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Three reasons you could end up paying U.S. estate taxes

Just a short time ago, a high-school dropout from Canada who had transformed himself into one of the most respected, well-travelled and recognizable journalists on American television died. I'm referring, of course, to Peter Jennings, who was 67. On April 5, Mr. Jennings had announced that he was suffering from lung cancer. That was his last appearance on ABC's World News Tonight.

His death caused me to think again about the many Canadians who move to the United States for their careers, or other reasons. It's not that tax implications should drive those decisions, but it's important to recognize that the U.S. estate tax is a real issue.

You see, there are three categories of people who will be subject to the U.S. estate tax -- and you could be counted here: (1) U.S. citizens, (2) permanent residents of the United States, and (3) those who own "U.S. situs property."

U.S. citizens

If you're a U.S. citizen, you'll be liable for U.S. estate tax no matter where in the world you live, as the tax is applied on the value of your worldwide estate. There are some deductions available to reduce the amount of your estate subject to the tax, such as funeral and administration costs, gifts to a U.S.-citizen spouse, gifts to a non-U.S.-citizen spouse -- up to $117,000 (U.S.) in 2005 -- and gifts to charity.

The amount of this tax can be huge: It's calculated using graduated tax rates ranging from 18 per cent on the first $10,000 to 47 per cent (in 2005) on the value of your estate over $2-million.

By the way, the U.S. estate tax bill on an estate worth $2-million is $780,800, before any deductions or credits.

So, you can see the importance of proper planning to minimize your taxable estate, or maximize your deductions and credits.

U.S. residents

Even if you're not a U.S. citizen, you'll be subject to the same rules as U.S. citizens if you permanently reside in the United States. Now, I don't want to get too technical here, but "residence" in the United States for income tax purposes is different than "permanent residence" -- called "domicile" -- for U.S. estate tax purposes.

If you are domiciled in the United States, you'll face the U.S. estate tax just as any U.S. citizen would on your worldwide estate. Mr. Jennings became a U.S. citizen in 2003, but even if he hadn't, he was certainly domiciled in the United States, which would have caused a U.S. estate tax liability just the same.

Want to avoid the U.S. estate tax? Avoid being a permanent resident (a "domiciliary") of the United States.

This type of planning, however, is going to take a visit to a tax professional.

U.S. property owners

Before you breathe a sigh of relief, be aware that the U.S. estate tax can apply even if you're not a U.S. citizen or permanent resident south of the border.

The tax also applies to anyone who owns "U.S. situs property," which includes U.S. real estate, almost all personal property located in the United States (vehicles, boats, art, jewellery, etc.), shares in U.S. corporations (including those held in your registered plans), U.S. debt obligations (i.e. government bonds, receivables from a U.S. person or company, etc.), and U.S. intangible properties (contractual rights, trust interests, patents, trademarks, and so on).

As a non-citizen and non-resident of the United States, you'll face estate tax on these U.S. situs properties at the same rates as U.S. citizens. The deductions and credits you'll be entitled to, however, are not quite as generous.

Next week, I'll look at some planning opportunities for those who might face the U.S. estate tax.

Tim Cestnick, FCA, CPA, CFP, TEP, is a tax specialist and author of Winning the Tax Game 2005 and The Tax Freedom Zone.

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