. Another consideration is whether there are any other implications of distributing the assets held in such a trust to the U.S. Child. What if the only asset in the trust are shares in a Canadian Controlled Private Corporation? What are the U.S. and Canadian legal, tax, and reporting consequences that would result? What financial impact would occur?

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. Only by way of example, in addition to asset considerations, if assets are distributed outright to a U.S. Child, would they be subject to U.S. estate tax exposure? Does the Client consider this as impacting the Equalization Intention, or would the Equalization Intention be achieved if the initial asset division amongst their children is equal, or as equal as possible?

Takeaway

The above considerations are examples of those that we would consider in the estate planning process. This would be within the context of determining what strategies could be implemented during the Client’s life and/or post-mortem to assist in achieving their intentions. To mitigate risks posed by hurdles, some of which were discussed above, I may suggest performing a stress test/fire drill, where you imagine the Client gets hit by the proverbial bus tomorrow and run through the estate plan. Step by step, what would the Client’s executors do, including with each asset? Is equalization possible? Should actions be taken now, during the Client’s lifetime (such as a potential reorganization) to establish a structure to better assist in meeting the Equalization Intention upon death?

About the Author

Tamar Silverbrook is a member of Fasken’s Private Client Services practice group. Tamar has a broad estates and trust practice, with a focus on succession planning. Tamar works with high net worth clients, entrepreneurs, and professionals to help navigate complex matters and develop customized strategies that reflect clients’ short- and long-term estate planning goals. These strategies are implemented through cohesive estate plans.

As part of her practice, Tamar advises clients on a variety of wealth management, estate, and family planning issues. In addition, Tamar assists clients with wills, powers of attorney, domestic contracts, trusts, insurance directions, and other documents relevant to succession planning. Tamar also advises executors, trustees, and beneficiaries in respect to ongoing estate administration issues.