U.S. Issues for U.S. Citizens Living in Canada March 26, 2009 Angela Zarn, CA, CPA, CAFA Presented to Scotia Bank
Table of Contents! Filing Requirements & Due Dates! Difference in Taxation between countries! Renouncing one s citizenship in the U.S.! Personal Tax Rates! Earned Income Exclusion! Principal Residence! Charitable Donations Deductibility! Capital Gains
Table of Contents (cont d)! Social Security (SS)! Registered Pension Plan (RPP)! Retirement Compensation Arrangements (RCA s)! Estate Tax! Gift Tax! Generation skipping tax
Filing Requirements & Due Dates! All U.S. citizens or permanent residents must file each year! Personal tax returns are due April 15 th each year! Automatic 2 month extension to file is granted if you live outside of the U.S.; however, taxes are still due by April 15 th! You can file an election to receive a longer filing extension (6 months)! Various filing statuses available in the U.S.
Filing Requirements & Due Dates (cont d)! Worldwide income is taxable in U.S. and Canada! Foreign reporting forms are required for all U.S. citizens holding shares in Canadian corporations and foreign financial accounts! If a U.S. citizen holds an interest in any bank or investment accounts with an aggregate balance of $10,000 or more at any time during the year, the taxpayer must file form TDF 90-22.1 for each account! If a U.S. citizen owns 10% or more of the share in Canadian corporation (form 5471); a $10,000 penalty can be assessed by the IRS if this form is not filed correctly or when required
Difference in taxation between countries! Canada taxes individuals based on residency! U.S. taxes individuals based on citizenship (i.e. it doesn t matter if you live in the country or not)! Both countries have time tests to determine residency status; however, you can escape filing a tax return in the U.S. if you qualify under the closer connection election or under the Tax Treaty (only available to non-u.s. citizens)! Each taxpayer or dependant of a taxpayer must have a social security number or an individual taxpayer identification number; ITIN *
Difference in taxation between countries (cont d)! Different types of income taxed in different ways between both countries (i.e. gambling winnings*, capital gains, dividends, pension income, etc.)! All U.S. citizens are entitled to a personal exemption and either the standard deduction or itemized deduction (whichever is larger) (amounts vary slightly from year to year)**
Renouncing one s citizenship in the U.S.! The only way for a U.S. citizen to get out of filing an income tax return in the U.S. is to renounce their citizenship; however, this is not an easy process and is an irrevocable process in most cases! A person wishing to renounce his or her U.S. citizenship must voluntary and with intent to relinquish U.S. citizenship:
Renouncing one s citizenship in the U.S. (cont d) 1. Appear in person before a U.S. consular or diplomatic officer; 2. In a foreign country (normally at a U.S. Embassy or Consulate); and 3. Sign an oath of renunciation
Renouncing one s citizenship in the U.S. (cont d)! One cannot renounce by mail, through an agent, or while in the United States and before renunciation is considered, one must ensure they already possess a foreign nationality or they may encounter other problems (i.e. traveling problems, lack of government protection, etc.)! Parents cannot renounce U.S. citizenship on behalf of their minor children.*! An applicant who renounced his/her U.S. citizenship before the age of eighteen can have that citizenship reinstated if he or she makes that desire known to the Department of State within six months after attaining the age of eighteen
Personal tax rates! Basic rates for single taxpayers for 2007 : Federal & MN Federal & MN $0 - $7,825 15.35% 25.90% $7,826 - $21,310 20.35% 25.90% $21,311 - $31,850 22.05% 27.00% $31,851 - $69,990 32.05% 35.00% $69,991 - $77,100 32.85% 40.00% $77,101 - $160,850 35.85% 43.40% $160,851 - $349,700 40.85% 46.40% $349,701 and over 42.85% 46.40%
Earned Income Exclusion! An individual meeting either the bona fide residence test or a physical presence test may elect to exclude up to $87,600 of earned income in 2008 (increased to $91,400 for 2009) using form 2555! To qualify, an individual must be a 1. U.S. citizen who is a foreign resident for an uninterrupted period that includes an entire taxable year (bona fide residence test); 2. U.S. citizen or resident present in a foreign country for at least 330 full days in any twelvemonth period (physical presence test), as long as the first month starts in the tax year being filed
Earned Income Exclusion (cont d)! Earned income includes income from employment or self-employment! The exclusion is prorated for the # of months in any fiscal year the individual is present in Canada vs. the U.S.! If income is over the threshold, foreign tax credits can be used to offset any taxes owing on that excess income in the year
Example:! Jessica was born in the United States but has lived and worked in Canada her entire life! T4 income of $120,000 (CDN), taxes paid of $50,000 (CDN)! Assume U.S. exchange rate of 1.25 (i.e. $1.00 U.S. = $1.25 CDN)
Example (cont d) Conversion Totals Earned income in U.S. $ $120,000 / 1.25 = $96,000 Taxes paid in U.S. $ $50,000 / 1.25 = $40,000 Excess over excluded amount Percentage of income excluded Taxes available for foreign tax credit purposes $96,000 85,700 = $10,300 $85,700 / 96,700 = 89% $40,000 x 11% $4,400
Example (cont d)! Based on the above results, $10,300 (U.S.) of earned income would still be taxable in the U.S. (before exemptions and deductions); however, Jessica has $4,400 of foreign tax credits available for use against any taxes applicable to that income! Note: Jessica would qualify under the physical presence test because she would have lived in Canada for 12 consecutive months
Principal Residence! Mortgage interest is deductible in the U.S. no matter if you use part of your home for business or not (certain restrictions may apply if you refinance your home and use the proceeds for something other than improvements to the home)! Full gain on sale of principal residence is exempt in Canada if you meet certain criteria! Only $250,000 is exempt from tax in the U.S. if you meet certain criteria; rest of the gain is taxed at long term capital gains rates (discussed later)! Exemption can be increased to $500,000 for married filing jointly taxpayers if certain criteria are met! Exemption can be used every 2 years! Loss from sale of principal residence is not deductible
Example! Tony, a U.S. citizen, paid $250,000 (CDN) for his Calgary home which he has lived in for the past 10 years (i.e. he only owns this house)! It is now worth $750,000 (CDN) and he is considering selling it! Assume U.S. exchange rate of 1.25 (i.e. $1.00 U.S. = $1.25 CDN)! If he sells it at FMV, he will have a tax free gain of $500,000 (CDN) in Canada; however, he will have a taxable long term capital gain of $150,000 (U.S.) at a tax rate of 15% (i.e. $22,500 in taxes owing in the U.S.)! Because this income is not taxable in Canada, Tony will not have any foreign tax credits available to reduce the tax on this particular type of gain in the U.S.
Charitable donations - deductibility! Overall limitations for contribution deductions in the U.S. is 50% of adjusted gross income (AGI); however, there is a second limitation of 30% of AGI for long-term capital gain property donated to specific charities (where gain is not reduced) and a third limitation of 20% of AGI (or a lesser amount) for donations made to other specific charities! The U.S. also has certain documentation requirements for donation over a certain dollar amount as well (i.e. non-cash property exceeding $500 in value must meet certain documentation guidelines in order to be deductible)
Charitable Donations deductibility (cont d)! If you are a Canadian resident and non-citizen of the U.S. and you donate money to a U.S. charity, you can only use the donation as a credit against U.S. source income! The same is also true if you are a U.S. citizen donating money to a Canadian charity, you can only use the donation credit in the U.S. against Canadian source income! Certain exceptions exist for the following organizations outside of Canada: A university outside Canada that is prescribed to be a university the student body of which ordinarily includes students from Canada; A charitable organization outside of Canada to which Her Majesty in right of Canada has made a gift during the individual s taxation year or the 12 months immediately preceding that taxation year
Capital Gains! Only 50% of a capital gain is taxable in Canada at the individual s applicable tax rate, 100% is taxable in the U.S. and the tax rate depends on the type of capital gain produced! Capital gains taxation is more difficult in the U.S. because they have various categories of capital gains (i.e. gains resulting from different types of property) which are all taxed at different rates, such as:
Capital Gains (cont d) Capital gain from assets held one year or less is taxed at the taxpayer s regular tax rates (i.e. short-term capital gains); Capital gain from the sale of collectibles held more than twelve months (i.e. antiques, metals, gems, stamps, coins) is taxed at a maximum rate of 28%; Capital gain attributable to unrecaptured depreciation on business property held more than twelve months is taxed at a maximum rate of 25%; and Capital gain from assets held more than twelve months (other than from collectibles and unrecaptured depreciation on business property) is taxed at a rate of 15% (or 5% for individuals in the 10% or 15% tax bracket)
Social Security (SS)! Social security in the U.S. is the equivalent of Canada s CPP! Generally, social security is not taxable in the U.S. until your income reaches a certain threshold.
Social Security (SS) (cont d) If you live outside the U.S. (i.e. in Canada), under the treaty, SS benefits will only be taxed in the country of residence. Canada has agreed to tax only 85% of the income to maintain the maximum taxable allotment to coincide with U.S. SS tax guidelines. This means that in Canada you pay tax on 85% of the SS benefits you receive no matter what your income threshold is. On your U.S. return, you will report the SS income but none of it will be taxed in the U.S. because you do not reside there. This eliminates double taxation but eliminates the threshold allocations applicable if you were to reside in the U.S.
Social Security (SS) (cont d)! CPP & OAS are treated as the same as SS benefits for U.S. tax purposes (i.e. not taxable in U.S. if you reside in Canada)
Registered Pension Plan! Income earned within a RRSP or RPP can be deferred in the U.S. as well; however, an election must be filed for each separate pension account to elect for the income to only be taxed when withdrawn (not automatically deferred) (form 8891)! RRSP and RPP contributions are not deductible in the U.S. because they are considered to foreign pension plans! Even though RRSPs and RPPs are considered foreign pension plans for U.S. purposes, the U.S./ Canadian tax treaty allows U.S. taxpayers to file an election to treat the income earned within these accounts as tax deferred in the U.S., same as it is in Canada (i.e. only taxed as income when withdrawn)
Registered Pension Plan (cont d)! Because the contributions are not deductible in the U.S., when amounts are withdrawn they are not taxable either; only income earned on a tax deferred basis as well as employer contributions are taxable upon withdrawal! Treatment for 401K contributions (U.S. equivalent of Canadian RRSPs) are similar
Example! Frank, a U.S. citizen living and working in Canada, contributed $100,000 to his RRSP s, his employer contributed $50,000 and he earned $20,000 of tax deferred income within the fund! If Frank withdraw $10,000 from his RRSP s in 2007 the following would result: Taxable in Canada Taxable in U.S. RRSP withdrawal $10,000 $4,100* *70,000/170,000 = 41% * 10,000 Note: all amounts must be converted to U.S. dollars for U.S. reporting purposes
Retirement Compensation Arrangements (RCA s)! RCA s are another retirement savings option for Canadians as well as U.S. citizens living and/or working in Canada! RCA s are a plan or arrangement between an employer and an employee under which: Contributions are made by the employer to a custodian of the RCA Trust; and The custodian may be required to make distributions to the employee or another person on, after, or in view of, the employee s retirement, the loss of an office or employment, or any substantial change in the services the employee provides.
Retirement Compensation Arrangements (RCA s) (cont d)! If you are an employer and your set up an RCA, you have to deduct a 50% refundable tax on any contributions you make to a custodian of the arrangement, and remit the amount of refundable tax you collect to the Receiver General on or before the 15 th day of the month following the month during which it was deducted! The custodian has to deduct income tax from any distributions made out of the RCA and remit the amount of income tax collected to the Receiver General as well
Retirement Compensation Arrangements (RCA s) (cont d)! Not may RCA s are actually being set up but they have interesting applications: For Employers: looking to create golden handcuffs for key employees; Business Owners wanting to lower the market value of the business prior to a sale or Estate Freeze Business Owners wanting to shelter some of the proceeds from an asset business sale For employees: looking to retire in a foreign tax jurisdiction;
Retirement Compensation Arrangements (RCA s) (cont d) Business with U.S. Citizens working in Canada Professional Athletes, Oil Executives For Businesses: looking for large tax deductions while at the same time augmenting cash flows by leveraging the RCA! If distributions from an RCA are made to a non-resident of Canada, the custodian must withhold income tax at 25% of the amount paid to the non-resident
RCA U.S. Citizen working in Canada! Professional Athlete / Oil Executive! Contribution to RCA included in income of taxpayer in U.S.! Contribution to RCA not included in income of taxpayer in Canada! Higher tax rate in Canada allows contribution to RCA without any incremental U.S. tax
Example! Dave earns a salary of $400,000 per year! Dave only requires $200,000 per year for living expenses! Dave is a U.S. citizen and intends to move back to the U.S. in the next couple of years! Is there a benefit to Dave having $200,000 of his salary contributed to an RCA?
RCA Example Without RCA Canadian U.S. Total Employment income 400,000 400,000 Foreign earned income exclusion 0-104,000 Taxable income 400,000 296,000 Taxes payable 168,567 73,013 Foreign tax credit 65,711 Total tax paid 168,567 7,301 175,868
RCA Example With RCA (lump-sum payment) 2005 2006 Canadian U.S. Canadian U.S. Total Employment income 200,000 200,000 0 0 Contribution to RCA 0 200,000 0 0 Payment from RCA 200,000 Foreign earned income exclusion 0-104,000 0 0 Taxable income 200,000 296,000 0 0 Tax liability 75,767 73,013 50,000 0 Foreign tax credit 0 65,711 Total payable 75,767 7,301 50,000 133,069 Savings 42,799
Periodic payments with RCA! Same situation exists for Dave but his payments from the RCA were considered periodic pension payments! If his payments were received periodically, the withholding tax rate would only be 15%
Illustration! Assume he receives $20,000 over 10 years! This generates $3,000 of tax per year for a total of $30,000 in tax (over 10 years)! Overall savings would be $62,799
Estate Tax! The U.S. has a separate tax system for gift and estate taxes as well as generation skipping taxes! The gross estate for a U.S. citizen includes the FMV of all property in which the decedent had an interest at time of death (i.e. not FMV of income but FMV of property owned); examples of items includable in the estate are: pension income, life insurance proceeds*, principal residence, vehicles, etc.! The executor can elect to use the FMV at the date of the decedent s death or the FMV at the alternative valuation date (a date six months subsequent to death), if such election will reduce both the gross estate and the federal estate tax liability
Estate Tax (cont d)! Estate tax deductions include funeral expenses, administrative expenses, debts and mortgages, casualty losses, charitable bequests, and an unlimited martial deduction for the FMV of property passing to a surviving spouse (note: not all of theses are deductible on a Canadian estate tax return)! Each U.S. citizen is entitled to the estate exemption equaling $2,000,000 at present (increased to $3,500,000 for 2009)
Estate Tax (cont d)! Canadian citizens/resident holding assets in the U.S. are also required to file a U.S. estate return but they are also eligible for an estate exemption; however, it depends on the value of the estate held in the U.S. compared to that held within Canada (using the tax treaty)! If the decedent is married to a non-citizen of the U.S., the IRS requires that proceeds transferred to the surviving spouse must be placed in a qualified domestic trust ( QDOT ); the surviving spouse may receive the income from the QDOT free of estate tax, but if part of the trust principal is distributed, that amount is subject to tax owned by the predeceased spouse s estate
Gift Tax! U.S. taxes individuals on gifts donated each year depending on the amount and who they are gifted to! The annual gift exclusion is up to $12,000 per donee for gifts of present interest (not future interests)! Generally the following gifts are not taxable: Gifts, excluding gifts of future interest, that are not more than the annual exclusion for the calendar year; Tuition or medical expenses you pay directly to a medical or educational institution for someone; Gifts to your spouse; Gifts to a political organization for its use; and Gifts to charities
Gift Tax (cont d)! A gift tax return must be filed on a calendar year basis if any gifts are made over the allowable exclusion amounts and the return is due on April 15 th of the following year! Gifts can be split between spouses if both spouses so elect (i.e. $20,000 donated by husband but both can elect to split 50/50 to stay under the $12,000 limit)
Generation Skipping Tax! Designed to prevent individuals from escaping an entire generation of gift and estate taxes by transferring property to, or in trust for the benefit of, a persona that is two or more generations below that of the donor or transferor (unless the grandchild's parent is deceased and was a lineal descendant of the grantor)! Imposed at a flat rate that equals the maximum unified transfer tax rate of 45% (2008)! $2,000,000 exemption per transferor for 2008 and an unlimited exemption is available for a direct skip to a grandchild if the grandchild's parent is deceased and was a lineal descendant of the transferor
QUESTIONS
Thank you! Angela D. Zarn, CA, CPA, CAFA Larry H. Frostiak, FCA, CFP, TEP Frostiak & Leslie Chartered Accountants Inc. www.cafinancialgroup.com