Written by Max Reed The recently passed US tax law makes it more complicated for American citizens outside the United States to run businesses, because their income may be “GILTI”....
On November 2, 2017, the House of Representatives unveiled the most sweeping reforms to US tax law in 30 years. If passed, it will make matters worse for some US citizens in Canada and keep it the same for others. Some key implications include:
- No elimination of citizenship-based taxation. US citizens around the world will continue to be taxed on their worldwide income.
- FATCA not eliminated. FATCA is US law that obligates Canadian banks to report bank accounts held by US citizens to the IRS. It is not eliminated. The IRS’ ability to track non-compliant US citizens remains intact.
- Lower US income tax rates. The reform proposal reduces US federal income tax rates. This won’t have a major impact for US citizens in Canada as Canadian rates are currently higher and US citizens get a credit for tax they pay to Canada.
- Increased estate and gift tax exemption. US citizens are currently subject to a 40% estate tax on their worldwide assets at death in excess of USD $5.49 million. This will increase to USD $10.98 million per US citizen and the estate tax will be phased out as of 2023. This means that only the wealthiest US citizens in Canada will be subject to the US estate tax going forward.
- More people will be able to renounce US citizenship without paying tax. Currently, there is an exit tax that applies to those who renounce US citizenship who have a net worth more than USD $ 2 million on the day they expatriate. It is possible to make gifts to reduce one’s net worth in advance of renunciation to the extent of the estate tax exemption. A larger estate tax exemption means that more people will be able to renounce US citizenship without paying tax.
- No change to current punitive rules that apply to foreign corporations. Many US citizens in Canada that own Canadian corporations that earn passive income are subject to complex and punitive rules. Aside from small, technical changes, these rules have not changed in a meaningful way.
- New punitive rules that apply to US citizens who own a business. Currently, most US citizens who own a Canadian corporation that is an active business don’t pay tax on the company’s profits until they take the money out. The House plan changes this. It imposes a new, very complicated, set of rules on US citizens that own the majority of a foreign corporation. The proposal would tax the US citizen owner personally on 50% of the entire income of the Canadian corporation that is above the amount set by an extremely complex formula. At best, this will make the compliance requirements for US citizens that own a business extremely complicated and expensive. At worst, this will cause double tax exposure for US citizens who own a Canadian business on 50% of the profits of that business.
- Imposition of a 12% one-time tax on deferred profits. Under the new rules, the US corporate tax system is transitioning to a territorial model. As part of this transition, the new rules impose a one-time 12% tax on income that was deferred in a foreign corporation. Although perhaps unintentional, since US citizens will not benefit from a territorial model, the new rules impose a 12% tax on any cash that has been deferred since 1986. Take a simple example to illustrate the enormity of the problem. A US citizen doctor moved to Canada in 1987. She has been deferring income from personal tax in her medical corporation and investing it. Now, 12% of the total deferred income since 1986 would be subject to a one-time tax in the US. That may be a significant US tax bill.
It is unclear what, if anything, will be enacted. However, US citizens in Canada – particularly those that own a business – should pay close attention as their tax situation could get significantly worse. Renouncing US citizenship may become an increasingly attractive option.