March 1995 Page 88-91
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.)