A tricky situation that often occurs in cross-border families is for a Canadian to select a close relative in the U.S. as an executor. If you’re considering this option, you should weigh the potential consequences.

To illustrate the problems, let’s use an example. Fictional married couple, James and Debra, live in Vancouver, British Columbia. However, their son, Brandon, lives in Bellingham, Washington. James and Debra are currently drafting their wills and, as is standard practice, they select the surviving spouse as executor. At the death of the second spouse, they want Brandon to be the executor. That can cause potential headaches on both sides of the border.

Canadian Tax Problems with Non-resident Executors
An executor living outside of Canada can cause the estate to depart Canada for tax purposes, making estate administration more complex.

For Canadian tax purposes, an estate is classified as a trust; therefore, the same rules that determine the residency of a trust apply to an estate. This means that the factual residency of an estate is determined based on where the estate is managed or controlled.

With Brandon as executor, the estate might become a non-resident of Canada, presenting the following issues:

  • Withholding tax would apply on any income earned by the estate.
  • If the estate owns real property that it would like to sell, then the buyer may be obligated to withhold funds on the sale. The withholding is generally 25%.
  • The departure of the estate from Canada might trigger more tax and make it more difficult to wind up corporations.

To put it simply, a non-resident estate makes administration of the estate more complicated and may increase the overall tax burden.

Paying U.S. Taxes
If Brandon manages the estate from the U.S., the risk is not only that it would be considered foreign from a Canadian tax perspective. Additionally, it might also have to file and pay U.S. taxes.

There are no clear-cut rules to determine when an estate is a U.S. resident and has to file U.S. taxes. In fact, there is little guidance on this. The IRS does not define a foreign estate. It merely states that a foreign estate is not subject to U.S. tax unless it has U.S.-sourced income or income from a U.S. trade or business.

So, how do we establish whether the estate is foreign or a resident of the U.S.? Instead of relying on clear-cut law or regulations, we must refer to conclusions that have been made through legal decisions. In the past, the IRS and the courts have focused on the following to determine the trust or estate’s residency:

  • The location of the property of an estate.
  • The nationality and residency of the trustee.
  • The location of the trust administration.
The residency of the beneficiaries and the grantor of the trust does not factor into the determination of residency for U.S. tax purposes. No single factor is decisive; however, in later rulings, the primary focus has been placed on the location of the trustee and of the trustee administration. In the example above with Brandon as the executor, there is a risk that the IRS would consider the estate a U.S. taxpayer. That would mean the estate has to file a U.S. Form 1041 and report its worldwide income to the IRS.

With proper planning and advice, these problems can be avoided. The easiest method is for James and Debra to name a Canadian resident as executor instead of their son, Brandon. If that’s not possible, Brandon should commit to managing the estate from Canada, ensuring all documentation is taken care of so that the estate does not leave Canada. Ultimately, this minimizes the risk that the estate becomes a U.S. tax resident and you’re potentially left with a surprise U.S. tax bill.