Two common concerns for Canadians who are thinking of regularly spending time in the United States are will they become subject to income tax or other reporting to the U.S. and will they become subject to U.S. estate tax upon death. While these questions raise some complexity that depends on individual circumstances, below are set out some of the key concepts to begin unwinding these issues.
U.S. Income Tax and Reporting
Canadians are required to file U.S. tax returns as non-residents if they have worked in the U.S., sold U.S. property or received certain other U.S.-source income, but additional concerns to be considered are circumstances in which Canadians could inadvertently become subject to reporting their worldwide income to the U.S. under
U.S. statutory rules and other U.S. reporting requirements that might arise. The U.S. statutory test for residency (known as the “substantial presence test”) provides that
you are considered resident in the U.S. in any year in which both:
- you were physically present in the U.S. for at least 31 days in that year; and
- you were physically present in the U.S. for 183 days during the three-year period that has that year as its ultimate year, where you count all days in the ultimate year, one third of the days in the penultimate year, and one-sixth of the days in the antepenultimate year.
As an example of application of the substantial presence test consider the following: if you were in the U.S. for 123 days in each of 2012, 2013 and 2014, you would be found to be a U.S. resident in 2014 because the sum of 123 for 2014, plus 41 for 2013 and 20 for 2012 is 184, which is more than 182. For this test you are treated as present in the U.S. on any day you are physically present in the U.S. at any time during the day, subject to some narrow exceptions. For example, day trips count, unless your trip to the U.S. is between two points outside the U.S.
Many Canadians are careful to be sure they do not spend more than 182 days in any calendar year in the U.S. in order to maintain their access to Canadian health care (i.e., they spend at least 183 days in Canada) but if they are staying more than allowed under the substantial presence test set out above, they are required to file with the U.S. to establish that they have a closer
connection to Canada on Form 8840. Form 8840 cannot be filed to claim a closer connection to Canada by persons spending more than 182 days in the U.S. in the year in question. If you are deemed to be a resident of the U.S., you may still be determined to be a resident of Canada for tax purposes under the Canada-U.S. tax treaty and that treaty does not allow you to be taxed as a resident of both Canada and the U.S., however you may still be held to be a U.S. resident for purposes other than taxation, which can require significant reporting. For example, if you spend more days than allowed under the substantial presence test and less than 183 days, you are required to file reports to the U.S. Department of the Treasury regarding your bank and investment accounts outside the U.S. (including Canadian Registered Retirement Savings Plans and other Canadian bank and investment accounts) on FinCEN Form 114, if the combined balance of those accounts exceeded US $10,000 at any point during that year, unless you have timely filed a Form 8840 to establish a closer connection with Canada or some other non-U.S. country. The penalties for failing to file these required Foreign Bank Account Reports (commonly known as FBARs) can be substantial (e.g., if the combined balance of the accounts exceeds US $250,000, the penalty for failure to file is up to US
$10,000, per year, per account, and if the failure is found to be wilful the penalty for each account is the greater of US $100,000 and 50% of the highest value of the account in that year). FBARs are due by June 30 of the year following the reported year, and there is no provision for extension of that deadline, whether the person reporting has obtained an extension to file tax returns or otherwise. Changes implemented in 2013 now require FBARs to be filed electronically. If you have timely filed
Form 8840 to establish a closer connection to Canada, you are only required to file any reportable U.S.-sourced income on Form 1040NR to the extent required by the Canada-U.S. tax treaty, and FBARs are not required to be filed.
U.S. Estate and Gift Taxes
The U.S. and Canada have different schemes for taxes arising on death
The United States imposes its estate tax on
U.S. citizens and U.S. permanent residents based on the value of all assets they own or have rights akin to ownership.*
Three ways that the U.S. estate tax scheme is significantly different than Canadian taxes are:
- the estate tax rate is higher (top rate of 40%)*;
- it is accompanied by a large exemption (US $5,340,000 in 2014, indexed to inflation so increases annually)*; and
- it is based on the value at death without regard for whether each asset has appreciated since it was acquired by the deceased.
Canadian residents who are not U.S. citizens are only subject to U.S. estate tax to the extent they hold U.S. situs property, but the estate tax exemption available to Canadians only shields a portion of the amount exempted from estate tax for U.S. citizens. Some ownership structures can restrict the
* Under tax changes enacted on January 2, 2013, the
U.S. estate tax exemption was set at US $5 million (2011 dollars and indexed to adjust annually with inflation) with a maximum estate and gift tax rate of
40%. These thresholds do not expire or “sunset” (as
was the case prior to 2013).
exposure to U.S. estate tax, but typical Canadian trusts will often not provide protection.
U.S. situs property includes: U.S. real estate, securities issued by U.S. issuers and tangible property located in the U.S. (e.g., art, automobiles, furniture, etc.). Importantly,
U.S. cash and bank deposits are not U.S.
U.S. gift tax is the companion tax for the estate tax
In addition to exposure to U.S. estate tax on death, any gift of U.S. situs property during the donor’s lifetime is subject to U.S. gift tax of 40%, and the only exemption typically available to Canadians from U.S.
gift tax is an annual exclusion of gifts up to US $14,000 per recipient.
Canadians subject to U.S. Estate Tax
If a Canadian who directly owns U.S. situs property dies, his or her estate will be subject to U.S. estate tax to the extent that the value of the U.S. real property exceeds the amount of the exemption. The statutory exemption available for non-U.S. citizens is only US $60,000, but there are provisions in the Canada-U.S. tax treaty that will provide an expanded exemption for many Canadian, although the cost of calculating and filing to obtain this expanded exemption may be significant.
Estimating U.S. estate tax payable by Canadian estates is a two-step process:
For Canadians, the exemption under the Canada-U.S. tax treaty is calculated by multiplying the exemption available to U.S. citizens by a fraction:
value of the U.S. property owned by the Canadian
exemption for U.S. citizen = exempt amount
value of the worldwide assets owned by the Canadian (calculated using U.S. estate tax principles)
As U.S. estate tax principles are very inclusive, Canadians estimating the value of the worldwide assets for the calculation above should include proceeds paid from life insurance, assets owned by trusts that they settled or which they are beneficiaries, retirement accounts and property held in joint title with spouses or any another person.
The exempt amount is then subtracted from the value of the U.S. property owned by the Canadian, and then multiplied by the applicable tax rate to estimate the total estate tax owing:
(value of U.S. property owned by the Canadian - exempt amount) x 40% = approximate estate tax owing
If a Canadian died in 2011 and had owned a U.S. property worth US $300,000, and owned assets in Canada and elsewhere outside the U.S. worth US $7,700,000, the exempt amount would have been approximately US $187,500, calculated as follows:
US $300,000 X US $5,000,000 = US $187,500 (US $300,000 + US $7,700,000)
The U.S. estate tax owing for this estate would be approximately US $45,000, because the 40% tax would be calculated on the US $112,500 that the U.S. property value exceeds the exempt amount, as follows:
(US $300,000 - US $187,500) x 40% = US $45,000
As the value of assets outside the U.S. increase, the portion of the exemption that a Canadian resident would receive falls. For illustration, if the worldwide estate was US $20 million in the example above, rather than US $8 million, the estimated tax owing increases to US $90,000.
Further specific advice is needed
As a summary, this memorandum necessarily does not provide a comprehensive discussion of the many complex issues that can arise when Canadians consider spending time in the U.S. We welcome the opportunity to provide you with legal advice specific to your circumstances.