david ingram's U.S./Canadian Newsletter Pages 149-154
CANADIAN FILING DEADLINE EXTENDED FOR SELF-EMPLOYED Page 149
EDITORIAL Page 149
U. S. Treasury (IRS) letter re Tax Deducted Page 149A
Be a SNOWBIRD Page 150
HISTORY OF SOCIAL SECURITY TAXATION Page 151
Receipt and Taxation of U.S. Social Security in Canada (Canadians) Page 152
Receipt and Taxation of U.S. Social Security in Canada (U.S. Citizens) Page 152
How to apply for reduction or elimination of withholding CANADA Page 153
How to apply for reduction or elimination of withholding U.S. Page 153
CANADIAN SELF-EMPLOYED TAX FILING DEADLINE EXTENDED
(Applies to most Realtors)
The 1995 budget speech changed the year end reporting for self-employed individuals. The details are still being worked out and because of this, the tax filing deadline for self employed individuals AND THEIR SPOUSE has been extended until June 15, 1997. This will give individuals the chance to get their year ends done and add 5% of the 1996 year end profit into the 1995 tax year. I know, I know, if your year end is Nov 30, 1996, you don't know what it is yet. I'll cover it in the next newsletter because the following is more important.
"MAY THEY ROT IN HELL" was the short and succinct verdict given about the negotiation skills of CANADA's negotiators for the new terms of the US/CANADA Tax Convention which was reproduced in the December, 1995 CEN-TAPEDE. Why would a 67 year old widow make such a powerful statement?
After all, the very first of my clients it applied to is going to get back $42,000 U.S. plus interest when we refile his deceased wife's 1992 U.S. estate tax return and all those gamblers are now going to be able to get back part or all of the tax deducted at Reno or Las Vegas or Lummi Island when they can show gambling losses (see Sept 94) to offset gambling winnings.
I have been pleased for 17 months at these projected changes and thought that two large inequities in the original 1980 treaty had been addressed. However, the 84 year old millionaire will hardly notice the $42,000 even if it is in U.S. dollars and it really doesn't matter if the gambler gets some extra money because it was all "THROW AWAY" money in the first place (or should have been if it wasn't).
The great losers from Protocol 9 of the Amendments are widows or other low income individuals who are existing on their U.S. Social Security payments received in Canada. THE WORST PART OF THIS IS THAT IT ONLY AFFECTS LOW INCOME PEOPLE.
And for 17 months I did not see what was about to happen and I have been doing this for 31 years. The effect on the usual client I deal with was minimal. However, after Gillian Shaw of the Vancouver SUN published my "tax consultant" answer, I was inundated with phone calls from people who "just had to complain" to someone. The following might be a solution.
I am using Canadian Dollars here and assume that all figures are in Canadian Dollars so that a $750.00 per month U.S. pension would be about $1,000 a month Canadian.
Let me explain. Up until December 31, 1995, 50% of the U.S. pension was taxable in Canada. There are thousands of widows, widowers, and just plain retired people who worked or lived for 10, 20, 30 or even 40 years in the United States. In many cases (such as my Aunt Sadie in Minneapolis) these were Canadian women who married U.S. men and never took out U.S. citizenship. When hubby died, they came back to Canada for many reasons.
Let me now use an example where this person (who could be anybody), comes back to Canada at age 65 and is receiving $1,000 a month (CDN funds) from U.S. Social Security. I have to make it clear that if they lived in the U.S., the $1,000 a month WOULD NOT BE TAXABLE if that was their only income. And if that was their only income, the $1,000 a month received in Canada was not taxable in Canada either although it did have to be declared on the Canadian return.
The new treaty means that the U.S. government will now withhold $255.00 a month as U.S. tax. Now, I have known about this since Aug 31, 1994. BUT, until January, 1996, I (and no one else I know) did not realize that the U.S. does not have a method of reducing this withholding amount for a non-citizen or non resident of the U.S. as Canada does.
In the reverse situation where a U.S. resident is receiving Canada Pension Plan or Old Age Security, the recipient can fill out a Canadian form NR7 and providing the recipient has more than 50% of his or her income from Canada, the Canadian government will reduce the 25% withholding to a figure from 0% to 20%.
If the pensioner in the first case above went back to the U.S., her social security would be "income tax free" AND he or she would qualify for Medicaid which is similar to our Medical for seniors, but in every case I have seen so far, the individual has possibly LOST THEIR "GREEN CARD" STATUS (i.e., their legal right to live in the U.S.)
The U.S. will cancel the withholding for legal residents of the U.S. and / or U.S. "CITIZENS" who are living in CANADA. It is only the "non-citizen" - "non-resident" who is affected. The letter on page 149A explains the situation from the U.S. government position but it makes the recent reductions in Welfare in B.C., Alberta and Ontario look minor by comparison.
1. Restore or enforce your U.S. citizenship. Sometimes individuals thought they had given up their U.S. citizenship when they became a Canadian citizen. In this case, it is usually quite simple to apply to have their citizenship restored (ask for my October, 1993 newsletter on dual citizenship). In other cases, President Clinton's "Technical Amendment Act of Oct 21, 1994" gave U.S. citizenship to children of U.S. citizen mothers when the Canadian was born (of the U.S. citizen mother) before May 24, 1934. This means that if your "grandmother" was from Chicago and your "mother" was born in 1906 in Manitoba, and she spent a couple of years in the U.S. going to university or just living at her aunt's place in Little Rock, "YOU" may be a U.S. citizen and "always were", even though the U.S. government did not recognize the situation until Oct 21, 1994.
2. Be a U.S. taxable SNOWBIRD. If our pensioner has someone to stay with in the U.S., he or she can take advantage of the "snowbird" legislation which requires any Canadian to file a U.S. income tax return when they have been in the U.S. for more than 183 days using the following formula which has longer and more detailed explanation in the April, 1994 CEN-TAPEDE.
To qualify to be a resident of the U.S. as a "SNOWBIRD" for the purposes of asking for cancelling of the withholding one has to be in the U.S. for more than 183 days and one can do this as a visitor without a green card.
Take the number of days in the U.S. in 1996, say 150
add one third of the 90 days in the U.S. in 1995, 30
add one sixth of the 60 days in the U.S. in 1994 10
For a total of 190 days 190
Under this situation, the individual HAS TO FILE A U.S. 1040 return and report their world income. If all or most of their money is from the U.S., and they are there that many days, it is my opinion that the individual can file a notice to declare themselves as a de facto resident of the U.S. and ask for the withholding to be cancelled.
In any case, if the individual was in the U.S. for 182 days in 1996 and 9 days in 1995 or 170 days in 1996 and 90 days in 1994 and NONE in 1995, the person would also HAVE TO FILE a U.S. return.
If the person had not been in the U.S. in 1994 and 1995, but was there for 185 days in 1996, they would also HAVE TO FILE AS A RESIDENT. After that, 121 days a year would force them to file a U.S. return as a resident.
Remember that to qualify as a visitor, the individual would have to maintain his or her house or apartment back in Canada while they were in the U.S.
This concept has not been "approved" by the IRS, or the U.S. Consulate, or Social Security, but it does address the situation and is in complete accordance with my April 1994 edition of the CEN-TAPEDE.
FOR BANKERS AND OTHER PROFESSIONALS
The following will allow you to explain to a client who receives U.S. social security benefits, WHY his or her cheque is short 25.5% this month.
I have received over 100 phone calls in the last 60 days about this subject. In about 50% of the cases, the person who called had NOT been reporting their U.S. social security on their Canadian tax return. They did not report it because it was not taxable in the U.S. when they started receiving it and when they moved to Canada (perhaps because of our medical benefits), they just never thought of putting it on a Canadian return even though the Canadian guide clearly says that one has to report U.S. social security pensions on line 115.
In a lot of cases, the person in question has been receiving about $750 U.S. a month and that is their total income which when converted to Canadian at 1995 rates, was a little over $1,000 a month tax free in CANADA. WHY TAX FREE in CANADA? Well, only half was taxable, so while the $12,000 was reported on line 115 and added into NET income, 50% was deducted on line 256 and taxable income was only $6,000 and the basic personal exemptions "ate up" the $6,000. In this case, a senior with the old age exemption could even get another $4,938 of interest or other pension and remain tax free in CANADA.
The New Treaty has changed this with the U.S. withholding 25.5% of the pension at source. A letter which came with the December cheque (but in many case went to their bank or other mailing address), told the recipient that they had sixty days (now expired) to appeal this withholding if the recipient was a U.S. citizen or if the recipient was a resident of a long list of other countries which did not include Canada.
The net result is that the person mentioned above is now receiving $250 a month less (in CDN $) and that is a tremendous blow to someone on a low or "fixed" income.
It is also unlikely that these results were intended or thought out. CANADA has an NR7 form which will allow (in the reverse situation) the U.S. resident receiving CPP and OAS pensions from CANADA to have the tax cancelled or reduced. The individual simply fills in the NR7 form and if they would be non-taxable, the 25% withholding will be cancelled or reduced.
As the IRS letter on page 149A suggests, THERE IS NO EQUIVALENT FORM FOR THE U.S. At the moment, the only official way to have the tax withheld reduced is to be a U.S. Citizen, be in possession of a "Green" card, or be a resident of a treaty country other than Canada, or to spend more than 183 days (by formula) in the U.S. in 1996 so that you HAVE to file a U.S. 1040 Income Tax return AND REPORT YOUR WORLD WIDE INCOME.
THEREFOR, in spite of the notice from the IRS office in Ottawa (reproduced on page 149a), THE TAX IS REFUNDABLE OR CREDITABLE IF THE CANADIAN RESIDENT FALLS UNDER THE SNOWBIRD RULES. File the return with the IRS in April 1997 (for 1996). This is logical because many of the individuals in question are also spending 4 or 5 months a year in the U.S. and should be filing world wide income returns to the U.S. because of the U.S. extended meaning of a resident rules (ask for the April, 1994 CEN-TAPEDE for a 8 page explanation of this line).
For instance, the lady who gave me this notice spent most of her life in the U.S. before returning to Canada and she and her husband are receiving $28,000 Canadian in U.S. social security. It is the lion's share of their income and almost all non-taxable under the old rules. The withholding of $7,000+ is enough to pay for a pretty super U.S. vacation every year. If this couple spends enough time in the U.S. in 1996, they are REQUIRED to file that U.S. return as a resident and can then claim a refund of most of the tax even if they do not qualify as a resident to claim an exemption from withholding at this moment. There is a "whole new travel agent business here".
Taxation of OAS, CPP and Social Security Government Pensions under old and New System
1980 to 1995 (OLD) RULES
From 1980, Paragraph 5 of Article XVIII of the United States-Canada Income Tax Convention (1980) read as follows:
5. Benefits under the social security legislation in a Contracting State paid to a resident of the other Contracting State shall be taxable as follows:
(a) Such benefits shall be taxable only in that other State;
(b) Notwithstanding the provisions of subparagraph (a), one-half of the total amount of any such benefit paid in a taxable year shall be exempt from taxation in that other State.
APPLICATION of the old rules (WHICH ALSO APPLY TO THE 1995 INCOME TAX RETURNS WHICH ARE BEING PREPARED NOW in 1996 for the 1995 tax year).
For a Canadian Resident receiving U.S. Social Security:
Until the 1996 tax year, U.S. Social Security was not taxable in the U.S. unless the person had other reasons to file a U.S. income tax return. Assuming that the Canadian resident had $10,000 (CDN funds) from the U.S., the Canadian would report the entire $10,000 on line 115 of their income tax return. This is true from 1984 to 1995 and unless Revenue Canada changes the line number for 1996, the entire amount of the pension goes on line 115 of the Canadian Tax return.
Then, from 1984 to 1995, the Canadian resident deducts one/half of the pension or $5,000 on line 256 of the Canadian return. This means that the entire $10,000 is added into "NET" income on line 236 and counts against the Canadian resident for the purposes of "clawbacks" on UIC, Family Allowance and Old Age Pensions from Canada AND it also counts against them for the purposes of claiming the GST credit and/or subsidized B C / ALBERTA / or other provincial medical plan.
It also means that a Canadian spouse cannot deduct the other person as a dependent in most cases.
Another item peculiar to Canada gets involved here. The 50% taxable (in Canada) part of the U.S. social security received is/was eligible for the $1,000 Canadian Pension deduction amount. Thus, if the Canadian had no other annuities or company pensions (OAS and CPP do not count) they were entitled to claim a tax credit of about 25% ($250.00) on another $1,000 and effectively only paid tax on $4,000 in the above example.
Canadian Taxable Income under $30,000
If the Canadian Resident had a taxable income UNDER $30,000 in this example, they would pay Canada tax of 25% or $1,000 tax on the $4,000 which was left leaving $9,000 to spend.
Canadian Taxable Income between $30,000 and $60,000
If the Canadian Resident had a taxable income between $30,000 and $60,000 in this example, the Canadian would pay tax of 40% on $4,000 or $1,600 plus the 15% difference on the $1,000 pension deduction amount of another $150. for a total tax of $1,750 or 17.5% of the $10,000 received leaving $8,250 to spend.
Canadian Taxable Income over $60,000
If the Canadian Resident had a taxable income OVER $60,000 in this example, the Canadian would pay tax of about 50% on $4,000 or $2,000 plus the 25% difference on the $1,000 pension deducting amount for another $250. for a total tax of $2,250 or 22.5% of the $10,000 received leaving $7,750 to spend.
Where the income was over $25,000 in the cases above, the person could start losing extra Old Age exemption amounts AND the clawback rules would apply and some or all of the Old Age Pension might be "clawed back" resulting in a zero Old Age Security.
Canadian Resident (but U.S. citizen or de facto SNOWBIRD U.S. resident) receiving US Social Security and required to file a U.S. return by residency rules
The amounts above are all the same except that filing the U.S. return triggers tax on up to 85% of the social security at rates from 15% to 39.6% (federal tax - state tax is extra up to 10%). In this case, the tax paid to the U.S. can be used as a credit against the Canadian income tax. (However, if the person was taxed (for the sake of argument) $2,500 in the U.S. on the social security paid out, the Canadian could only use a percentage of the $2,500 ((proportional to the amount taxed in the U.S.) as a credit in Canada. This amount is then further reduced because only 50% of the U.S. social security was taxable in Canada).
United States Resident receiving Canadian OAS or CPP
From 1980 to 1995 the person receiving Canadian OAS or CPP or both in the U.S. will enter the gross pension (converted to U.S. dollars) on line 17a of the U.S. 1040 income tax return. He or she would then enter one half of that amount as the taxable portion on line 17b. Assuming that there was no other pensions and that the amount received from Canada was $10,000, line 17a would be $10,000 and 17b would be $5,000. They would then pay (from 1988 to 1995) 15, 28 or 31% tax on the $5,000 or $750, $1,400 or $1,550 leaving $9,250, $8,600 or $8,450 left to spend. Up until 1996, there has been no "clawback" applied to the OAS received by a non-resident of Canada.
1996 - "NEW" RULES
NEW RULES EFFECTIVE JANUARY 1, 1996 - PROTOCOL 9(2) REPLACES ARTICLE XVIII(5) OF THE UNITED STATES CANADA INCOME TAX CONVENTION (1980) with the following words:
1. Paragraph 3 of Article XVIII (Pensions and Annuities) of the Convention shall be deleted and replaced as follows:
(3) For the purposes of this Convention, the term "pensions" includes any payment under a superannuation, pension, or other retirement arrangement, Armed forces retirement pay, war veterans pensions and allowances and amounts paid under a sickness, accident or disability plan, but does not include payments under an income averaging annuity contract or any benefit referred to in paragraph 5.
2. Paragraph 5 of Article XVIII (Pensions and Annuities) of the Convention shall be deleted and replaced by the following:
(5) Benefits under the social security legislation in a Contracting State paid to a resident of the other Contracting State (and in the case of Canadian benefits, to a citizen of the United States) shall be taxable only in the first mentioned State.
For Canadian Resident (non U.S. citizen) receiving US Social Security.
The Canadian receiving U.S. social security will now have 30% of 85% of the social security withheld as a U.S. "non-resident" withholding tax. This works out to 25.5% or a deduction of $2,550 leaving $7,450 to spend out of the $10,000.
The Canadian will include the ENTIRE $10,000 on line 115 of their 1996 Canadian income tax return. This will serve to RAISE their net income and cause the possible clawback of Canadian old age pension, reduction of extra old age exemption amount, and possible loss of some GST credits.
However, the Canadian will then DEDUCT the ENTIRE $10,000 on line 256 and pay no tax to CANADA on the U.S. social security. If the CANADIAN recipient has no other ties to the U.S., the calculation stops here. THERE IS NO RECOURSE TO THE U.S. for either reduction or refund of the 25.5% tax withheld.
But, If the Canadian Recipient is also a U.S. citizen or is a U.S. resident for tax purposes, he or she can apply to their nearest Social Security Administration office to have the withholding tax cancelled. One such address for Vancouver people would be:
Social Security Administration
104 Magnolia (at Cornwall)
Bellingham, U.S.A., 98225
Canadian Resident (but U.S. citizen) receiving US Social Security. (or Canadian SNOWBIRD U.S. defacto resident) required to file a U.S. 1040 income tax return.
The same situation applies as above for Canada but the U.S. citizen files their U.S. tax return and reports their world income. The tax rate may work out to less than this 25.5% in which case they can apply to have no tax withheld or if tax was withheld in excess, apply for a refund.
United States Resident receiving Canadian OAS or CPP
The United States resident will only receive $7,500 of the $10,000 because Canada is now taking $2,500 as a withholding tax. The individual can apply for a lesser withholding by filling in a form NR7 and filing it with:
Revenue Canada Income Tax, Excise and Customs
International Tax Office
Ottawa, CANADA, K1A 1A8.
To have this accepted, more than 50% of your income has to come from Canada. You also have to declare your world income and clawback provisions will apply to the Old Age Security and many people will lose 100% of their Old Age Pension.
This corrects an unfair situation which has existed up to now.
Before these new rules, Canadian "resident" recipients of OAS with income over $55,000 or so started losing their OAS on a graduated scale depending upon how high their income was. The worst case scenario was that you virtually paid 100% tax on the OAS.
However, a non-resident person who received the pension "out of Canada" could have a $1,000,000 a year income and not lose any of the pension other than ordinary income tax. Both individuals are now being treated equally with regard to "clawbacks".
WE NO LONGER HAVE THE SITUATION WHERE A CANADIAN RESIDENT WITH $75,000 OF INCOME LOST HIS OLD AGE PENSION AND THE NON-RESIDENT WITH $100,000 OF INCOME KEPT THE FULL PENSION ALTHOUGH HE DID HAVE TO PAY TAX ON 50% OF IT TO THE U.S. GOVERNMENT.