The 'Anti-Clawback' Rule: Why the IRS is Watching Your Gifts
As the sunset approaches, a strategy known as "slop-over gifting" has become popular. The logic is simple: use the high exemption now before it disappears. However, this sparked a major fear among taxpayers—would the IRS "claw back" the tax benefit if a person made a $10 million gift in 2024 but died in 2027 when the limit was only $7 million? To address this, the Treasury Department issued Treasury Decision 9884.
According to the IRS guidance in TD 9884, "individuals taking advantage of the increased gift and estate tax exclusion amount in effect from 2018 to 2025 will not be adversely impacted after 2025 when the exclusion amount is scheduled to drop." This 'Anti-Clawback' rule is a green light for gifting, but it comes with strings attached. The IRS has recently signaled that they will closely scrutinize the valuation of these gifts. For expats, this often involves valuing Canadian private corporations or real estate. If the IRS determines your $12 million gift was actually worth $15 million, you could face immediate gift tax liabilities and penalties.
We've observed that the IRS 2023-2024 Priority Guidance Plan specifically mentions increased enforcement on high-income non-filers and gift tax compliance. This is why we emphasize the importance of Form 709 (United States Gift Tax Return). Even if no tax is due today, filing an accurate Form 709 starts the statute of limitations clock, protecting you from future audits once the exemption drops in 2026.
Source: Treasury Decision 9884 - Federal Register
The Cross-Border Conflict: Deemed Disposition vs. Estate Tax
One of the most complex challenges we manage at Zenith is the interaction between Canadian and US death taxes. Canada does not have a formal "estate tax." Instead, the Canada Revenue Agency (CRA) applies a "deemed disposition" on death. According to the Income Tax Act (Canada), a deceased person is treated as having sold all their assets at Fair Market Value immediately before death, triggering capital gains tax on their final T1 return.
Conversely, the US levies a tax on the total value of the estate itself (Form 706). This creates a risk of double taxation. Fortunately, Article XXIX B of the US-Canada Tax Treaty provides relief. It allows a credit for Canadian taxes paid on the deemed disposition against the US estate tax liability. However, the calculation is far from straightforward. The credit is limited to the portion of the US tax attributable to the Canadian property.
| Feature |
Canadian Treatment (CRA) |
US Treatment (IRS) |
| Tax Trigger |
Deemed sale at Fair Market Value |
Total value of the gross estate |
| Primary Form |
T1 Final Return |
Form 706 |
| Standard Exemption |
N/A (Capital gains based) |
$13.61M (2024) / ~$7M (2026) |
As we move toward 2026, the margin for error shrinks. If your estate is worth $10 million, under current rules, you owe $0 to the IRS. After 2026, you could owe 40% on the $3 million excess. While the Treaty credit helps, it rarely eliminates the entire US liability if the assets have a low cost-basis but high total value. Professional expat tax planning is required to sequence these credits correctly.
Audit Triggers for Expats: Form 3520 and Foreign Trusts
The IRS is increasingly utilizing data from FinCEN and foreign bank reporting to flag potential estate tax avoidance. According to FinCEN data, there has been a 15% increase in the reporting of foreign financial accounts (FBAR) by US citizens living abroad over the last three years. This transparency allows the IRS to identify individuals whose global assets might exceed the looming $7 million threshold.
A major audit trigger we see is the use of Canadian "Alter Ego" or "Joint Partner" trusts. While these are excellent for avoiding Canadian probate, the IRS often views them as Foreign Grantor Trusts. Per IRS Form 3520 and 3520-A guidelines, these must be reported annually. Failure to report a foreign trust can result in penalties starting at $10,000 or 35% of the gross value of the trust assets, whichever is greater. As the 2026 deadline nears, the IRS is looking for "aggressive" estate planning structures that fail to meet these stringent reporting requirements.
Furthermore, the IRS Small Business/Self-Employed Division has recently expanded its "Global High Wealth Industry Group" (the so-called 'Wealth Squad') to specifically target international taxpayers. They are looking for inconsistencies between FBAR filings (FinCEN Form 114), Form 8938 (FATCA), and gift tax returns. Our team works to ensure that your cross-border structure is not just tax-efficient, but "audit-proof" by maintaining rigorous documentation and contemporaneous valuations.
Source: FinCEN FBAR Guidance
PRO TIP: The "Use It or Lose It" Spousal Strategy
If you and your spouse are US citizens residing in Canada, consider the "portability" election. Even if the first spouse to die has an estate below the threshold, filing a Form 706 can "port" their unused exemption to the surviving spouse. This is critical as we approach 2026 because it allows the survivor to lock in the current high exemption levels for use later, even if they die after the sunset occurs. Don't leave millions in tax-free capacity on the table because you thought you didn't need to file.
Common Mistakes Expats Make with the 2026 Sunset
- Assuming the Marital Deduction is Unlimited: If your spouse is a Canadian citizen (non-US citizen), you cannot leave them an unlimited amount of money tax-free. The marital deduction is limited for non-citizen spouses unless you use a Qualified Domestic Trust (QDOT). For 2024, the annual gift tax exclusion for a non-citizen spouse is only $175,000 (per IRS Pub 559).
- Waiting Until Late 2025: The demand for qualified cross-border appraisers and tax attorneys will skyrocket in late 2025. Gifting assets requires time for legal documentation and valuation. Starting in December 2025 may result in a rushed valuation that invites an IRS audit.
- Ignoring the Step-Up in Basis: While gifting now saves on estate tax, it often means the recipient takes your original cost basis. If you hold assets until death, they receive a "step-up" to Fair Market Value. We help you run the math to see if the 40% estate tax savings outweighs the potential capital gains tax for your heirs.
Frequently Asked Questions
Does Canada have a gift tax similar to the US?
No, Canada does not have a gift tax. You can generally give money to adult children tax-free in Canada. However, if you are a US citizen, you are still subject to US gift tax rules regardless of where you live. You must file Form 709 if you give more than $18,000 to any one person in 2024.
What happens if I die exactly on January 1, 2026?
Under current law, you would be subject to the new, lower exemption levels. The law that governs your estate is the law in effect on the date of your death. This is why many advisors are recommending "deathbed" gifts or structural changes in 2024 and 2025.
Will my Canadian RRSP be included in my US estate?
Yes. The IRS considers the Fair Market Value of your RRSP/RRIF as part of your gross estate. While these accounts are tax-deferred for income tax purposes, they are fully taxable for estate tax purposes if you exceed the exemption threshold.
Can I use my Canadian principal residence exemption to lower my US estate tax?
No. The Canadian principal residence exemption applies to capital gains in Canada. It does not reduce the value of the home for US estate tax purposes. If your Vancouver or Toronto home is worth $5 million USD, that full $5 million counts toward your $7 million (post-2026) limit.
Don't Let the 2026 Sunset Erase Your Legacy
Cross-border estate planning is a race against time. Our team at Zenith Financial Advisors specializes in protecting US-Canada expats from the $7 million cliff. We ensure your gifting strategies are IRS-compliant and Treaty-optimized.
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