Beware the CRA … and … the IRS!

Benj Gallander, Ben Stadelmann, and Philip MacKellar
Sunday May 20, 2018

One of the great things about writing an investment letter is the opportunity to learn from subscribers. Such was the case the other day, when we received a letter from a self-described elderly gentleman from Quebec who noted that his results for 2018 were modest because he only holds Canadian stocks. He explained that he doesn’t buy American stocks because he doesn’t want his estate to have to pay US tax upon his death.

Our initial reaction was that this fellow was misinformed. Although we were aware that there could be some tricky points with a scenario such as owning a retirement condo in Florida, we thought there was no potential liability attached to owning US stocks in a Canadian brokerage account.

Wrong! It turns out that one’s estate can incur a US tax liability even though you’ve never visited Disney World, taken in the wonders of the Grand Canyon or even set foot in the land of the Star-Spangled Banner.

On the Internal Revenue Service’s website, there is a tax form called a 706-NA. The executor of the estate of any “nonresident not a citizen of the United States” with assets situated in the United States worth at least $60,000 (all figures in USD) must complete this form. The stock and bonds of US corporations, even if acquired through a Canadian broker, count in this category.

That’s a rather modest baseline, especially as US holdings get no protection when they are in a registered education savings plan (RESP) or a registered retirement income fund (RRIF).

The silver lining in all of this? There are generous deductions available through the United States-Canada tax treaty. It’s a complicated agreement, but the gist of it is that qualified Canadians get similar deductions to Americans living in their own country.

Under the rules in effect up to this year, Americans could shield up to $5.5 million in assets from estate tax. The Republican Party is of the opinion that wealthy Americans ought to be able to transfer more to their children tax-free, and under the Tax Reform Act, this amount was slightly more than doubled to $11.2 million.

For Canadians, the size of the deduction has a wrinkle. It is calculated as a ratio of US assets to worldwide assets, multiplied by $11.2 million. For example, if you had a portfolio of US stocks worth $2 million, and all of your assets were worth $10 million, the tax credit would be $2.24 million, so your heirs wouldn’t have to fork anything over to the IRS.

Therefore, except for the very wealthy, Canadians don’t have to worry about part of their US investments going to the IRS upon their departure into the Great Beyond.

The kicker is that, in order to claim that credit, your executor still has to fill out the 706-NA form, and that is no barrel of laughs. All of the valuations of your assets have to conform to IRS rules, and there are various additional schedules depending on circumstances. The executor has nine months to file; penalties for being late or undervaluing assets are severe.

Of course, many heirs and executors are unaware that such a filing is necessary. Others might choose to flout the regulations. An article on CNBC estimated that the IRS is losing billions in estate tax revenue. According the US Commerce Department, foreigners own around $33 trillion in American assets. In 2014, only 849 people worldwide filed alien tax returns, bringing in a relatively trifling $60 million.

Currently, the IRS lacks the means to reach into other countries to collect, but as global financial systems continue to harmonize and integrate, that might not continue to be true.

The Contra guys hope to be shuffling about this mortal coil for a while, so we won’t worry too much about reducing our US exposure. However, when the time approaches that buying green bananas requires overt optimism, it could make sense to scale back below the filing threshold to avoid saddling heirs with an onerous task.

An important thing to consider is that US assets do not include American depositary receipts (ADRs) of foreign corporations purchased on the NYSE or other American exchanges. It is prudent to diversify investments outside of Canada, but there are plenty of overseas candidates to choose from that do not have US estate tax consequences.

It’s a big, wide world out there for investors; there is no need to take a chance on the capriciousness of the American tax collector.