How U.S. tax reforms affect cross-border clients

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House Republicans have unveiled the biggest overhaul of the U.S. tax code in three decades, which would sharply lower rates for corporations and reduce personal taxes for many Americans.

For your cross-border clients, though, the plan underwhelms.

“Nothing is getting better for most U.S. citizens in Canada,” says Max Reed, a cross-border tax lawyer at SKL Tax in Vancouver, in an email to Advisor.ca.

For example, U.S. citizens will still be taxed on worldwide income, and FATCA reporting obligations remain unchanged, notes Reed in a blog post.

Further, reduced U.S. tax rates don’t benefit U.S. citizens in Canada, as Canadian rates are higher and U.S. citizens get credit for paying Canadian tax.

There are also no changes to the punitive tax rules for U.S. citizens owning PFICs and foreign corporations. “Aside from small, technical changes, these rules have not changed in a meaningful way,” says Reed.

Bad news for business owners
If your cross-border client owns a business, his tax position “may get substantially worse,” Reed says, noting two areas of concern:

  • a one-time 12% tax will be imposed on all income previously deferred from U.S. tax in Canadian (foreign) corporations; and
  • new complex rules make it difficult for U.S. citizens who own Canadian (foreign) corporations to defer active business income.
  • The 12% tax is part of the transition to a territorial corporate tax system.

    “Although perhaps unintentional, since U.S. citizens will not benefit from a territorial model, the new rules impose a 12% tax on any cash that has been deferred since 1986,” says Reed.

    He offers the example of a U.S. doctor who moved to Canada in 1987 and has since deferred income from personal tax in her medical corporation, and invested it — resulting in a potentially significant tax bill.

    Deferring active business income

    As it stands, most U.S. citizens who own a Canadian corporation that is an active business don’t pay tax on profits until they’re removed from the corporation.

    The proposal changes this with a complicated set of rules, says Reed, which includes taxing the U.S. citizen business owner personally on 50% of the corporation’s income above an amount determined by a complex formula.

    “At best, this will make the compliance requirements […] extremely complicated and expensive,” says Reed. “At worst, this will cause double tax exposure […] on 50% of the profits of that business.”

    Motivation to renounce?
    There is some positive news: the proposal increases the exemption for estate tax.

    U.S. citizens are currently subject to 40% estate tax on their worldwide assets at death, in excess of about US$5.5 million per person (US$11.2 million per family for 2018). The plan would increase that to US$11.2 million per person ($22.4 million per family for 2018). Estate tax would be phased out as of 2023.

    That means “only the wealthiest U.S. citizens in Canada will be subject to the U.S. estate tax going forward,” says Reed.

    He also notes that the increased estate tax exemption will make it possible for more cross-border clients to renounce U.S. citizenship without paying tax. Currently, a U.S. citizen with a net worth greater than US$2 million is subject to exit tax on renunciation.

    To avoid exit tax, net worth can be reduced by making gifts before renunciation “to the extent of the estate tax exemption,” says Reed.

    “Renouncing U.S. citizenship may become an increasingly attractive option,” he says.

    Transcontinental Media G.P.