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Financial advisors with clients who are U.S. residents or citizens living in Canada or Canadians with U.S. assets won’t have any major changes to deal with this tax-filing season, but there are administrative delays and expiration dates on existing laws to keep in mind, experts say.
As the April 15 U.S. tax deadline approaches, with extensions available for non-resident taxpayers, advisors are updating these clients on the status of proposals the Biden administration put forward that could have affected their portfolios, such as hiking the top capital gains rate for wealthier Americans and removing certain tax breaks on appreciated assets for heirs.
However, with much of the U.S. Democratic Party’s proposed income, gift, and estate tax changes now stalled, advisors are asking Americans in Canada and Canadians with U.S.-based assets such as real estate or equities to turn their attention to potential issues down the road.
One of them is the pending expiration of a U.S. estate tax exemption put forward by the previous Trump administration that’s currently about US$12-million. If the exemption expires in 2026, the amount is expected to drop by about half to the range of US$5-million to US$6-million, which is the original amount indexed to the cost of living. Another issue to watch for is the decoupling of the lifetime gift tax exemption from the U.S. estate tax and setting the exemption at US$1-million.
“The fact that there haven’t really been any substantive tax changes in the U.S. [in 2021] is probably good news, but the clock is still ticking on these other exemptions,” says Darren Coleman, senior vice-president, private client group, and portfolio manager with Coleman Wealth at Raymond James Ltd. in Toronto.
Americans in Canada should be thinking about these issues, particularly as governments seek to source more funds after providing billions of dollars in stimulus during the pandemic, he says.
Russia’s invasion of Ukraine is also expected to cost the U.S. and other governments more money as they provide aid to the embattled country.
“The problems are going up and the time to plan ahead for possible tax changes is right now,” Mr. Coleman says.
Focus on the road ahead
Among the Biden administration proposals that haven’t passed is an increase in the top capital gains rate to 39.6 per cent from 20 per cent for people with an annual income of more than US$1-million. That’s not including the 3.8 per cent net investment tax known as the “Obamacare tax” on investments, which takes the capital gains rate to 43.4 per cent from 23.8 per cent.
Another proposal that hasn’t moved forward is removing an existing tax break at death, known as the “step-up in basis,” that allows appreciated assets to pass to heirs tax-free. The proposal is that any gain of more than US$1-million per taxpayer is subject to taxes, plus an additional gain of US$250,000 for a principal residence.
Shlomi Steve Levy, partner and lawyer with cross-border tax and estate-planning firm Levy Salis LLP, says U.S. President Joe Biden’s proposals haven’t passed because they were divisive, including among his own Democratic Party.
“I doubt any U.S. tax changes are happening in this term. The likelihood of anything passing is slim to nil,” Mr. Levy says, but he says the focus for taxpayers is on 2026 if those laws that expire aren’t changed before then.
He says one issue many Americans residing in Canada are having is with the sale of a primary residence, particularly in the current hot housing market.
While Canadians don’t pay taxes on the gains from a sale of a primary residence, an American would have to for anything above the US$250,000 exemption. Americans also pay taxes on worldwide income.
Mr. Levy uses the example of a home purchased by a couple – an American husband and a Canadian wife – for $1-million in Toronto that sold for $3-million 10 years later. The $2-million gain is tax-free for the wife, but the American husband (assuming he still has U.S. citizenship) would have to pay taxes on any gain of his share in excess of US$250,000.
Mr. Levy says couples can work around this by putting the home in the Canadian spouse’s name before the sale. As part of this process, the American husband could gift his portion of the home to his Canadian wife, using his allowable U.S. gift tax exemption.
Mr. Coleman says people in this situation may want to use this strategy before the gift tax exemption rules are potentially changed.
“Who knows what a future government may choose to do? Maybe they keep it where it is. Maybe they lower it, you never know,” he says. “What we are saying to clients is, ‘Let’s actually make sure that if any of this could affect you, let’s get in front of it.’”
Issues with filing taxes in both countries
Another issue that advisors need to consider is the administrative challenges between the Canada Revenue Agency (CRA) and the Internal Revenue Service (IRS), says Terry Ritchie, vice-president and private wealth manager at Cardinal Point Capital Management Inc. in Calgary.
The dual-filing process became more onerous about five years ago when the CRA began requiring taxpayers to provide a copy of an IRS tax account transcript to support any U.S. taxes paid for foreign tax credit purposes, he says.
The tax agencies are also facing huge backlogs, especially south of the border where the IRS reportedly has a backlog of more than 23 million pieces, according to a recent Wall Street Journal report.
“The IRS is so behind in the processing of these returns that a tax account transcript is often not yet available to submit to the CRA for part of its review,” Mr. Ritchie says.
He adds that advisors can’t even get through to a special phone line the IRS has set up to help expedite these types of requests.
Furthermore, the CRA isn’t being accommodative to the issues south of the border and if the transcripts aren’t available, sometimes, the files end up going to collections, he says.
“The review folks and the collections folks have different systems and so they don’t know what’s going on in either area,” Mr. Ritchie says. “So, this has become quite the challenge for U.S. taxpayers in Canada who are trying to accommodate that CRA’s review requirements.”
He expects it will be worse this tax season. He has outsourced this work because of the time and effort involved in dealing with the two tax agencies.
“There are many taxpayers who face this issue and will continue to face it. It’s very frustrating,” Mr. Ritchie says, for advisors and their clients.
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