Date: 2012
Los Angeles and New York City are places where fame and fortune have lured more than half of the estimated 600,000 Canadians living in the United States. I have lived in both cities for many years, and know that it is truly a blessing to leave your home town (whether to study or to work) to experience life in another part of the world. After all, our lives are but a collection of our experiences. And the thrill of these adventures, and what elates our hearts can be found in the dreams we pursue. But Canadians following their life goals in NYC or LA, (or other fantastic U.S. destinations) do not stop to consider how the tax laws of Canada and the United States can impact their journey—and there would probably be something medically wrong with them if they did. Alas, Canadians moving to or living in the States, do not appreciate how understanding the rules that impact their personal lives can foster financial wellness and make their lives easier Hopefully, their financial and professional advisors –You! can spread the word. Here then is a sample, but not more than that, of some of the issues that may need the attention of your family, friends, and clients living in the States.
RECEIVING TIMELY CROSS BORDER TAX ADVICE CONCURRENT WITH US IMMIGRATION COUNSEL
Canadians travelling to the hot climate regions this winter will no doubt see advertisements in print, TV, or online, urging them (through somewhat convincing and graphical advertisements) to forestall the inevitable attacks on their GI systems and all of the ensuing horrors that go with that, through preventative travel medications. While it is unlikely we are going to see ads advising would be immigrants to the U.S. to get timely cross border tax advice to avoid unnecessary personal and financial trauma, it is worthwhile to point out that immigration and taxation are truly two sides of the same coin. Those professionals assisting Canadians with U.S. work and family visas in Canada and the United States can do their clients a tremendous high value service (not to mention following “best practices”) by strongly recommending their clients to obtain cross border tax advice from accountants and lawyers. The advice to be effective, should come from licensed accountants and or lawyers in both countries, and be provided in an integrated (given after professionals from both countries have consulted with each other on various issues) format rather than through unilateral advice (a potentially disastrous approach). Not only should this advice be given prior to a client relocating to the U.S., but it needs to be given on an ongoing basis, to be effective because people’s lives change, and so do the tax laws. To be certain, there are no magic bullets or templates, tax wise---every client will have his or her own unique personal goals and needs which need to be thoughtfully considered by cross border tax experts.
CROSS BORDER ESTATE PLANNING CONSIDERATIONS – EXECUTORS, POWERS, BEQUESTS, JOINT TENANCIES, DOMICILE
Being the Executor of Your Parent’s ‘Canadian’ Estate While You Are Living in the U.S.
Marjorie is a doctor who lives in Washington State. She was the executor of her father’s will in Toronto. Marjorie does not have a remarkable story, she moved to the U.S. from Canada for graduate school and married and American and became a U.S. citizen. She has been practicing medicine in Seattle for many years and is soon going to retire. We met not too long ago to make some changes to her family’s estate plans. As executor to her dad’s estate, one of the issues that we discussed is the possibility that depending on the later facts, the estate could be considered to be resident under U.S. federal tax law in the United States, or, under Canadian federal tax law, or heaven forbid, in both countries at the same time (What does the treaty say about that?). Marjorie was planning to administer the estate part in Ontario, and part back in Washington. How each of Canada and the United States determine the residence of an estate (or trust in Canada under the Act because estates under the Act are regarded as trusts for tax purposes), is beyond the scope of this article.[1]
The U.S. has a nasty tax called the gift tax. It can apply in seemingly innocuous situations, but it is not expected to go away (even if the estate tax does) and the rates can approach 50%. Unlike Canada, which to simplify the concept, may impose a gift tax on the ‘appreciation’ in the value of an asset, the U.S. gift tax applies to the fair market value of an asset. In addition, because Marjorie under the terms of her dad’s will would hold certain powers relating to the distribution of the assets of the estate of her dad, a further issue that could potentially arise, is whether those powers would give her a ‘general power of appointment,’ (for U.S. transfer tax purposes) which could attract a gift tax, say on the division of the estate. Long story short, her dad, Melvin decided to instead, ask an old time family lawyer friend who lived in Ontario to fulfill this role of executor and really make all of these potentially troublesome and costly issues disappear. Additionally, Marjorie held a live financial power of attorney for her dad (powers of attorney given in Ontario are typically live and usable when executed). Again, under U.S. gift tax principles, the use of the power by Marjorie, could in certain instances, trigger an unwanted U.S. gift tax. Alternate solutions existed to fix this problem, and Marjorie and her dad selected one.
Receiving a Gift or Bequest from Your Family in Canada
Peter is a successful architect in New York. When his parents pass away, his share of their estate in Ontario will exceed $3.0 million. Peter lives with his spouse Amanda on the Upper West Side, near Zabars. Like Canada, the United States generally does not have at the Federal level an inheritance tax per se, although some states like Iowa do. If Peter receives a bequest from his family in some millions of dollars, then that bequest will when he dies will form part of his gross estate for U.S. and New York estate tax purposes (assuming down the road there remains an estate tax). I might add, even if an estate tax disappears at the federal level, it is unlikely to disappear at the cash starved state level.
First off, it is important to note that any inheritance from a foreign estate or distribution from a foreign trust must be reported by a resident in the U.S. with the annual return for that person, or there is a risk that the inheritance or trust distribution may be subject to an enormous confiscatory penalty of up to 35%. Moreover, of equal or perhaps greater concern, Peter’s inheritance will be subject to creditor exposure that Peter may have in his business or personal life. As a U.S. citizen, or resident, one of the greatest financial and estate planning advantages available, is to receive a bequest in trust from your family in Canada. The bequest in trust can be structured to be impervious to the U.S. transfer tax regime (estate and gift tax), and also to be beyond the reach of most potential creditors. By changing their estate planning design, Peter’s family was able to leave Peter’s inheritance in a special trust that will permit him all of the income and as much capital as he may desire. The cross border tax aspects of the trust are very complex and a description of these rules, and the US transfer tax rules applicable to the planning is simply beyond the scope of this article. Additionally, careful planning is required to avoid some of the most draconian income tax provisions applicable to trusts in the Code. This is a good place to point out that inter-vivos gifts (gifts made during the life of the donor) by a Canadian family to children living in the U.S. can also merit important tax and creditor protection planning. Generally, gifts of more than the US$100k received by US residents from family members in Canada (or non-residents) generally must also be reported with a person’s annual tax return (potential severe penalties may apply for failure to report such large gifts). There are many more cross border estate planning issues we regretfully do not have time to discuss.
Holding Property as Joint Tenants
The owning of property, most commonly, the family home often is taken in the form under state law as joint tenancy which permits the property to pass to the surviving spouse as a matter of law upon the first to die. This is to be distinguished, for example, by taking property as tenants in common. Both of course are subject to inclusion in the U.S. estate tax, although under the joint tenancy, the property passes outside of the deceased spouse’s estate for local probate purposes. The holding of real property such as a family home as joint tenants where one of the owners is a non-U.S. citizen can create significant tax complexities and liabilities that for purely tax reasons should be avoided at all costs. Holding property as joint tenants can raise very important estate tax, gift tax, and income tax issues which can adversely impact a family at multiple stages of ownership and result in potentially significantly more taxation than if the property were held in a different legal form, for example, as tenants in common, or solely by one spouse. Although the subject of another day, this tax blight applies with an alarming rate to families in Canada where one spouse is American, and the other, Canadian. Because of the very adverse tax consequences that can flow from this type of ownership, families with this issue should consult expert U.S. tax counsel to understand their own situation and discuss possible remedial measures which may be taken now. This disingenuous design is also far too often found with “Snowbirds” acquiring vacation property in the U.S.
Planning to Avoid Having a U.S. Domicile
Of course, whether as a result of a person’s travel to the U.S., and stay in that country, he or she will become subject to the complex and potentially costly U.S. tax rules governing estates and gifts is determined (if they are not a US citizen) on that person’s domicile. Briefly, a person may acquire a domicile in a place by living there for even a brief period of time, with no definite present intention of later removing themselves from that place. Planning to avoid having a U.S. domicile based on the juridical interpretation of the concept is recommended for many persons in the U.S., in particular high net worth Snowbirds with homes in the U.S. who live there more than six months of the year. Different rules apply to the application of the estate and gift tax laws affecting non-resident aliens.[2]
U.S. INCOME TAX AND REPORTING ISSUES
Regretfully, we do not have a book to list all of the cross border tax issues (including the many Canadian tax issues) that need to be considered prior to immigration, and afterwards. I receive so many calls from recently arrived Canadians who refuse to spend the money to meet with experienced and licensed cross border tax advisors. How a Canadian files in regard to his or her status as a resident in Canada (and in regard to the Treaty) in the year they leave the country and afterwards can have a serious financial tax impact under the Act (including, triggering a deemed sale of their assets). The Treaty contains provisions which can help improve the tax situation of Canadians immigrating to the U.S., for example, in connection with their principal residence. Also of note, are the onerous U.S. foreign asset reporting rules relating to assets and accounts held by a US resident outside the U.S. which can have potentially devastating penalties (see the FBAR penalties—please see my previous 4 articles on this subject). Perhaps one of the most critical factors that many Canadians do not consider, is the relatively new U.S. exit tax. The U.S. exit tax, if applicable, can as part of its penalty structure impose a tax on a deemed sale of a person’s worldwide assets. I have written many articles on this tax, and so not to bore any readers here, those with green cards need to understand how the exit tax can apply to them, and whether the green card is the immigration pathway that’s the most savvy choice for an individual. Perhaps one of the least understood aspects of the exit tax, is that its provisions can potentially apply to aliens (non US citizens and non green card holders/permanent residents) who are resident in the U.S. (even as a snowbird) for a short period (say 3 years) then leave for a brief period, and then return. There are many potential tax “land mines” which can impede wealth preservation that need pointing out before coming to America, there just isn’t time to deal with them here. These same issues can also be demoralizing on a personal level if left to be discovered too late on a person’s journey.
EXECUTIVE RELOCATION & BUSINESS EXPANSION TO THE U.S. – MAKING SAVVY CHOICES
Entrepreneurs or private investors often have a choice in making a decision as to which immigration approach to follow to permit one or more members of their Canadian enterprise to live and work in the United States. Incorporating cross border tax planning before an entrepreneur, executive, or employee transfers to the U.S. should always be a part of the standard relocation checklist. The benefits can be huge, including achieving a lower combined effective tax rate (like why pay close to 70% CanAm taxes –I see this all the time!!! When you can pay closer to 50% or lower), and minimizing costly penalties by following federal, state, and local tax and reporting requirements.
U.S. Withholding Taxes
The United States generally imposes withholding obligations on wages paid to U.S. citizens, residents, and non-residents for services performed in the United States. These obligations also apply to foreign employers. The three primary areas of federal withholding are: income tax withholding, Federal Insurance Contribution Act withholding (FICA), and Federal Unemployment Act withholding (FUTA). Certain exceptions may apply under the Internal Revenue Code and the Canada-U.S. Tax Treaty (the “Treaty”). The Code imposes civil penalties for various kinds of noncompliance with reporting and payment of these withholding taxes. Don’t forget about the Patient Protection and Affordable Care Act!
Planning to Minimize Having Your Canadian Business Pay U.S. Taxes
Article VII (Business Profits) of the Treaty limits the taxation by the U.S. of the business profits of a Canadian resident enterprise to business income that is attributable to a permanent establishment in the U.S. Under Article V of the Treaty, a permanent establishment may take many forms, including an office, store, or manufacturing facility. The office may include space made available to the Canadian resident whether rent is paid for the space or not. More recently, the Treaty now deems a Canadian enterprise to have a permanent establishment in the U.S. by virtue of providing services in the U.S. through it’s employees (and possibly its agents). Moreover, a Canadian enterprise is generally required to file U.S. tax return if at any time during the taxable year it is engaged in a U.S. trade or business. Failure to properly and timely file returns can lead to penalties and the loss of business deductions.
Planning to Minimize Tax and Compliance Exposure to 50 “Mini-Countries”—the States
Canadian companies must also navigate the different rules of 50 states jurisdictions relating to nexus and obligations to file state income tax returns and the reporting and withholding for state unemployment taxes (SUTA). The presence of personnel from a Canadian enterprise in a state may also trigger other state compliance obligations such as sales and use taxes. Some states also have very onerous employment laws and practices with severe penalties, such as state disability insurance laws in New York State.
Not too long ago, I received a call from Alan, a successful Toronto entrepreneur in the IT software field. His company engaged personnel in the U.S. in twelve states to market/distribute his firm’s software. In addition to unconsciously creating a U.S. permanent establishment his operation was also running afoul of state and local income and sales and use tax laws that could in a future sale of his company, clobber his family. Whatever the business and immigration plan being considered by a company or entrepreneur, it is critical to evaluate these plans in light of the applicable cross border (including Canadian) tax and compliance issues relating to choices. Where the chickens usually come home to roost on these delinquencies is on a strategic day of reckoning for the company—a future financing, PE, merger, IPO, or sale. These issues stick out on due diligence and can result in serious financial holdbacks. Fortunately, we fixed Alan’s problems.
CONCLUSION
I tell my clients to live their lives in the way that they believe will bring them happiness. My role is to help them understand what the tax obligations and potential liabilities may be associated with their choices. This often involves working together with other professionals to design and implement cross border strategies to help the client realize their life goals and at the same time keep more of their earnings for themselves. In many situations, clients will choose to maximize the quality of their lives over maximizing the quantity of their assets. And such is as it should be, according to the values of the person or family. Part of travelling across the great frontier between our lands is understanding the impact of the tax laws on one’s journey, if not before embarking on it, at the very least, before it ends. Yes you can orient your cross border expedition away from the storm, just point the directional arrow on your compass to financial wellness, and live with ease. Safe, and fun journey.
[1] For a detailed explanation of the residence of trusts and estates in Canada and the United States, including a recent update on the Supreme Court’s decision in Garon Family Trust (Trustee of) (subnom St. Michael Trust Corp., as Trustee of the Fundy Settlement) v. R., 2012 SCC 14, aff’ing 2009 TCC 450, 2009 (TCC [General Procedure], 2010 FCS 309 (FCA) see Article IV – Residence in the Tax Advisor’s Guide to the Canada U.S. Tax Treaty. See also Article XXII – Other Income in the same service for a discussion on the Canadian and US taxation of distributions from foreign trusts and estates.
[2] An explanation of the U.S. estate and gift tax regime, and of the U.S. exit tax regime is provided in Article 29B Taxes at Death of the Tax Advisor’s Guide to the Canada-U.S. Tax Treaty. The chapter also discusses international aspects of the Canadian taxation of trusts and estates.