What happens to your estate if you are Canadian and your spouse is a U.S. citizen? What should each of you know before one spouse dies? Many cross-border couples have not considered how assets on both sides of the border will be treated when one of them dies or what the surviving spouse needs to know beforehand.
The rules governing the tax treatment of these assets in both countries can be complex. As discussed below, the rules that govern one type of U.S. asset may not apply to its Canadian equivalent. Planning ahead is essential to avoid surprises and ensure that the surviving spouse understands the steps and reporting obligations that may follow.
What Is a TFSA?
Most Canadians have what is known as a tax-free savings account (“TFSA”), a registered account that allows Canadians to earn investment income and growth tax-free in Canada. This investment income may include interest and dividends, making TFSAs an attractive planning tool for Canadian investors. Because of these protections, the Canada Revenue Agency (“CRA”) does not require income earned inside a TFSA to be reported on an individual’s Canadian income tax return.
Naming a Spouse
Many married individuals name their spouse as either the successor account holder or the designated beneficiary of their TFSA. Naming a spouse as the successor account holder can be beneficial because, when the account holder dies, the surviving spouse may continue the TFSA in their own name and preserve the account’s Canadian tax advantages.
Considerations for a U.S. Spouse
One lesser-known issue arises when the Canadian spouse is not a U.S. person, but the Canadian-resident spouse who may inherit the TFSA is a U.S. citizen or is otherwise treated as a U.S. person. Although the CRA does not tax income earned inside a TFSA, the Internal Revenue Service (“IRS”) is not as forgiving.
In general, the IRS may tax income earned in a Canadian TFSA if the account holder is a U.S. person. Depending on the circumstances, U.S. persons can include Canadians living in the United States for a certain length of time, U.S. green card holders residing in Canada, and Canadian residents who hold U.S. citizenship. These individuals generally have ongoing U.S. reporting obligations and must report taxable investment income to the IRS annually.
If you are a Canadian resident and name your spouse, who holds U.S. citizenship, as the successor account holder of your TFSA, your spouse may face additional IRS reporting obligations when they inherit the account. In other words, a designation that works well for Canadian tax purposes can create unexpected U.S. tax and reporting consequences for the surviving spouse.
The Canada–U.S. Tax Treaty
Cross-border issues of this kind are often addressed through the Canada–U.S. Tax Treaty (the “Treaty”). For example, a U.S. citizen or green card holder living in Canada may defer tax on income earned in a registered retirement savings plan (“RRSP”) until funds are withdrawn from the account. RRSPs are afforded this protection under Article XVIII of the Treaty.
The last major amendment to the Treaty occurred in 2007, two years before the TFSA was introduced in Canada.
Conclusion
Although a TFSA may be highly valuable for a Canadian spouse, it can create important planning issues when the other spouse is a U.S. person or is otherwise subject to U.S. tax reporting. Because the IRS and the CRA may not treat income earned within the account in the same manner, other planning options may be more appropriate for a cross-border couple.
Prudent couples should coordinate their beneficiary designations, estate-planning documents, and recordkeeping with advisors in both countries.
For more information, please contact Helen R. Schweitzer at 416-777-2398 or HSchweitzer@DWlaw.com, Jennifer C. Leve at 416-777-4043 or JLeve@DWLaw.com, or another Dickinson Wright tax attorney.
Related Services:
- Taxation
- Estate Planning and Administration About the Author
About the Author
Helen Schweitzer is an associate in Dickinson Wright’s Toronto office. She can be reached at 416-777-2398 or HSchweitzer@dickinsonwright.com