Recent U.S. tax reform impacts U.S. citizens living in Canada

Posted -

The U.S. is in the process of enacting the broadest change to its tax system since 1986. Rather than analyzing each change, the following 2-part series will focus on the changes impacting U.S. citizens living in Canada, and the changes impacting Canadian based multinationals doing business or investing in the U.S.

Part 1: Changes impacting U.S. citizens living in Canada

Increase in estate tax exemption

For estates of decedents and gifts made after 2017 and before 2026, the exemption is doubled from approximately $5.6 million per U.S. individual to $11.2 per U.S. individual and will be indexed for inflation.

Observation:  For wealthy U.S. expatriates, a window for intergenerational wealth transfer is now open.  U.S. citizens with a high net worth may want to consider gifts to the next generation in case a future U.S. government reduces the estate tax exemption. Also, if a U.S. citizen is the settlor of a Canadian family trust which is treated as a grantor trust for U.S. purposes, consideration should be given to an accelerated “wind-up” period to transfer assets.

Deemed repatriation tax on CFCs

A U.S. person who owns a Controlled Foreign Corporation (“CFC”) will be subject to a deemed repatriation tax on an amount approximating the retained earnings of the corporation.  The tax on cash and cash equivalents will be up to 17.5%.  Retained earnings and profits which are not cash or cash equivalents will be subject to a tax of up to 9%. The measurement date of the cast equivalents is the greater or the December 31, 2017, amount or the average of the two fiscal years ended before November 2, 2017.

A CFC is usually present when U.S. shareholders who individually own 10% or more of the voting power of a non-U.S. corporation own more than 50% of either the combined voting power of all classes of stock of the corporation that are entitled to vote or more than 50% of the value at any one day during the tax year.

The retained earnings to be included are the greater or the post-1986 earnings as of November 2, 2017, or December 31, 2017.  The earnings measured will not include earnings attained prior to becoming a CFC.

Foreign tax credits may be used to offset the deemed repatriation tax but they are ground down by the same percentages (55.7% and 77.1%) as noted above and may only be available to those who elect to be taxed as a corporation for this purpose. In order to use foreign tax credits, a complex analysis must be undertaken with respect to the tax paid in association with the amount subject to the deemed repatriation tax.

Observation:  Congress imposed the deemed repatriation tax as a “balance” for a corporate law change which will allow U.S. based multinational corporations such as Apple, Facebook, Alphabet, etc. to repatriate offshore assets of more than $2.5 trillion on a tax-free basis beginning in 2018.  Though U.S. citizens are not the primary beneficiary of this tax break, they are being slapped with the same deemed repatriation tax which is, in fact, a tax break for the major companies which, would otherwise, have been subject to a 35% U.S. tax on repatriated earnings.  For U.S. citizens to be subject to the burden of the tax change without receiving any of the associated benefits is extremely unfair.

Change to the 10% ownership rules of a CFC

Only 10% voting shareholders have been counted towards determining whether a Canadian corporation is a CFC.  From a practical consideration, this rule protected Canadian Family Trusts, settled by a Canadian, which owned one or more Canadian corporations from CFC status in situations where a majority of the value was held by U.S. beneficiaries.  This is a result of the U.S. beneficiaries usually owning less than 10% of the voting stock.

Under the revised rules, the 10% voting requirement will no longer apply.  Therefore, to the extent that the related U.S. trust beneficiaries own a majority of value of the trust, the underlying Canadian corporations may be considered CFCs.  The rule change will be effective post-2017.  Therefore, the deemed repatriation rules should not apply.  However, on a prospective basis these beneficiaries may be subject to additional U.S. compliance requirements including the annual filing of Form 5471 for each CFC.

The Global Intangible Low Tax Income (“GILTI”) tax

Beginning in 2018, the U.S. will be imposing a tax on the current income of U.S. owned foreign corporations.  Though the guidance provided in the law is limited, it should apply to any Canadian corporation owned by a U.S. individual or corporation where the corporate tax rate is below 26.25%.

Increase in Child Tax Credit

Beginning in 2018, the Child Tax Credit is increased from $1,000 to $2,000.  The phase-out of the credit will be increased from $55,000 to $200,000 for those married filing separate returns and double the amount for those married filing joint tax returns.

The refundable portion of the credit will increase to $1,400 per qualifying child subject to indexation for inflation.

Other highlights applicable to individuals

  • A reduction of highest tax rate from 39.6% to 37% which will apply to greater than $600,000 in income for married couples filing a joint return; $500,000 for single individuals and $300,000 for married individuals filing separately.
  • An effective doubling of the standard deduction coupled with an elimination of personal exemptions.
  • Limitation of state and local income and property taxes as itemized deductions to $10,000. In another slap in the face to U.S. expatriate citizens, foreign real property taxes may not be deducted.  Prepayments of 2018 state and local income tax in 2017 will be treated as having been paid in 2017.
  • For some acquisitions or binding contacts for such occurring after December 14, 2017, the deduction for mortgage interest will be limited to $750,000 of mortgage costs for those married filing jointly and half that amount for those married filing separately. For all earlier acquisitions, the new limitations will not apply.
  • Interest on home equity lines of credit will not be deductible unless the refinancing occurred before December 15, 2017, in which case, existing limits will continue to apply.
  • The threshold for the medical expense deduction will revert to 7.5% of Adjusted Gross Income for all taxpayers retroactive to 2017.
  • The limitation on charitable deductions to public charities and certain private foundations will increase from 50% to 60% beginning in 2018.
  • Beginning in 2018, miscellaneous itemized deductions subject to a 2% floor will not be allowed.
  • Moving expenses will no longer be deductible except for members of the Armed Forces on active duty.
  • The individual AMT thresholds have been increased.

Stay tuned for part 2 which will address the business tax changes.

Zeifmans is committed to assisting our clients in navigating the new tax rules and planning to mitigate the impact of them.  Please contact your Zeifmans advisor today, or Stanley Abraham, U.S. Tax Partner at 416.256.4000 or sa@zeifmans.ca, should you have any questions.

Not on our mailing list? Sign up today to stay up to date on this topic and related news.