Tax & Estate Planning for Snowbirds Amin Mawani Schulich School of Business York University amawani@schulich.yorku.ca
Taxes do influence behaviour Windowless Castles Narrow frontages SIN & gasoline taxes RRSP contributions
Taxes Matter How much dependency deduction and child credit do you get for a kid born on December 31 st? Taxes and the Timing of Births by Dickert-Conlin and Chandra. Journal of Political Economy, 1999.
Taxes and the Timing of Births 12/31 Holiday effects High income vs. low income
Taxes and the Timing of Death? Estate tax rates have varied across the past century Dying to Save Taxes: Evidence from Estate-Tax Returns on the Death Elasticity by Slemrod and Kopczuk. Review of Economics and Statistics May 2003.
Dying to Save Taxes High tax Low tax Low tax High tax
Changing Estate & Gift Tax Rates Year Max Estate Max Gift Tax Rate Tax Rate 2008 45% 45% 2009 45% 45% 2010 0% 35% 2011 55% 55%
And Changing thresholds Year Estate Transfer Lifetime Gift Exempt Amount Exempt Amount 2008 $2 million $1 million 2009 $3.5 million $1 million 2010 tax repealed $1 million 2011 $1 million $1 million
Outline: US Income Tax Issues US residency requirements for taxation Substantial Presence Test (SPT) Exemption from Substantial Presence Test Earning US Rental Income Individual Taxpayer Identification Number (ITIN)
US Estate Planning Increasingly important to your clients Strengthening Canadian $ Declining US house prices More Canadians purchasing recreational property in the U.S. Need to be aware of U.S. estate tax exposure before directly investing in US real estate
Basis of US Taxation US residents (for tax purposes) & citizens taxed on their worldwide income by the US Double tax relief with Foreign Tax Credits (FTC) Nonresident aliens taxed only on US source income Passive income subject to withholding tax on gross income Capital gains not taxed except for Capital Gains on US real property interests
Required to File US Personal Tax Return if: US Citizen Green card Holder Trigger Substantial Presence test (SPT) Spend lots of time (e.g., 4 months) in the U.S. every year
Substantial Presence Test (SPT)
Substantial Presence Test (SPT) triggered in 2008 if Spend > 31 days in the US in 2008 and # of days spent in US in 2008 + 1/3 # of days spent in US in 2007 + 1/6 # of days spent in US in 2006 183 days Spending 4 months ( 122 days) in the US each year for 3 consecutive years triggers SPT making the snowbird a resident alien in the US for tax purposes requiring reporting of worldwide income to IRS
Counting the # of days in the US Canadians may soon be subject to an automated entry / exit system at the Canadian US border that automatically tracks the exact # of days spent in US Canadians currently exempt from using this system
Nonresident alien If the total # of days in the US over the immediate past 3 years 182, the snowbird is deemed to be a nonresident alien for US income tax purposes Days spent in US while seeking medical treatment for condition arising in the US are counted as non-us days for SPT
Escaping SPT Filing IRS Form 8840 Closer Connection Exception Statement for Aliens by June 15 th of the year following the SPT trigger Claiming exemption under the Canada- US Tax Treaty Closer Connection Exception is easier
Shorter visit to the US every 3 rd year IRS Form 8840 needs to be filed annually if you meet the SPT If in one of the 3 years you are not in the US long enough to achieve a 3-year average of > 122 days, then the SPT count effectively starts over again Filing requirement for Form 8840 may end up being deferred for a few years
Closer Connection Exception Claim that you have a closer connection to Canada than to the US, and therefore deserve to be treated as a non-resident for tax purposes (in IRS Form 8840) Claim determined by (1) location of family home; (2) family; (3) personal belonging; (4) social, political, cultural & religious ties; (5) business activities
Escaping SPT via the Tax Treaty A snowbird could be considered resident of both Canada and the US for tax purposes Canada-US Income Tax Convention allows choice under Article IV(2) based on: (1) location of permanent home; (2) centre of vital interests (where are economic and personal relations closer?); (3) habitual abode; (4) citizenship; and (5) competent authority
Taxation of US Rental Income As a non-resident, file a US income tax return (Form 1040 NR) reporting NET rental income (Schedule E) By June 15 th of the following year Report gross rents and remit 30% withholding taxes Normal expenses against gross rents such as property taxes, mortgage interest expense, utilities, management fees, Tax depreciation (CCA) must be claimed for US tax filing purposes (IRS Form 4582) Straight line depreciation over 27.5 years Unlike Canada where CCA is optional, and is often not claimed if the property is not producing sufficient income
Dual reporting Rental Income Nonresidents also required to file Canadian income tax returns reporting NET rental income (in Canadian $) on a timely basis Double tax (usually US tax) on US rental income eligible for foreign tax credit (FTC) in the Snowbird s Canadian income tax return Take care of different reporting deadlines in Canada and the US Penalties & taxes for non-compliance
Tax Compliance Issues - ITIN Non-resident aliens need a US Individual Taxpayer Identification Number (ITIN) for tax reporting (Not the same as U.S. SIN) ITIN obtained by IRS Form W-7 & necessary for escaping SPT (IRS Form 8840) reporting US rental income (IRS Form 1040NR) reporting US capital gains on sale of real property for recovering withholding taxes (Form 1040NR)
Outline: US Estate Planning What assets are subject to estate tax? Timing & Base of estate tax Understand the threshold exemptions How the estate tax is computed? How the estate tax credit is computed? Estate Planning Strategies
Assets subject to US Estate Taxes Real estate in the US Shares of US corporations; US T-bills Mutual funds Gold, jewelry, art Annuity contracts payable by US corp Canadian pooled funds investing in US securities
Assets not subject to estate taxes Cash in US banks not used in business Cash in Canadian branch of US banks Life insurance proceeds of a nonresident alien US government bonds > one year Canadian mutual funds in US $ that invest directly in US securities
Timing & Base of Estate Tax Upon transfer of a deceased person s US taxable estate Base = gross fair market value of assets located (or deemed to be located) in US and owned at the time of an individual s death
Estate tax credits & exemptions US residents & citizens entitled to a unified credit of $780,800 (in 2008), which exempts $2 million of property from estate taxes US$3.5 million exempted by 2009 Unlimited amount exempted by 2010 US$1 million exempted by 2011
Lower credit for Non-residents US residents / citizens allowed full credit Non-resident aliens entitled to a lower $13,000 unified credit (under US domestic law) OR enhanced unified credit (under Canada US Income Tax Treaty) of: $780,800 x value of US situs assets value of worldwide assets
Estate tax rate schedule - 2008 taxable estate then plus of excess > tax =(A) (B) over (C) 100,000 150,000 23,800 30% 100,000 150,000 250,000 38,800 32% 150,000 250,000 500,000 70,800 34% 250,000 500,000 750,000 155,800 37% 500,000 750,000 1,000,000 248,300 39% 750,000 1,000,000 1,250,000 345,800 41% 1,000,000 1,250,000 1,500,000 448,300 43% 1,250,000 1,500,000 and over 555,800 45% 1,500,000
Example Snowbird is a non-resident alien residing in Canada (under treaty definition) Owns a Florida condo: $400,000 Worldwide estate at death: $2,000,000 On US estate tax return, Snowbird is eligible for unified credit of $780,800 x ($400,000 / $2,000,000) = $156,160
Example - continued Gross estate tax on condo with fair market value of $400,000 at time of death = $121,800 (from rate schedule) $121,800=$70,800 + 34%(400,000 250,000) Unified tax credit > Gross estate tax, OR $156,160 > $121,800 Snowbird will not pay any estate tax
Canadian residency emphasized Numerical example applies to Canadian residents (as determined under the Tax Treaty residency rules) If Snowbird had died while being a nonresident of Canada (for income tax purposes), she would be limited to the $13,000 unified credit Non-residents of Canada do not qualify for the enhanced unified credit under the Treaty
Additional credits against US estate taxes Marital credit if snowbird transfers US property at death to Canadian spouse Feature of the Canada US Tax Treaty Effectively doubles the available credit Need to make an election on estate tax return (IRS Form 706-NA) Unlimited marital deduction for gifts & bequests made to US citizen spouses
Canadian Foreign Tax Credit (FTC) Canada allows a tax credit for US estate taxes paid Credit limited to related Canadian tax on the capital gains from property in the same year US estate tax based on gross value While Canadian tax based on capital gains If value of property is large relative to accrued gain, then FTC offers only limited relief U.S. & Canadian tax need to be triggered in same year for FTC to be applied
Estate Planning Strategies Sell US securities held directly Consider Canadian capital gains tax Gift US property prior to death US shares / debt not subject to US gift tax annual gift tax exemption: $12,000 per tangible gift Annual limit = $125,000 for gifts between NRA spouses No limit to the number of gift recipients Could trigger Canadian capital gains tax Consider Canadian income attribution rules
Estate Planning Strategies Hold US shares in Canadian mutual funds, since mutual funds not considered US situs because of their trust structure Keep worldwide assets $2 million Includes fair market value at death of RRSPs, RRIFs, business interests, principal residence, personal property, investment accounts, chequing accounts
Non-Recourse Mortgages (NRM) Lender s only claim against the borrower s assets is the specific property pledged as security for NRM Lenders of NRM cannot access the borrowers personal or estate assets if the borrower defaults on the mortgage
Non Recourse Mortgage (NRM) Unlike a conventional mortgage, a Non Recourse Mortgage (NRM) reduces the net value of the US real estate subject to US estate tax In contrast, a conventional mortgage reduces net assets subject to US estate taxes by the fraction: US Assets / Worldwide Assets
NRM Example Conventional Mortgage Non Recourse Mortgage Value of US Real Estate $500,000 $500,000 Value of Worldwide Estate $5,000,000 $5,000,000 Mortgage $300,000 $300,000 US Real Estate $500,000 $500,000 Less: Mortgage -10%*(300,000) -100% ($300,000) Estate subject to US estate taxes $470,000 $200,000 10% = $500,000 / $5,000,000
Conventional vs. NRM Since US assets = 10% of worldwide assets (=$500,000 / $5,000,000), then only 10% of the conventional mortgage (or $30,000) can be netted from value of US real estate (for estate tax purposes) In the case of a NRM, the entire $300,000 mortgage can be netted from value of US real estate
Refinance US real estate with NRM Exchange conventional mortgage with Non Recourse Mortgage Subject to risk tolerance, keep financing high to reduce value subject to estate tax NRM is tax-deductible (for Canadian tax purposes) if used to purchase income generating investments outside RRSPs This may portfolio risk if more equities
Non Recourse Mortgage (NRM) Appropriate for High Net Worth Clients Banks will not lend >60% of prop. value Now offered by Canadian Banks Appropriate only for Canadian residents owning real property in the US Needs to be at arm s length Strategy does not apply to US citizens
Corporate owned real estate No US estate taxes on the death of the shareholder However, CRA assesses a taxable benefit on the shareholder of a single purpose corporation - ITA 15(1) (since 2004) corporate owned real estate not practical Can use Canadian partnership to purchase US property, with the partnership electing to be treated as a corporation for US estate tax purposes ( check-the-box election) and treated as a partnership for Canadian tax Shareholder benefit issues avoided
Partnership Election Snowbird considered to own shares of Canco upon death, & not US real estate Drawback: (long-term) capital gains tax rate on disposition of property is higher for corporations (35%) than for individuals (15%) Drawback eliminated if election delayed until after death and property sold before death, since property deemed to be sold by a partnership (while snowbird alive) Needs complex post-mortem planning to avoid double taxation
Multiple owners of US property US estate tax divided among co-owners IRS allows valuation discount on partial interest in a property since it is more difficult to sell a partial interest Each co-owner gets own unified credit Reduces aggregate US estate taxes But future disposition more complex Allowners have to agree on the disposition
Canadian Personal Trust Snowbird (settlor) can settle the trust with sufficient funds to purchase US property Spouse / children are named beneficiaries Snowbird is neither beneficiary nor a trustee Necessary to avoid IRC 2036 on attribution Snowbird funds annual operating costs Life interest for spouse & capital interest for spouse & children value of the trust property is not part of the Snowbird s estate Caveat: 21-year deemed disposition rule
Life insurance to fund US estate tax Often not feasible for elderly snowbirds or those with serious medical conditions Insurance policy premiums to fund US estate tax liability not deductible for tax purposes Insurance proceeds on life of a non-resident, non-citizen not considered US situs property and therefore not subject to estate tax However, insurance proceeds reduce unified credit since insurance proceeds (payable to the estate) included in gross value of deceased s worldwide estate ( denominator )
Questions? Comments?
Thank you!! Amin Mawani Schulich School of Business York University amawani@schulich.yorku.ca