For the more than one million Americans living in Canada, it’s important to know that the IRS enforces many different tax rules on U.S. citizens living abroad. Here are some of the cross-border tax issues for Americans living in Canada, courtesy of The Globe and Mail’s recent article, “Americans living in Canada: Be aware that the IRS is watching you.”
Principal place of residence. When U.S. citizens sell their principal residence in Canada, they’re not taxed on the gain by the Canada Revenue Agency (CRA). However, the IRS will tax the portion of the gain that exceeds $250,000. The problem is that if there’s no capital gains tax paid in Canada, there are no foreign tax credits available to offset tax owed in the U.S.
Foreign accounts in the aggregate of $10,000. There’s an IRS requirement that U.S. citizens file a Report of Foreign Bank and Financial Accounts (FBAR) for each year they have a financial interest in or signing authority over certain foreign financial accounts. This has a broad scope and includes accounts, such as corporate, trust and joint accounts. The penalties for not filing can be severe, so American citizens should be sure to report all applicable accounts each year.
U.S. gift and estate tax. Any U.S. citizen who makes gifts, is subject to U.S. gift taxes. However, not every gift is taxable. There’s also a lifetime gift tax exemption amount of $11.18M (for 2018). Using the lifetime gift tax exemption may, however, create U.S. estate tax (or death tax) liability in the future.
Life insurance. If a U.S. citizen owns a term life insurance policy upon death, the policy’s proceeds are included when calculating the value of the policyholder’s gross estate for estate tax purposes in the U.S. If those proceeds increase their estate beyond the exemption amount in the year of death, an estate tax liability may result. Another option is having a term life insurance policy in an irrevocable life insurance trust. Income earned inside a Canadian whole life policy that’s tax-exempt by the CRA might not be tax-exempt by the IRS, which means the U.S. citizen may have to pay tax to the IRS on income earned inside a Canadian whole life policy. Therefore, U.S. citizens in Canada may want to think about owning whole life insurance policies.
Renunciation. There are some U.S. citizens in Canada who don’t want to address their U.S. tax obligations for the rest of their lives. Renouncing their U.S. citizenship is the only way to effectively end all U.S. tax obligations. This process can be long and expensive. The renunciation fee is $2,350, but prior to renouncing, a U.S. citizen must generally show that they have been tax-compliant for at least five years, or they risk being deemed a “covered expatriate.” That means they may be subject to a U.S. exit tax. Individuals worth $2M or more, as of their renunciation date, are also considered “covered expatriates.” However, with some careful planning, it’s possible to avoid being deemed a “covered expatriate,” and also avoid the U.S. exit tax. Talk to a cross-border attorney on avoiding or mitigating U.S. exit tax exposure, if you are thinking about renouncing your U.S. citizenship.
One of the main goals of our law practice is to help families like yours plan for the safe, successful transfer of wealth to the next generation. Call our office today to schedule a time for us to sit down and talk about your estate plan, where we can identify the best strategies for you and your family to ensure your legacy of love and financial security. Our office is located in Santa Ana, CA but we serve all of California including Irvine, Orange, Tustin, Newport Beach, and Anaheim.
Reference: Globe and Mail (September 19, 2018) “Americans living in Canada: Be aware that the IRS is watching you”