Apart from any other estate planning measures one might choose to implement, there is always a role for a well-planned will. However, the content of those wills depends on whether one or both spouses are US citizens.

Mixed Marriage – One Spouse is a US Citizen

In the case of a mixed marriage, the wills of each spouse will be very different. The reason for this is that different strategies and tools will be employed based on the rules that apply to a given estate.

To illustrate this scenario, take the example of Harry and Wanda. Harry is a US citizen by birth who came to Canada as a child. He married Wanda, a Canadian citizen, and they had three children who did not inherit Harry’s US citizenship. Their combined estate is $10 million, virtually all of which is held in joint names. 

Their current structure is not good. If Harry dies first, his taxable estate will include the entire value of the jointly held assets, almost doubling his lifetime exemption from estate tax. He may therefore have a significant tax to pay on first to die, without some planning. Likewise, if Wanda dies first, Harry will own the combined assets such that the kids will receive substantially less than the $10 million after US estate tax is paid on Harry’s assets.

The first aspect of the planning should include a consideration of whether to sever the joint tenancies on the assets. If Harry and Wanda each owned one half of the total, they would have greater certainty about what would be transferred by the wills they had prepared.

Such a division of the ownership of the assets would also decrease the value of Harry’s gross estate, since he would not be subject to the presumed ownership of their joint assets (per s.2040 of the Code). This simple step would essentially eliminate the potential for US estate tax if Harry were first to die.

Note, however, that in severing the joint tenancies care must be taken to ensure that no taxable gift is made. Because Wanda is not a US citizen, Harry may be subject to tax on a gift that exceeds the annual exclusion amount on gifts to a non-citizen spouse ($143,000 in 2013). As such, after the division, the assets held by each should more or less reflect their previous proportional ownership.

Harry’s Will

In planning Harry’s will, several factors should be kept in mind. First, he wants to ensure that any Canadian capital gains tax on death is deferred in the event that he dies first. This means that assets with unrealized capital gains have to pass either directly to Wanda or to a spousal trust for her exclusive benefit during her life. If anyone else can benefit from such assets during Wanda’s life as a surviving spouse, no capital gains deferral is allowed under the IRS.

Assuming that his assets are still valued at $5 million on Harry’s death, no US estate tax would be due, as his unified credits would be sufficient to cancel it out. However, a well drafted will must take into account the possibility that his estate will have grown above the exemption amount by the time he passes away. It is possible that the exemption amount may be reduced by new legislation effective in the year of his death.

In order to ensure that no tax is payable on Harry’s death as first to die, the will should provide for an election under Code section 2056A, creating something called a “Qualified Domestic Trust” (QDOT). Terms and conditions of the carefully drafted QDOT should be included in the will.

QDOTs were established in the Code as a means of softening the financial blow of losing a spouse, where the survivor is not a US citizen. A QDOT is similar to a spousal trust, except that any distributions of capital from the trust are subject to deferred estate taxation at the rate that would have applied had no QDOT been formed.

Wanda’s Will

Since Wanda is not a US citizen, she does not need the same type of US estate tax planning built into her will. Unless they have US-situated assets, she will not be subject to the US estate tax at all. As such, Wanda’s will has two primary objectives.

First, Wanda and Harry want to ensure that they defer Canadian capital gains tax at death in the event that Wanda passes away first. This will be achieved with an exclusive spousal trust for Harry, with a remainder interest for the kids upon his subsequent death.

Second, it will be important to shelter the assets within that spousal trust from US estate taxation upon Harry’s passing. Therefore, provisions in the trust will need to be included that prevent the estate inclusion rules. The key to achieving this objective is to ensure that Harry’s power to distribute trust capital to himself is limited in accordance with the restrictions set forth in the Code while balancing such restrictions against Harry’s potential requirement for capital in the trust.