Jan 19, 2022
As we advised in Tax Tip 20-04 , significant additional disclosure and filing requirements for trusts were announced in the 2018 Federal Budget and are scheduled to apply for trust’s 2021 and subsequent tax years.
It is a fairly common estate planning technique in the United States to utilize a revocable living trust (“RLT”) as part of a “United States person’s” estate planning. For U.S. estate tax purposes, a United States person would include a U.S. citizen and a U.S. domiciliary. What is not so common though, is the potential foreign impact when the underlying U.S. grantor moves to a foreign jurisdiction.
To be clear, because these types of trusts are fully revocable by the grantor, the assets held in the trust are includable in the decedent’s gross estate for U.S. estate tax purposes. In addition, for U.S. income tax purposes any income earned in the RLT is taxed to the grantor under the grantor trust rules contained in Subpart E of the Internal Revenue Code. In many instances the assets held in an RLT do not produce current year income. Such an asset, for example, being personal use real property.
If that is the case, what is the point of establishing a revocable living trust? A properly structured revocable living trust can and does act as a will substitute which, in turn, eliminates the decedent’s estate from probate.
What is probate?
Probate is the judicial process whereby a will is “proven” in a court of law and accepted as a valid document as the true last will and testament of the decedent. There are at least two potential issues involved with probate:
For example, in Florida the attorney fees for estates under Formal Administration may be determined under Fla. Stat. Ann. §733.6171. These fees work on a graduated schedule. For an estate worth between US $3 million and US $5 million the attorney fees can be 2% of the amount over US $3 million, plus the appropriate fees for that portion of the estate less than US $3 million. At the lower end, that is over US $60,000 of attorney fees.
In California, probate fees are set by California’s Probate Code §10810. The statutory fees prescribed by §10810 are based on the value of the estate, as determined during the probate process. For example, the statutory fee for that part of an estate in excess of US $15 million, is 5%.
We wish to emphasize, however, Cadesky U.S. Tax Ltd. does not provide legal advice. The above is only meant to give an indication of potential costs. If readers are interested in determining the actual probate costs in a potential U.S. state it is recommend that they contact an attorney in the state of interest.
Why use a revocable living trust?
There are several situations in which a revocable living trust may be an appropriate will substitute. A decedent’s property held in a revocable trust is not part of the decedent’s probate estate and, therefore, is not subject to the administrative procedures and costs of probate.
Another potential reason to avoid probate is that many states have post-probate court supervision of testamentary trusts. This can be a costly and time consuming process. Some states, for example, require the trustees of testamentary trusts to file annual accounts with the local courts or with designated officials of the courts. However, the trustees of revocable living trusts are not required to file any accounts with the courts.
A client who owns an asset for which accounting may be quite difficult, such as an unincorporated business, also has a valid reason to avoid probate. In this situation, placing the business in a revocable living trust may be prudent. Of course, the income tax considerations must also be considered.
Moving to Canada
When a U.S. person who has an RLT moves to Canada they must then look to Canadian tax law to determine the Canadian tax impact, if any.
Section 94 of the Canadian Income Tax Act (“ITA”) will deem a non-resident trust to be a Canadian resident where the trust has had a resident contributor. A Canadian resident contributor is any “entity” that is (now) a Canadian resident and is or was a “contributor” to the trust. The term “entity” is interpreted in a substantially broad manner and includes persons with no legal personality such as partnerships, joint ventures, and syndicates. The U.S. grantor will be a “resident contributor” for Canadian tax purposes and the U.S. based RLT will be deemed to be a resident Canadian trust. As a resident Canadian trust, the RLT will have to file an annual Canadian trust return.
In addition, because the RLT is revocable, it will be considered to be a “75(2) trust” for Canadian tax purposes. Subsection 75(2) of the Act is commonly called the “reversionary trust” rule. This provision is designed to tax all income (or losses) or capital gains (or capital losses) that are realized from the trust property back to the settlor (grantor) of the trust property to the extent that the trust property is held on condition that it may “revert to the person from whom the property was directly or indirectly received,…”. Furthermore, where subsection 75(2) could apply to a trust, Canada will treat a transfer of assets out of the trust, to be a sale at fair market value except to the extent the property goes to the grantor and the grantor is alive.
Any foreign taxes paid by a “75(2)” trust do not flow through to the settlor/grantor for US foreign tax credit purposes. However, the U.S. grantor reports the income and pays tax in the US. The result is double tax. Where a RLT owns Canadian real estate, such as a cottage, RLTs can also be problematic.
Many Canadian advisors, however, fail to ask their U.S. citizen clients if they have a U.S. based revocable living trust. Many U.S. advisors also create RLTs that include Canadian real estate.
Additionally, because the RLT is a disregarded entity for U.S. tax purposes (since it is a grantor trust), many U.S. persons do not think about any potential Canadian issues (they may, for example, assume that Canada will tax the trust in the same manner as the U.S.) and, as such, fail to advise their Canadian advisors of the trust’s existence.
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The material provided in this U.S. Tax Tip is believed to be accurate and reliable as of the date of posting. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither Cadesky Tax nor Cadesky U.S. Tax can accept any liability for the tax consequences that may result from acting based on the contents hereof.