Gift Tax Developments

While it is possible to donate property in Canada without any tax consequences, it is quite a different affair for Canadians in the United States. Thus, it is important for Canadians holding assets in the U.S. to be informed about the rules underlying the donation, without which the noble intention of offering a present to someone you love can quickly turn into a poisoned gift.

The basic scheme of the tax on the donation is that a person who disposes of property for free or for less than the fair market value must pay a tax based on the full fair market value of the asset. Gift tax applies in the context of inter vivos disposition since the donation through testamentary disposition will be governed by the estate tax.

The first step in determining whether or not the tax is applicable is to assess the value of the gift. For tax year 2012, the Internal Revenue Code (“IRC”) allows a Canadian citizen to gift up to $13,000 per person without any tax consequence. The exemption increases to $139,000 for a gift made to a non-resident spouse. Any gift in excess of the aforementioned amounts triggers a tax at a 35% rate (for 2012). For example, if John, sole owner of a real property in Florida, valued at $400,000 wants to add his wife and his two children on title, so that they each own a 25% interest in the property, such gift of $100,000 to his wife would not trigger any tax since the value is below the exemption of $139,000 per year. However, such gift of $100,000 to John’s children would trigger gift tax of $87,000 at a 35% rate, equaling a tax bill of $60,900, which John must pay to the Internal Revenue Service (“IRS”). Failure to pay the gift tax will result in additional penalties and interest to be computed as of the date of the gift. The irony of this example is not that has John decreased his interest in the property, but that tax is payable by the donor under IRC rules.

A major breakthrough contained in recent decisions allows the tax liability on the gift to be transferred to the donee if the donor defaults. It is reasonable to assume that the donee may be liable for gift tax up to the value of the property received, but the IRS has a difficult approach to this logic. Interest on the tax due is not capped at the value of the property received. The reasoning of the IRS appears to be related to the power of action of the parties, being understood that once the notice of assessment is received by the donee, he has the ability to pay the bill and so it is by his own negligence that interest runs. In doing so, a donee may end up in an absurd situation where, taking into account the interests, the debt would be higher than the value of gift received. The interest can be devastating if no tax declaration was filed for the year of the gift, and that interest accrues for years.

The moral of this blog post is of course to remain informed of the rules in effect prior making any transfer of assets in a foreign jurisdiction. The Canadian and U.S. tax rules are different and what is customary in Canada can create a lot of tax headaches in the United States. In any event, better safe than sorry!

The information contained herein is for informational purposes only, and is not legal advice or a substitute for legal counsel. It is not intended to be attorney advertising or a solicitation. If you have a legal question please consult with a cross border licensed attorney.