U.S. TAX ISSUES: A plethora of planning problems National Wealth Management Conference

U.S. TAX ISSUES:A plethora of planning problemsNational Wealth Management Conference Will Todd, Davis LLP Taxation / Wills, Estates & Trusts Sean Rheubottom, Regional Vice-President, Wealth Planning, United Financial, a division of CI Private Counsel LP

Topics: 1. Americans in Canada and tax reporting 2. Estate and gift tax exposure 3. Real property ownership structures

U.S. Reporting U.S. Citizens in Canada and Canadian Snowbirds “The challenge is that we pass among you undetected”

Who should consider U.S. tax? • U.S. persons (citizens, residents and green card holders) • Income annually and wealth at death subject to U.S. tax • Spouses and parents of U.S. persons • Planning may offer opportunities to pay less tax • Owners of U.S. situs property • Even non-U.S. persons are subject to U.S. tax

Are you American? Is your child? • Generally, only three ways to become a U.S. citizen: • Naturalized as a U.S. citizen • Born in the U.S. or • Born to a U.S. parent who resided in U.S. • Only one U.S. parent required • Parental residency requirement prior to birth varies with date of birth • Citizenship goes back to birth (no “activation” required)

Residence - Individuals • U.S. statutory calculation: trigger is about 120 days/year • “Closer connection” exception – file IRS form 8840 • Cannot be a tax resident in both countries • Tie-breaker rules under Canada-U.S. Tax Treaty based on “centre of vital interests”

Zombie Green Cards • Immigration benefits of green cards expire 10 years after issuance • Annual tax filing obligations continue until the card is terminated • Termination of a green card more than 7 tax years after issuance can result in Expatriation Tax

Income and Asset Tax Reporting • U.S. persons are required to report to the U.S. their worldwide income, irrespective of residence • Report value of financial accounts and assets outside U.S. valued over US$50,000 (US$200,000, if resident outside U.S.) • Special reporting for certain non-U.S. assets

Structure and Asset-Based Reporting • Trusts that are not U.S. Domestic Trusts • Non-U.S. private companies • Canadian mutual funds

Foreign Trusts • Trusts that are not U.S. domestic trusts with U.S. persons as beneficiaries • Annual reporting by trust and U.S. beneficiary • Annual $10,000 penalty for failure to report • Distributions made (or implied) to U.S. beneficiaries subject to anti-deferral rules

U.S. persons with interests in foreign trusts • Distributions from current year taxed on same basis as if earned directly • Distributions from the trust of income or gain “earned” by the trust in prior years are taxed as if they were ordinary income received in the year “earned,” plus interest at the IRS rate for late paid tax

Trust distribution of long-term capital gain • A Canadian trust sells a property it acquired 3 years prior for a gain of US$300,000 and distributes to beneficiary who is a U.S. taxpayer: • Gain is allocated $100,000 to each of the 3 years: • $100,000 is taxed as ordinary income (up to 40%) and subject to interest for two years • $100,000 is also taxed as ordinary income (up to 40%) and subject to interest for one year • $100,000 is taxed as capital gain (10-20%) for the current year • Often these calculations result in an amount of tax plus interest exceeding the amount distributed, in which event the amount of tax plus interest is reduced to the distributed amount

Foreign Corporations – active businesses • Interests in non-U.S. private companies held by U.S. shareholders subject to annual reporting • annual $10,000 penalty for failure to report • Differences in the tax regimes can trigger additional tax; a few examples: • timing – double tax, if only deferred in one regime • attribution – spousal transfers can wreck havoc for FTCs • exemptions – Canadian CGE does not eliminate U.S. tax

Foreign Passive Investments • Income from PFICs subject to complex additional reporting and taxation • In 2010, IRS determined that Canadian mutual funds have always been subject to PFIC as investment companies • U.S. taxpayers should not invest in Canadian mutual funds outside registered plans

Foreign Bank Account Reporting • U.S. persons required to report bank and investment account balances outside U.S. if the total exceeds US$10,000 at any time in that year • Due June 30 (no extensions – ever) • No tax due when filed – significant penalty exposure for late filing

U.S. Gift and Estate Tax Value-based taxes on inter-generational transfers for Americans and holders of certain U.S. property “You can’t take it with you – at least not 40% of it”

U.S. Estate Tax for Americans • U.S. citizens and U.S. permanent residents • Very inclusive view of estate • Large exemption ($5.25 million in 2013, indexed)* • High tax rate above exemption amount (40% on value) ** The chaos of expiring tax provisions was eliminated by January 2, 2013 amendment

Broad Base for Tax • Value of estate on date of death • Gross estate – very inclusive: • Land and immovables • Tangibles and intangibles • Business interests • Life insurance proceeds • RRSPs • Most jointly-owned property • Trust assets depend on terms of trust

Traditional U.S. Estate Planning • Preserving the exemption of the first spouse to die • Maximize exempt gifting to reduce estate • Lower value of estate with valuation strategies

Cross-Border Marriage … but I married a Canadian U.S. spouse can use either: • a Qualified Domestic Trust (QDOT) to defer estate tax until death of Non-U.S. spouse or • marital credit under Treaty for gifts to Canadian spouse or spousal trust but not both

QDOT vs. Marital Credit • QDOT guarantees no tax on prior death of U.S. spouse, but: – Requires on-going compliance with U.S. trust rules – Any assets remaining in QDOT subject to tax on second death • Marital Credit • Almost doubles exemption amount on gifts to spouse or properly constructed spousal trust • Future exposure to U.S. estate tax only on U.S. property if non-U.S. spouse otherwise not subject to U.S. tax

Cross-Border Marriage … so I married an American • Trust by Non-U.S. spouse avoids surviving U.S. spouse having combined estate – Must address U.S. trust reporting – Trustee powers of surviving U.S. spouse technically restricted – Not possible for joint assets

U.S. Law: Spouses and Joint Title • Full exemption for transfers to U.S. citizen spouse • Recent recognition of same-sex marriage for federal estate tax applies where legally married • Joint title to property is 50-50 if both are U.S. citizens, but if not, rule is 100% owned by first to die (unless you can prove survivor provided funds from separate assets)

Estate tax on non-U.S. persons • U.S. Estate Tax and Gift Tax are due on U.S. situs assets: • U.S. land • Tangible property located in the U.S. • Stock of U.S. corporations and institutions • But not if held through certain non-U.S. entities • Same tax rate, different exemptions • Credit for estate tax paid can reduce Canadian federal tax on deemed disposition on death

Exemptions for Canadians • $60,000 exemption for all Non-U.S. persons • Canada-U.S. Tax Treaty allows Canadians the portion of the U.S. person exemption that their U.S. assets bear to their worldwide assets • Exemption almost doubled if transfer is to surviving spouse and no deferral spousal trust

Exemption under Canada-U.S. Tax Convention Cdn Exemption = U.S. Exemption x Value of U.S. Property Value of Entire Estate • Estate very inclusively calculated, and all must be reported to determine exemption amount • Valuation of all non-U.S. assets can be burdensome and expensive

Using a testamentary trust to avoid double tax • Property that is not in joint title can be transferred to a specially structured trust in the Will of the owner to prevent survivor’s estate paying additional estate tax • Should be considered for both surviving spouse and future beneficiaries

Gift tax for U.S. citizens and U.S. property • All inter vivos transfers by U.S. persons (or of U.S. situs property) at 40%, unless exemption: • Unlimited exclusion of gifts to U.S. legal spouse • $5,250,000 cumulative lifetime exemption for U.S. citizens • Reduces estate tax exemption as used • $143,000 annual exclusion for non-U.S. legal spouse • $14,000 annual exclusion; per donee per year • Tuition and healthcare directly to provider • Charitable gifts to U.S. charities

Gift Planning Strategies • Cross-border couples can use US$143,000 annual exclusion to gift principal residence to Canadian spouse • U.S. citizens can gift up to US$14,000 to each family member annually • minority interests in family businesses can augment gifting by discounting to fair market value

U.S. Real Property Structures Recreational property ownership for Canadians without U.S. estate tax exposure “Southern exposure can be worse than sunburn”

U.S. Real Property Issues • Rent received reportable as U.S.-source income • U.S. withholding / capital gains tax on sale • Foreign tax credit for Canadian capital gains tax • Capital gains rates impacted by structure choice • Estate tax • Gift tax • Probate costs and delay • Owner’s liability determined by a U.S. court

Investment Properties – no personal use • Canadian corporation • Partnership • TrustEach structure has advantages, so structure choice is dependent on investor objectives and circumstances.Considerations: cost, complexity, capital gains rate, deduction of losses, estate tax exposure, liability risk.

Investment Properties: consider the trade-offs • U.S. Limited Liability Companies (LLCs) usually result in foreign tax credit mismatch increasing income tax • Corporations face higher capital gains rates in the U.S. • Limited partnerships generally receive parallel tax treatment in both Canada and U.S. • Trust planning addresses probate exposure, but may result in foreign tax credit mismatch for taxes at death • Joint title addresses probate exposure, but may increase estate tax exposure

Personal Use Properties (including mixed use) Avoid Canadian corporations (attract Canadian tax) Structures to consider: • Specially-structured trust for married couples • Ownership by Canadian with simple assets worth less than $5 million (“poor spouse plan”) • Plan to sell to younger family members while alive • Plan to donate to a U.S. charity • Partnership or tenants-in-common ownership

Canadian Trust to Buy • Structured Trust must purchase from third party • Typical Canadian discretionary/family trust does not work because interest of contributor of assets or broad powers held by trustees • Capital gains taxes at favourable individual rates • Protection from owner’s liability • Assets of trust not included in estate of either spouse for both probate and estate tax

If you already own U.S. property: • Less flexibility – cannot use trust (U.S. gift tax and retained interest rules) • Gift tax is always the worst option • Sell and buy your neighbour’s property using a trust

Thank you For advisor use only Assante Wealth Management’s advisory services are offered through Assante Financial Management Ltd., Assante Capital Management Ltd. and Assante Estate and Insurance Services Inc. Assante Estate and Insurance Services Inc. is owned by Assante Financial Management Ltd. and Assante Wealth Management (Canada) Ltd. ®The Assante symbol and Assante Wealth Management are registered trademarks of CI Investments Inc., used under licence.

U.S. TAX ISSUES: A plethora of planning problems National Wealth Management Conference