New rules have reduced the danger to Canadians, but there are still risks in that Sunbelt home.

Canadians thinking about buying a property in the Sunbelt to escape from our long, cold winters have for years found themselves facing a complicated and potentially expensive problem – U.S. estate taxes.

Well, we have some good news for you. In most cases, you don't have to worry about it any more. There have been some major changes that make estate planning much easier for Canadian snowbirds, at least for the time being.

The problem is that if you live too long, you could find yourself looking at exactly the same difficulties all over again! Believe it or not, the changes that U.S. Congress introduced to the estate tax laws in that country all expire after 2010 and we'll be back to square one unless something more is done.

But before we get into all that, let's look at some background. The U.S. approach to determining the value of an estate is quite straightforward. Essentially, they just add up the value of everything you own and apply the appropriate tax rates to it. There is no blanket exemption for spouses, although they do receive a partial tax break. Nor can you escape by giving your property away because the U.S. imposes a gift tax at the same rate as the estate tax.

Until the mid-‘90s, U.S. non-residents were entitled to an exemption of only US$60,000 on the value of their estate if they died. Anything beyond that was subject to American taxes at onerous rates that could run as high as 92% (federal plus state), according to the Canadian chartered accounting firm of BDO Dunwoody.

And it was not just U.S.-based property that was at risk. A Canadian estate could end up being taxed on anything with a U.S. connection, including bank accounts, stocks, bonds, and other types of securities. It was a potential nightmare.

As a result of changes to the Canada-U.S. tax treaty in the mid-‘90s, the exemption for Canadians was raised to US$600,000, the same as for U.S. citizens and residents. But that wasn't an absolute amount. The exemption had to be pro rated by the total value of a Canadian's estate, which meant that it might in fact end up being worth much less once your home in Canada, your RRSP or RRIF, your Canadian investment portfolio, your cottage on the lake, and anything else you own was taken into account. So many Canadian snowbirds with winter homes in Florida, Arizona, California, Hawaii or elsewhere were still potentially on the hook.

In 1998, the U.S. Congress approved a measure to gradually increase the exemption for calculating estate taxes, and the higher limits also extended to Canadians under the tax treaty provisions. The limits have been rising gradually, and were fixed at US$700,000 in 2002-03. After that, they were to escalate sharply, reaching US$1 million in 2006.

However, that was still not enough for the U.S. Republican Party, which historically has found its main constituency in middle to upper income Americans who oppose estate taxes in principle. When George W. Bush was elected, one of his priorities was to eliminate the U.S. estate tax entirely, as part of his massive tax-cutting program.

Legislation which appeared to fulfill that goal was passed by Congress in May 2001. But as the accounting firm of Ernst & Young commented after analyzing the measure in detail, "reports of death of the estate tax have been greatly exaggerated".

Here's a summary of where things now stand.

In 2002 and 2003, the estate tax exemption has been increased to US$1 million. The federal estate tax rate is reduced to 50% in 2002 and 49% in 2003 (it was 55%, with a 5% surtax on certain estates over US$10 million.)

The exemption rises to US$1.5 million in 2004-05, with the tax rate dropping one percentage point each year.

From 2006-08, the exemption moves up to US$2 million, with the tax rate dropping to 45%. In 2009 the exemption jumps to US$3.5 million, and in 2010 the estate tax disappears entirely.

But here's the rub. The new Act has a sunset clause that has the effect of causing all its provisions to disappear after the end of 2010. Ernst & Young notes that this is a function of the Budget Act of 1974 which curtails the ability of the U.S. Congress to pass any tax cut that increases the federal deficit beyond certain limits.

In other words, a future Congress will have to decide whether to leave the estate tax abolition intact by passing new legislation. If nothing happens, the situation will revert to the status of 2001.

Clearly, this throws a monkey wrench into the entire process of U.S. estate planning. Canadians do not know what rules they will be operating under in the future, any more than Americans do.

The increased spending requirements brought on by the War on Terrorism and the need to substantially beef up domestic security may cause a future Congress to think twice about extending the estate tax repeal. Even if it is believed to be fiscally sound to do so, a Democratically-controlled Congress under a future Democratic president might find the resurrection of the tax to be philosophically desirable.

So where do we net out on all this? Here are some guidelines to help you:

1) Unless you're very wealthy, don't worry about the impact of U.S. estate taxes until 2011. If you think you still might be subject to estate tax even with the higher exemption, talk to a professional advisor.

2) Don't take a hefty mortgage on your U.S. property if the sole aim is to reduce estate tax exposure.

3) If you own a U.S. property through a single-purpose corporation, review the situation with your lawyer/tax advisor to see if changes are warranted.

4) As the years pass, pay attention to new changes in U.S. estate tax laws to see if the repeal is extended or if the tax will come back again after 2010. Plan accordingly.

In short, you probably don't have to worry now. But you may have to worry later.