March
1995 Page
88-91
the
CEN-TAPEDE
david ingram's US/Canadian
Newsletter
CANADIAN
DEPARTURE TAX
Canada has
always had a departure tax. This means that when a Canadian gives up his or
her residence in Canada, all assets are deemed to have been sold at
departure and any accrued capital gains tax is payable before leaving. There
are some exceptions to this when persons have come to Canada and owned the
assets before coming, and Real Estate assets in Canada are exempt because
there are non-resident tax provisions which take over, but DEPARTURE TAX has
always been an important consideration.
To be
fair, Canada values assets one owns when becoming a resident of Canada at
the fair market value when the person becomes a resident. This means
that if you sell an asset after becoming a Canadian resident, you only pay
tax on the increase in value between the day you came to Canada and the date
of sale. The U.S. on the other hand taxes you on the cost price even if you
owned it for thirty years BEFORE becoming a U.S. resident.
UNITED STATES DEPARTURE TAX
- (NEW
IN 1995)
On February
6, 1995, the U.S. announced a similar (but different) DEPARTURE TAX when
a person gives up their U.S. citizenship.
Although the
details have not been released in full yet, the general idea will be that
the American citizen who gives up his or her citizenship will be taxed on
all assets as if they were sold the day before.
Up until
February 6, 1995, a U.S. citizen could give up their U.S. citizenship and
their assets just quietly slid out of the U.S. tax system.
If the U.S.
feels that the person only gave up citizenship to avoid U.S. income, gift
and estate taxes, (remember that the U.S. continues to tax its citizens on
world wide income no matter where they live), then the U.S. will continue to
tax the U.S. citizen for Income, Gift and Estate tax for ten years after the
citizenship was given up. (We have a separate bulletin on this - ask for
pages 74 to 77 to get this information).
This new
Departure tax will not affect persons who gave up their citizenship before
February 6, 1995. However, those ex-citizens are still at risk from the ten
year rule.
_______________________________
The IRS has
also recently announced that they will be DOUBLING the number of audits this
year. About one out of 30 individuals with self employed income can expect
an audit, and anyone claiming an office in the home can expect to have it
turned down as a tax deduction unless it is the absolute main place of
business and the work is actually performed there. Record keeping offices or
offices in the home which are used to make appointments will not be allowed.
Canada has moved in the same direction of course and I expect to see many
home offices turned down by Revenue Canada and the IRS in the next couple of
years.
One of the
reasons that audits can be doubled is that there is just so much information
in the computer systems that the IRS can run test after test on all facets
of U.S. taxation. One of the things I have noticed is that they are also
running these tests WAAAAAAYYYYYY back.
In the last
month, we have had one person show up with a $194,000 U.S. tax bill for
1986, 87 and 88 from capital sales in those years (he had actually lost
money) which were not reported when he moved to Canada. A Canadian
accountant had told him not to worry about them because he had lost money
and the losses were of no use on his Canadian return.
The IRS has
actually run its computer tapes of property sales information (form 8288-A)
in 1986, 87 and 88 against the recipients' names and hit big.
Of course,
the U.S. takes the position that they can always tax the gross income and if
you do not file on time, they can turn down the expenses. Canada does the
same when someone omits a sale which qualified for the $100,000 exemption
but didn't report the income and claim the exemption.
In another
case, a client received a bill for $18,000 social security payments for 1988
and 1989 earnings in CANADA. The earnings were exempt under ARTICLE XXIX.4
of the US/CANADA Income Tax Treaty 1980. They do not owe the tax, but the
IRS tried. Their computer went back to 1988 and 1989 in March, 1995.
Another lady
received a bill for $3,000 for 1990 and 1991 because the tax withheld did
not match up with the amounts in the IRS computers.
What is
interesting is that the IRS is running their new and sophisticated programs
on old returns and going after significant monies. They do this by running
four and five year comparisons for items like wages, interest, dividends and
capital gains.
Low incomes
reported by people with addresses in expensive areas and paying $20,000 a
year interest are in extreme risk of an audit. Remember that U.S. banks
report the interest paid to them for mortgages (and by whom by SSN) to the
I.R.S.
WATCH WHO
YOU DEAL WITH
On March 5,
1995 I received a call from a western Canadian Doctor who had received a job
offer in the U.S. Pacific North West. He was referred to a Los Angeles
immigration Attorney who knew and was told that the Canadian Doctor had not
written his U.S. MLE (medical licencing exam). Note that this exam is not
required if the doctor is entering the U.S. as a resident alien (green card
holder). It is only necessary for a work permit.
The lawyer
sent him to Vermont to get a visa to work in the U.S. and the paperwork
was issued by the Vermont office. However, the ultimate grantor of
entrance to the U.S. is the officer you deal with when you finally show up
at the border to "move in."
In this case
the INS officer asked if the doctor had passed his MLE and when he was told
"no", turned him back. Well, at this point, it still doesn't sound
too bad. He will clear it up with his immigration lawyer who suddenly
becomes very hard to get hold of.
The doctor is
now sitting in his house in Canada waiting for the new owners to take
possession. Oh yes, he sold his house and his practice in Canada
before going to the border and being turned back. If he still wants
to go south, he has to write the MLE which involves three exam sittings over
a year.
It would have
been so much easier if he had simply been told to write the exams over the
next year and go south when he was qualified.
DON'T HOLD
OVER
If you do get
an H2-B visa or an L-1 and it expires, do not stay past the expiry date.
Even if you are not caught at the time, it can catch you in the future. I
was at U.S. immigration at the Vancouver Airport on March 6th and could not
help overhearing a chiropractor getting the third degree. He had an expired
H2-B visa in his possession and was going back to the hospital where he had
worked legitimately with the visa. The INS officer was incensed that the
fellow had stayed in the U.S. past the expiry of his visa and was now going
back on a "return" ticket to the same place.
The
chiropractor was stating that he was only going back to "observe".
He was not going back to teach (which required a visa), or work (which
required a visa) or be a student (which required a visa). Frankly, the INS
officer did not believe the story "one little bit".
If your visa
expires, you must leave the US immediately before you go back as a visitor.
_______________________________
$100,000 EXEMPTION
- GOING,
GOING,
GONE!
Now that we
have had a bit of time to look at the actual implementation of the phasing
out of the $100,000 capital gains exemption, I can say that it is a complete
boondoggle and is disrupting the life of every accountant and advisor in
Canada. Some situations are very simple. But figuring out the Adjusted Cost
Bases of 15 $5,000 U.S. mutual funds is no fun and takes an hour each in
some cases. Charging for the service is also difficult. The clients are
having a hard time accepting that this is really important, time consuming,
and worth significant fees. The silly part is that a $200,000 gain on an
island property takes 20 minutes, is split in half between the two owners
and gets a future $200,000 tax free while the person with the 10 mutual
funds takes hours and sometimes saves very little in future taxes.
Explaining
the clawbacks and loss of deductions, exemptions, and credits is also a
non-rewarding exercise.
Showing mom
and dad that they will have a total of $10,000 of clawbacks and loss of
pensions because they are claiming the exemption today is usually treated
with incredulous wonder. The couple wants to claim the exemption so that the
kids don't have to pay the tax when the kids inherit the property. But mom
and dad can't afford the $10,000 clawback and tax now.
Suggesting
that the three kids (35, 45 and 50 years old) be approached to pay the
$10,000 now so that they will save $50,000 in the future is also met with a
negative result.
It is an
interesting human conundrum which just isn't describable or measurable until
you have watched it unfold twenty or thirty or 90 times (one CEN-TA GROUP
person has now completed ninety of these and agonizes over every one).
WHAT HAPPENS
WHEN YOU TOP UP YOUR $100,000 EXEMPTION.
1. GST
credit. If your combined family income exceeds $25,921, you will lose 5%
of net income against a maximum credit of $304 for yourself and $199 for a
spouse or equivalent child and $199.99 per child thereafter.
2.
Provincial Tax Credits
vary from province to province but can be considerable. These are not
significant in British Columbia.
3.
Unemployment Insurance. If you received UIC and the "top up" puts your net
income up over $60,840, expect to pay back up to 30% of your UIC. Of course,
this 30% is now not taxable so your tax bill goes down from 25% to 55% of
the 30%. In other words, the 30% paid back becomes a deduction from taxable
income on line 235 so you do not pay tax on the amount you pay back.
4. AGE
Credit.
When your net income goes over about $25,000, your age exemption of $3,482
is reduced by $50 per thousand up to one half of the exemption amount up to
$1741 This will cost you approximately 25% of $1741 or about $435 of actual
tax (money).
5. OAS.
After a net income of $53,215, OAS is clawed back at 15% to the maximum of
$4,647. Depending upon your tax rate, this will save $1,150 to $2,300 of
income tax as well because the amount you pay back becomes a deduction from
taxable income on line 235.
6.
Guaranteed Income Supplements.
If you are receiving these supplements, expect to lose them for a year.
7. Medical
Expense credit
exists but is not very significant. Claiming the top up will increase your
net income and reduce your medical claim up to $53,800 of net income. After
net income of $53,000, it has no more effect.
(As an aside, note that
the top up affects medical, GST, old age exemption amounts, spousal tax
credits and guaranteed income supplements up to about $55,000 and OAS and
UIC clawbacks after about that amount (it would help if there was only one
limit amount to think about.))
8. Child
tax benefits
are affected over a wider range depending upon the number of children
starting at about $26,000 of net income for the family.
9.
ALLOWABLE BUSINESS INVESTMENT LOSS. I am still not handling this well. Eight solid days
programing the forms into my computer program just prove that it is tough
and I should be in another business (maybe a coffee house with free tax
advice, I'll call it the Fourth
Dimension).
If you have
already received a tax deduction for an ABIL since 1985, you have to pay
that tax back BEFORE you can claim the TOP UP. So, if you have already
claimed $100,000 worth of gross ABIL, there is likely no TOP UP available to
you.
9. CNIL
(CUMULATIVE NET INVESTMENT LOSS). Your CNIL balance at December 31, 1994 is also
taxed at full rates before you get your TOP UP. If you have a $100,000 CNIL
as several of my clients do, there is no practical TOP UP.
10.
Alternative minimum tax (AMT). Even though you got the TOP UP tax free, if your
income is low (maybe you also topped up your RRSP with a $20,000 deduction)
you can end up paying AMT on either the RRSP or the 25% tax free part of the
TOP UP (or a combination thereof).
(This
AMT is recoverable in future years, but does affect your cash flow.)
