Coming to Canada

How to advise Americans who want to cross the northern border for good

Donald Trump has recently been sworn in as the 45th President of the United States. For some Americans, that prospect may have been too much to bear, as increased traffic volume crashed the Citizenship and Immigration Canada website on election night.

Politics aside, there has long been a regular flow of people across the Canada–U.S. border in both directions, both temporarily and permanently. Regardless of their politics and motivations, all Americans residing in Canada require informed professional assistance with their wealth matters, both before and after the big leap. Here are some key issues to consider.

Renouncing U.S. citizenship?

Also known as expatriation, this is obviously an extreme measure, so all implications for personal liberty and financial wellbeing should be fully understood. While it is not within the licensing of a financial advisor to provide legal advice, an important item to bring to the potential expatriate’s attention is the U.S. expatriation tax.

This tax is invoked if the person is a “covered expatriate,” which may apply if their net worth is more than $2 million (all figures are in U.S. dollars), if their average income over the last five years is more than $160,000 (2015 figure, indexed annually), or their federal tax filing obligations have not been met for the last five years. If any of these apply, all assets are deemed disposed at fair market value the year of departure, forcing tax on realization of gains.

Ongoing tax filing

Assuming the person remains a U.S. citizen, annual tax return filing is required, regardless of residence. And if that person has more than $200,000 in non-U.S. financial assets (including RRSPs, RRIFs or pensions), Form 8938, which discloses details of those holdings, must be included. The annual deadline is April 15, or the next business day if that lands on a weekend or holiday.

There is a separate filing obligation for U.S. citizens holding more than $10,000 in foreign bank accounts. This online form, FinCen Report 114 , the Report of Foreign Bank and Financial Accounts (FBAR), is due by June 30 each year (with no mention of any “business-day” extension in the FBAR guide).

Constraints on investment accounts

An American who has earned income in Canada will be entitled to make RRSP contributions beginning the following year. Prior to 2014, a Form 8891 was required to protect RRSP growth from taxation in the U.S., but the U.S. Internal Revenue Service has eliminated that requirement. However, the aforementioned Form 8938 may still be required if minimum asset thresholds have been reached. Also, note that RRSP contributions are not generally deductible in the U.S., though a U.S. tax advisor may be consulted to determine whether a limited deduction using Form 8833 may be possible.

Many other common Canadian registered plans are not accorded tax-sheltered treatment by the U.S. These include the Tax Free Savings Account (TFSA), Registered Education Savings Plan (RESP), and Registered Disability Savings Plan (RDSP). Not only will the account holder be subject to tax on income and growth (and likely government grants for the latter two), but the information filing requirements can be onerous, and there are associated additional compliance costs.

In terms of non-registered investments, Americans holding Canadian mutual funds may be subject to the punitive passive foreign investment corporation (PFIC) rules. Some of this harm can be alleviated if the fund company provides customized income data (prepared under U.S. tax rules) to be filed with the investor’s U.S. tax return. Even with that, tax counsel with expertise from both sides of the border should be consulted to advise on dealing with non-registered investments.

Pension issues

A U.S. pension is not deemed disposed just because a person takes up residence in Canada, nor even on expatriation. However, a “covered expatriate” may be subject to a higher withholding tax when payments are made in the future, so those rules should be reviewed in this context.

If instead, that new Canadian resident wishes to bring the U.S. pension money to Canada, it can’t be transferred directly, but there is a two-step procedure to obtain RRSP room when a foreign pension is collapsed. (For more detail, see “Come from Away” in our April 2016 issue.)

U.S. gift tax and estate tax

The U.S. gift and estate taxes continue to apply to U.S. citizens who reside in Canada. The gift tax can apply on per-person gifts of more than $14,000 in a year, though many exceptions apply.

The U.S. estate tax may apply to a U.S. citizen who is a resident in Canada on death, though only if the worldwide estate is more than $5.49 million (2017 figure, indexed annually). It’s worth noting that during the election campaign Mr. Trump vowed to repeal this tax, so stay tuned.

Generally, there is no problem advising a Canadian resident with respect to Canadian accounts, within the scope of a financial advisor’s licensing. For assets that remain with a U.S. institution, a discussion with compliance counsel is in order to determine if you have the business capacity and regulatory clearance to proceed.

Bringing a foreign pension to Canada – A two-step technique

Our nation was born through immigration, and it continues to welcome new arrivals in a steady stream. While some newcomers will be at the start of their careers, many will be arriving in the midst of their working lives.

Frequently, immigrants have significant tax-sheltered savings in foreign pension plans, and may wish to bring those funds over to their new home in Canada. They may be surprised, however, to learn that our system does not allow tax-free transfer of foreign pensions to Canadian registered retirement or pension plans. However, all is not lost.

If appropriate steps are taken – on a timely basis – the net result can be continued tax-sheltering of their retirement savings.

No direct transfers

While it may seem harsh to not allow direct tax-free transfers, it’s simply not practical for our tax system to be so intimately intertwined with foreign tax systems.

Instead, our system makes allowance within the domestic tax rules once the person has collapsed the foreign pension. As this “deregistration” of the foreign pension is likely irreversible, at minimum the person will want to be certain:

what gross and net-of-tax amounts are involved,
that the particular plan and transactions qualify, and
whether the actions can be completed in the required time frame.

Step 1 – Foreign tax procedure

Generally, the foreign pension administrator will be required to withhold taxes according to that jurisdiction’s laws. This may include the administrator evaluating the nature of the transaction to determine whether it has a withholding obligation at all and, if so, for what amount. The amount of withholding tax may in turn be reduced if there is an applicable provision in the tax treaty Canada has entered into with the foreign state.

Some jurisdictions also impose penalties on some withdrawals when taken below a specified age. In the past, the Canada Revenue Agency had not allowed credit for that type of penalty imposed on individual retirement plans from the United States. However, it reversed its position a few years ago. It would be advisable to verify CRA position on plans originating from other countries to be sure what to expect.

The Canadian resident will receive a payment denominated in the foreign jurisdiction’s currency, net of all withheld amounts. Unless there is a continuing connection, this withholding will usually satisfy the person’s final tax obligation on the pension to the foreign jurisdiction.

Step 2 – Canadian tax calculation

Income inclusion

Canadian residents are taxable on worldwide income. Accordingly, the gross amount received from the foreign pension, converted to Canadian dollars, must initially be included in calculating Canadian tax liability.

The withheld foreign taxes entitle the person to claim a foreign tax credit when calculating this initial Canadian tax due. Depending on the circumstances, however, the credit may be less than the withheld amounts (see provisos below).

Special RRSP/RPP deduction

A special deduction will be allowed if the pension satisfies the Canadian definition of superannuation, pension benefit or foreign retirement arrangement. Additionally, the payment must be a lump sum and specifically not be part of a series of periodic payments.

The deduction is in the form of an allocation of contribution room toward either a registered pension plan (RPP) or registered retirement savings plan (RRSP). Though not obligated, the person may make an RPP or RRSP contribution up to the amount taken as income as a result of collapsing the foreign pension. This does not require or affect existing contribution room.

The special deduction must be used in the same taxation year as the income inclusion or within the first 60 days of the following year. To be clear, any unused room from this allocation cannot be carried forward.

Some practical provisos

Bear in mind that the actual payment received from the foreign plan will be net of withheld amounts. If the person wishes to take advantage of the full contribution/deduction, other cash will be required for that top-up. On the other hand, if the amount is not topped up, then Canadian tax will still be due on the difference between the gross income amount and the chosen contribution.

The foreign tax credit is limited to the lesser of the actual foreign tax paid/withheld (up to a maximum of 15%) and the Canadian tax due on the foreign-sourced income. The credit may thus be less than the withheld amount. Furthermore, this type of credit cannot be carried forward for use in future years.

As you’ve likely come to realize, determining how to deal with a foreign pension can be a complicated matter. As a starting point, the person should obtain a clear statement from the pension administrator as to the procedure and amounts from that end. The statement can then be analyzed with the person’s Canadian tax advisor to determine how best to proceed.

Snowbirds, your days are numbered – New border monitoring on the horizon

Heading south for the winter is a common way for many Canadians to spend their retirement years. Those who have already been at it a while may even recall a time when all that was needed to cross the border was a driver’s licence and a smile.

Well, the times they are a-changing, and not just because a passport is now a must.

It has long been the case that overstaying one’s time south of the 49th could lead to tax and other complications in both countries. Despite this concern, snowbirds may have flown under the radar, as cross-border tracking historically relies – at least in part – upon self-reporting. Soon enough, it appears that will no longer be the case.

Canada-US entry/exit initiative

In 2011 as part of a broader program addressing mutual border security and economic flows, Prime Minister Harper and President Obama agreed to explore the feasibility of exchanging border crossing data. One country’s entry data would effectively serve as the other’s exit data, assisting in monitoring periods of admission, immigration qualification and other policy needs.

A pilot project to test the technology began in 2012, tracking non-citizen movements at four land ports of entry in British Columbia/Washington State and Ontario/New York. This was extended in 2013 to all major land border crossings, though again not applying to either country’s citizens.

The collected data covers first name, middle name, last name, date of birth, nationality, gender, and document type, number and country of issuance. In addition to the biographic information, the date, time and port of entry is also shared.

The next phase is to extend coverage to citizens, and to add airports. However, due to concerns expressed by our federal privacy commissioner, the planned July 1, 2014 launch was delayed pending legislative and regulatory amendments. Once these requirements are satisfied and the next phase is implemented, authorities in both countries will know which side of the border snowbirds may be on, and for how long – and all in real time.

Tax implications

US income tax reporting

The US taxes its citizens and residents on their worldwide income. Snowbirds found to have exceeded their allowed time in the US could be exposed to taxation as US residents.

It is a common misconception that US tax reporting obligations arise only after a person has hit 183 days in the US. In fact, the “substantial presence test” applies once a person exceeds 31 days in a current year, and has been resident for 183 days total according to the formula:

All days in the current calendar year, plus
One-third of the days in the preceding calendar year, plus
One-sixth of the days in the 2nd preceding calendar year

That comes out to a maximum of about 4 months a year, or a consistent average of 121 days to be just below the limit. As a part-day is considered a full-day in this calculation, careful attention should be paid to travel days, and potentially even time of day for those cutting it really fine.

Those who meet the substantial presence test but have been present less than 183 days in the current year may file IRS Form 8840 “Closer Connection Exception Statement for Aliens”. This allows the person to claim non-resident status (and therefore no US reporting obligation) if another jurisdiction is proven as home.

If the person has exceeded 183 days in the current year, a nil non-resident 1040NR return may be filed, attaching Form 8833 to claim Canada-US treaty benefits. Further information filing requirements may apply, despite making these timely filings.

Generally these forms will be due June 15 the year following the taxation year.

US estate tax

The definition of US resident is different (and more complicated) for estate tax purposes from what it is for income tax purposes. Regardless, the more robust entry/exit reporting will potentially expose estates of snowbirds to estate tax scrutiny, to the potential detriment of heirs.

Canadian taxes

Less likely, but not outside the realm of possibility, is the potential that the Canada Revenue Agency will deem the snowbird to have become a non-resident. This would give rise to departure related taxes based on the deemed disposition of capital assets (with some exceptions). While not entirely determinative, day count is an important factor in this analysis.

Lengthy US travel bans

Beyond privacy and tax concerns, the new entry/exit initiative could expose snowbirds to the “unlawful presence” rules under US immigration laws.

A 3-year travel ban is imposed on someone who exceeds 180 days of unlawful presence, or a 10-year ban if the offending time exceeds a year. This is not limited to calendar years, and multiple periods of unlawful presence could be added together.

For snowbirds who had planned a life of leisure in sunnier climes during their golden years, this could leave them with anything but a smile on their faces.