Estate tax issues under the 1995 Protocol to the U.S.-Canada tax convention.

The U.S.-Canada tax treaty was recently amended by Protocol to add a new Article XXIX B, covering taxes imposed by reason of death. Without these new provisions, double taxation could be imposed on the estate of a citizen of one country who resided in the other, or on a citizen and resident of one country with property situated in the other. Assuming the highest tax rates were to apply, this double taxation could result in a tax of approximately 90% of the property's value.

Paragraph 1 of the new article provides that charitable bequests made by an individual resident in one of the countries to an exempt organization resident in the other will be given the same death tax treatment (i.e., a charitable deduction) by the first country that such country would have provided had the exempt organization been a resident of that country.

Paragraph 2 provides a "pro rata" unified credit to the estate of Canadian-resident decedents in determining their U.S. estate tax. The credit amount is the greater of the unified credit of $192,800, multiplied by the ratio of the portion of the decedent's gross estate situated in the U.S. to the decedent's entire gross estate wherever situated, or the nonresident unified credit of $13,000.

Paragraph 3 provides a special marital credit against U.S. estate tax on transfers to a surviving spouse meeting the following requirements:

* The property must pass to the surviving spouse and be property that would have qualified for the Sec. 2056 marital deduction if the surviving spouse had been a U.S. citizen.

* At death, the decedent must have been either a U.S. citizen or a Canadian or U.S. resident.

* At the time of the decedent's death, the surviving spouse must have been either a Canadian or U.S. resident.

* If both the decedent and the surviving spouse were U.S. residents at the time of the decedent's death, at least one of them must have been a Canadian citizen.

* The executor of the estate must timely elect the benefits of paragraph 3 to the exclusion of any estate tax marital deduction allowed under U.S. domestic law.

This marital credit is the lesser of the unified credit, or the amount of U.S. estate tax that otherwise would be imposed on the transfer of qualifying property to the surviving spouse (i.e., the amount by which the estate tax that would be imposed if that property were included in computing the taxable estate exceeds the estate tax that would be imposed if the property were excluded).

Example: H has a worldwide gross estate of $700,000, of which $500,000 is real property situated in the U.S. H bequeaths U.S. real property valued at $100,000 to W. The remainder of H's gross estate, consisting of U.S. and Canadian situs real property, is bequeathed to H's child, C. H's estate would be entitled to a pro rata unified credit of $137,714 ($192,800 X $500,000 [divided by] $700,000). In addition, H's estate would be entitled to a marital credit of $34,000 (the lesser of the unified credit ($137,714) and the U.S. estate tax that otherwise would be imposed on the property transferred to W before allowance of any credits ($155,800 tax on $500,000 U.S. taxable estate -- $121,800 tax on U.S. taxable estate of $400,000 = $34,000)). The U.S. estate tax that otherwise would be imposed on the transfer of qualifying property to the surviving spouse generally equals the excess of the estate tax that would be imposed if that property were included in computing the taxable estate over the estate tax that would be imposed if the property were not so included. (See Art. 19, Technical Explanation to the Protocol, U.S. Treasury Department.)

Paragraph 5 provides "rollover" treatment for Canadian income tax purposes (in certain circumstances) on Canadian property transferred by a U.S. resident decedent. Rollover treatment generally allows tax to be deferred on the transfer of property by a Canadian resident decedent to a surviving spouse who also is a Canadian resident. Paragraph 5 extends this treatment to transfers if the decedent was a U.S. resident immediately before death, and permits the Canadian competent authority to provide similar treatment with respect to certain trusts.

Paragraph 6 provides a Canadian income tax credit to Canadian residents and Canadian resident spousal trusts for U.S. Federal or state estate or inheritance taxes imposed on U.S. situs property of the decedent or trust.

Paragraph 7 provides a credit to the estates of U.S. citizens or residents (and to certain "qualified domestic trusts") for U.S. estate tax purposes for Canadian federal and provincial tax on property situated outside the U.S. Previously, Canadian federal taxes were not creditable taxes for U.S. estate purposes because they were considered income taxes.

In paragraph 8, the U.S. has agreed to limit the application of its estate tax on Canadian resident decedents whose worldwide estates are less than U.S. $1.2 million. In such cases, the U.S. will impose its estate tax only on U.S. real property and on certain U.S. business property.

The Protocol entered into force on Nov. 9, 1995. Paragraphs 2 through 8 of Article XXIX B generally became effective for estates of decedents dying after that date. The benefits of these provisions also are available with respect to decedents dying after Nov. 10, 1988 (the effective date of the U.S. Technical and Miscellaneous Revenue Act of 1988 (TAMRA)), provided that the claim for refund due as a result of these provisions is filed by the later of one year from the date on which the Protocol entered into force or the date on which the applicable period for filing such a claim expires under the domestic law of the concerned country. (It is unusual for the U.S. to agree to such retroactive effective dates, but because TAMRA was the impetus for the treaty negotiations, it was considered appropriate in this case.) Paragraph 1 of Article XXIX B is not covered by this special effective date and, therefore, is subject to the general rule that the provisions of the Protocol become effective for estates of decedents dying after Nov. 9, 1995.