As we have previously discussed on our blog, the assets left behind by individuals who live and die in a number of jurisdictions other than Canada may be subject to an inheritance tax.  For example, in the United States, inheritance tax is payable on the value of assets beyond an initial $5.45 million exemption.

Inheritance tax may not be payable on all assets inherited by one’s surviving family members.  Tax-avoidance vehicles that are well known in Canada, such as joint ownership, inter vivos gifts, and trusts can be used in certain circumstances to limit one’s exposure to inheritance tax.  However, fewer of our readers may be aware that a limitation may also apply to inheritance tax payments in respect of assets being passed on to a surviving spouse.

Sub-section 2056(a) of the U.S. Internal Revenue Code specifies as follows:

For purposes of the tax imposed by section 2001, the value of the taxable estate shall, except as limited by subsection (b), be determined by deducting from the value of the gross estate an amount equal to the value of any interest in property which passes or has passed from the decedent to his surviving spouse, but only to the extent that such interest is included in determining the value of the gross estate.

Inheritance Tax
“In the United States, inheritance tax is payable on the value of assets beyond an initial $5.45 million exemption.”

The application of subsection 2056(a) would typically result in the exclusion of assets passing to a surviving spouse from the calculation of inheritance tax.  However, there are certain limitations to the marital deduction, which are described under subsection 2056(b) of the legislation.  For example, the marital deduction may not apply if the surviving spouse’s entitlement in an asset is limited to a life interest.

Litigation recently emerged in respect of the estate of author Tom Clancy, who altered his estate plan by executing a codicil that had the effect of qualifying the share of his estate being left for his second wife and her child for the marital deduction.  Clancy’s will established three trusts: (1) one for the benefit of his second wife, (2) one for the benefit of his second wife and their child together, and (3) one for the children of his first marriage.  The children from Clancy’s first marriage argued that, notwithstanding the terms of the codicil, the marital deduction should not apply to funds held in trust for both Clancy’s wife and their child.  If the second trust had not qualified for the marital deduction, the approximate $16 million in inheritance tax would have been deemed payable out of the assets of both the second and third trust, rather than exclusively borne out by the third trust.  The result would have increased the total inheritance taxes paid (from approximately $12 million), but reduced the tax burden to be paid out of the share left for Clancy’s children from his first marriage.  The matter proceeded to court in Maryland and it was determined (and upheld on appeal) that the codicil did, in fact, have the effect of qualifying the second trust for the marital deduction.

Thank you for reading.

Nick Esterbauer