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Know the Facts about FATCA, U.S. Tax Law, and U.S. Immigration Law before Renouncing Your U.S. Citizenship

written by Brent Soucie, Consultant, CPA, CA

July 27, 2015
Merged Flag of Canada and USA

 

With all of the recent attention on the Foreign Account Tax Compliance Act (FATCA), I thought it would be a good time to address some of the issues surrounding our friends who reside here in Canada and hold U.S. citizenship – there are an estimated one million of you!

You come from all walks of life. Some of you emigrated here shortly after birth, some moved here to start or grow your career(s), and some of you have lived here your entire lives, having derived your U.S. citizenship through your parents. In any case, FATCA impacts you and you need to know how.

I’m often asked about the merits and drawbacks of keeping versus renouncing U.S. citizenship. Such is a deeply personal decision with potentially serious ramifications, so you need to make it with your eyes wide open. Here are some important things to consider.

Are you a U.S. citizen?

• If you were born in the United States, you are a U.S. citizen – no exceptions
• If you were born in Canada to two U.S. citizen parents, you are a U.S. citizen
• If you were born in Canada with one U.S. citizen parent, your date of birth, as well as the amount of time your U.S. parent resided in the U.S., will determine whether or not you are a U.S. citizen

Facts about U.S. citizenship

• It is illegal for U.S. citizens to enter or leave the U.S. without a valid U.S. passport (section 53.1)
• Carrying U.S. citizenship offers several benefits, including protection while travelling abroad, consular services, access to the U.S. domestic job market, ease of travel to and from the U.S., and the right to vote in U.S. elections

Facts about U.S. income taxation

• U.S. citizens are required to file a U.S. tax return every year, regardless of where they live
• U.S. citizens must declare their worldwide income on their U.S. tax return, every year
• U.S. citizens can claim a credit on their U.S. tax return for taxes paid to a foreign country (e.g., Canada)
• Approximately 19 out of 20 U.S. tax returns filed by Canadian residents result in little or no balance due to the IRS because Canadian tax rates (combined federal and provincial) tend to be higher than U.S. tax rates (including state tax) on most types of income
• U.S. citizens must also disclose information about their non-U.S. financial accounts to the IRS on an annual basis and on the Report of Foreign Bank and Financial Accounts (commonly known as the FBAR form)
• U.S. citizens are subject to the U.S. estate tax, which is levied on estates greater than $5.43 million USD. This is different than the methodology for U.S. estate tax payable by a non-U.S. citizen who owns U.S. property. Learn more about Canadians’ exposure to U.S. estate tax here
• The sale of one’s principal residence can create a U.S. tax liability, as the IRS’s principal residence exemption is limited to $250,000 USD of gain ($500,000 USD for married individuals filing jointly)
• Now that FATCA is in effect, Canadian financial institutions are required to find out which of their clients are U.S. citizens, and disclose their names to the IRS
• Many Canadian financial tools are less efficient for U.S. citizen taxpayers. This includes, but is not limited to, RESPs, TFSAs, Family Trusts, private and/or professional corporations earning certain types of income, foreign (non-U.S.) partnerships, non-U.S. mutual funds, non-U.S. pooled funds, and/or non-U.S. exchange traded funds (ETFs). Several of these noted funds qualify as Passive Foreign Investment Companies, which is a topic in and of itself
• If you are a U.S. citizen and have not filed tax returns for several years, there are amnesty programs in place that allow you to catch up: the streamlined program for non-resident U.S. filers, and/or the Offshore Voluntary Disclosure Programs. These programs are very different and suit individuals based on their own personal circumstances
• The IRS is looking to bring their non-compliant or delinquent filers back into compliance. In other words, the IRS wants you to file your tax returns and your FBAR forms (non-U.S. financial account disclosure forms)

Facts about renouncing U.S. citizenship

• If you choose to renounce your U.S. citizenship, you will typically cease to have the above-noted income tax filing obligations
• Renouncing your U.S. citizenship does carry a potential exit tax (i.e., a deemed sale of all your assets)
• The U.S. exit tax is applicable to individuals with a worldwide net worth greater than $2,000,000 USD, as well as other individuals who meet certain income tax liability thresholds. The determination of your net worth is in accordance with U.S. tax law, and includes some assets that some individuals may not otherwise consider (e.g., present value of pension plans)
• Each quarter, the names of (former) U.S. citizens who have renounced are published in a publicly available Federal Registrar
• The number of U.S. citizens renouncing their citizenship has increased drastically since 2008 (up to approximately 1,300 per quarter)
• There are seven U.S. Consulate offices in Canada that offer regular renunciation appointments (Vancouver, Calgary, Toronto, Ottawa, Montreal, Quebec City, Halifax), each having different wait times
• There are ways to reduce the size of one’s taxable estate (subject to the exit tax); however, one needs to be cognizant of the U.S. gift tax regime and other nuances in the U.S. tax system. Simply gifting your estate away could create more tax than it might save
• Before you can renounce your U.S. citizenship, you must be compliant and up to date with your income tax filings (typically, the last five years)
• It is highly advisable to retain the services of a U.S. immigration lawyer, who can coach you through the process of renouncing. At present, some of the top tier firms offering this service are quoting $12,000 per case
• There is a $2,350 USD fee payable to the U.S. government for applying to renounce your U.S. citizenship
• If you are determined to have renounced your U.S. citizenship for the sole purpose of avoiding taxation, such can cause you to be inadmissible to the United States (hence the importance of proper assistance from a U.S. immigration attorney throughout the renunciation process)

Travellers and Greencard holders

• The U.S. exit tax also applies to U.S. Greencard holders who are “long-term residents” of the United States (those who have resided in the U.S. for eight of the past 15 years) looking to give up or surrender their Greencard.
• If you renounce your U.S. citizenship, you can still travel to the U.S., collect U.S. social security, purchase U.S. real estate, and receive payments from U.S. based retirement plans. The same rules that apply to a Canadian traveller typically apply to a former U.S. citizen who resides in Canada
• Travellers who cross the U.S. / Canada border are now required to swipe passports when both entering and departing each respective country. As such, the border authorities now keep track of a traveller’s day count

If you are considering whether or not to renounce your U.S. citizenship, it’s highly advisable that you reach out to a professional service provider to explore your personal circumstances. Knowing the facts and dispelling myths about the U.S. tax system can go a long way in reassuring you that you’ve made the right decision.

Personable and professional, Brent Soucie specializes in cross-border tax and financial planning for U.S. citizens and/or Green Card holders residing in Canada, as well as Canadian residents with U.S. employment and/or property. His clients include professional athletes, entrepreneurs, and corporate executives.

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Special thanks to our speakers: Nicola Elkins, Virginia Trieloff, DeWayne Osborne and Éric Devlin for lending their expertise, and to our valued guests who showed much enthusiasm and curiosity.

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via Investment Executive | August 2015

A pediatrician and his wife, an interior decorator, want to ensure their high joint income creates a comfortable retirement for themselves and security for their two young children

“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue,Investment Executive spoke with Matthew Ardrey, consultant and manager, financial planning, with T.E. Financial Consultants Ltd. in Toronto; and David Goodridge, portfolio manager, and George Oroc, investment advisor and financial planner, with MacDougall MacDougall & MacTier Inc. in Montreal.

The scenario: David, 45, is a pediatrician; his wife, Andrea, 40, is a consultant in an interior-decorating business. The couple live in Montreal with their two children, ages 7 and 11. David and Andrea want to retire when Andrea is 65 and be able to spend about $150,000 a year in today’s dollars to age 95.

David’s practice is incorporated, with income of $325,000 a year. He takes $300,000 in salary each year and leaves $25,000 in the holding company. He has $600,000 in RRSP assets, $31,000 in a tax-free savings account (TFSA) and $800,000 in the holding company’s non-registered corporate account. The holding company is structured with a trust that can pay dividends to the beneficiaries: David, Andrea and the children. David contributes $20,000 a year to his RRSP and $5,500 to his TFSA. He has $35,000 in unused RRSP room and hasn’t made his 2015 contribution yet.

David has a $500,000, 10-year convertible term life insurance policy, inflation-indexed disability insurance (DI) that would pay $10,600 a month and health-care insurance that covers the family.

Andrea makes $150,000 a year, has $250,000 in an RRSP, $21,500 in a TFSA and $40,000 in non-registered assets. She contributes 10% of her salary to her RRSP. She has $15,000 in unused RRSP room and $15,000 in unused TFSA room.

She has DI that would pay $3,000 a month, which is not inflation-indexed, and a $100,000 whole life insurance policy. She also expects to inherit a family cottage, worth $375,000, and $200,000 in financial assets when her parents die.

The couple own a $700,000 home on which there is $240,000 owing. Their monthly mortgage payments are $2,000 and they make $15,000 in prepayments each year.

There is also $65,000 in a family registered education savings plan.

The couple currently spend about $195,000 a year but could reduce this to $150,000 and still maintain a comfortable lifestyle. This expenditure is after taxes, mortgage payments ($39,000, including the $15,000 prepayment), and RRSP and TFSA contributions ($40,500). The annual expenses include $25,000 for vacations.

The couple, who are moderate-risk investors, want to know if they can meet their goals. Andrea also is concerned about the possibility of her business running into problems due to a prolonged absence of either herself or her business partner.

The recommendations: The financial advisors say David and Andrea should be able to spend $150,000 a year in today’s dollars during their retirement to age 95. The couple could spend more, particularly if David takes advantage of the tax benefits of leaving earned income in his holding company for investment purposes. Income left in the holding company is taxed at 19.9%, while money withdrawn as salary (above $139,000 a year) is taxed at 49.7%. David needs only $240,000 in salary to meet the family’s current lifestyle needs, so an additional $60,000 can be left in the holding company. This will result in tax savings of $17,880 a year.

Once the home’s mortgage is paid off, a further $54,000 can be left in the holding company, increasing the annual tax savings to $33,972.

Further savings will be possible when the children reach age 18. As long as they are pursuing post-secondary education, they won’t be liable for much, if any, taxes. They could get as much as $38,000 in dividends from the holding company’s trust without paying taxes; this money could be returned to their parents.

To protect the children, Oroc recommends a 10-year term life insurance policy for $240,000, which would pay off the mortgage, and a 20-year term life policy of $1.3 million. Both policies would be joint last-do-die policies, with annual premiums of $462 and $3,350, respectively.

Oroc also suggests increasing the couple’s DI policies to provide an additional $7,300 a month for David and $6,500 for Andrea, at an annual cost of $1,870 and $2,943, respectively.

In addition, Oroc recommends $100,000 in critical illness (CI) insurance to age 75 for both spouses, costing $1,560 per year for David and $1,130 per year for Andrea.

Ardrey recommends that David increase his term insurance by $700,000 to $1.2 million and extend the term to 20 years, at which point he should have enough assets to not need insurance. This would cost about $950 in additional annual premiums, assuming David is a non-smoker and in good health. Ardrey thinks Andrea’s current term insurance is adequate.

Ardrey also thinks CI should be considered, but not long-term care insurance, as there will be sufficient assets when the couple are in their 70s or older to cover those costs.

The advisors also recommend that Andrea contribute the maximum she is able to her TFSA. She can start by transferring assets from her non-registered account. When that is depleted, she can get what she needs through a dividend from the holding company.

Neither Ardrey nor Oroc suggests that David’s and Andrea’s unused RRSP room be used up. They don’t want to have to take too much out of RRIFs during retirement, as that income is taxable.

The advisors say that, with two principals, Andrea’s business should have a partnership agreement that sets out how the business is run, including who does what and how decisions are made. The agreement also should set out what happens if one of the partners becomes disabled, dies or wishes to withdraw from the business. Oroc suggests that there also should be a non-disclosure agreement to prevent the partner who is leaving from taking clients or using the firm’s “unique” ideas.

Insurance also could be helpful, including buy/sell insurance to provide bridging financing to the partner buying out the other principal, as well as key person insurance to cover expenses until the departing partner can be replaced.

The couple’s wills and powers of attorney should be updated, and the advisors suggest testamentary trusts for the children in the wills. Such trusts no longer offer tax benefits, but do allow for graduated access to assets should David and Andrea die while the children still are relatively young.

Ardrey also suggests that David consider an estate freeze by adding another level to the holding company’s structure that would permit the use of both preferred and common shares. David and Andrea would hold the preferred shares; the children, the common shares. This strategy locks in the capital gains at the present-day level for David’s and Andrea’s estates, while all future growth and, thus, the taxes owing on it due to capital gains are deferred to the children.

For financial assets, the advisors recommend an overall initial asset mix of 75% equities/25% fixed-income, even though David and Andrea are moderate-risk investors. “Research shows that you reduce long-term volatility and risk with this asset mix, assuming the portfolio is regularly rebalanced,” explains Goodridge.

As the couple nears retirement and their investment time horizon becomes shorter, a smaller equities portion should be considered. However, Ardrey says that the equities portion shouldn’t fall below 60% until the couple are “well into retirement” because stocks provide inflation protection.

The advisors also recommend that the investments be broadly diversified by geography and sector.

Goodridge favours a “growth at a reasonable price” investment style. He also thinks there’s a place for hedge funds for the couple, but not for more than 5% of their total assets.

Ardrey suggests that the couple consider investing up to 10% in a mortgage investment corporation that focuses on one- to two-year secondary commercial loans, which typically yield 7%-9%.

Ardrey and Goodridge are fee-based advisors who charge a percentage of assets under management – in this case, 1%.

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