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WHITE PAPER ON

CROSS BORDER TAXATION

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WHITE PAPER ON CROSS BORDER TAXATION

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A message from Evelyn Jacks, President, Knowledge Bureau

We are very pleased to present to you this Knowledge Bureau White Paper on Cross Border Taxation,

written by Faculty Member, Dean Smith of Cadesky Tax. We have three specific goals for you in delving

into this material:

Goal 1: Deeper, Richer Conversation Tools for Great Year End Tax Planning Discussions

We have included talking points and strategies to guide you towards deeper and richer conversations

about planning for your clients who want to engage in tax efficient wealth management in the area of

cross border taxation.

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We also invite you to visit and explore Knowledge Bureau’s Website for deeper, richer content that

embellishes planning opportunities with your clients. Here you will find the opportunity to learn more

about our certificate courses on Cross Border Taxation, Personal and Canadian Corporate Taxation. Call

us to inquire about how we can help you develop your specialized professional development.

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AUTHOR BIOGRAPHY

Dean T. Smith

BRIEF INTRODUCTION: Dean is a partner with Cadesky and Associates LLP and the President of Cadesky

U.S. Tax Ltd. Cadesky is a boutique accounting firm which provides only taxation services. Dean has

been involved with expatriate tax work for over 23 years assisting companies moving employees around

the world. Clients also include private individuals who have multiple jurisdictional filings. Dean is also

an instructor and writer with Knowledge Bureau.

CAREER HIGHLIGHTS:

• Graduate Certificate in Estate Planning (U.S.) – Golden Gate University, San Francisco (2005)

• Ph.D. (in Financial Accounting), University of Waterloo, Waterloo, ON Canada (1999)

• Honours, B Comm. – McMaster University, Hamilton, ON Canada (1987)

NOTEWORTHY ENGAGEMENTS

• President – British Canadian Chamber of Trade and Commerce (BCCTC)

• Past Chair Tax Committee - American Chamber of Commerce in Canada (Amcham)

• Member - Society and Trust and Estate Practitioners, Toronto

• Chartered Professional Accountant – CPA Ontario

• Chartered Professional Accountant – CPA Manitoba

• Certified Public Accountant – Illinois

• Certified Financial Planner – Financial Planners Standards Council

AREAS OF PRACTICE:

• Practice Leader - US-Cross Border Tax Services

• High net worth individuals with cross border needs

• Acceptance agent for IRS, can assist clients with obtaining U.S. Individual Taxpayer Identification Numbers (ITINs)

• Assistance with the implementation of Retirement Compensation Arrangements (RCA) and Immigrant Trusts

• Use of trusts in tax and estate planning.

• Cross-border personal tax – Canada, U.S. and U.K.

• Cross-border estate tax planning and compliance - U.S. estates and trusts

©Knowledge Bureau, Inc. All rights reserved.

FORMS, FORMS, AND MORE US TAX FORMS!

By Dean T. Smith, CPA, CA, Ph.D., CFP, TEP

Tax compliance is complex and time consuming, no doubt. But in the United States, clearly the IRS loves

its forms, especially for U.S. Citizens living abroad! Unfortunately, many taxpayers, are not aware of

what forms need to be filed, how long this process will take, and the enormous penalties they may be

exposed to for not filing them on a timely basis.

To prepare for the challenge, readers can actually find out the amount of time the IRS expects taxpayers

to spend in regards to this annual ritual as it relates to

(i) Recordkeeping (for the form);

(ii) Learning about the law of the form; and

(iii) Preparing and sending the form to the IRS.

To give you an idea of the depth of information for U.S. taxpayers who are living abroad, Nina Olson (IRS

National Taxpayer Advocate) stated in her 2011Taxpayer Advocate’s Report to Congress:

“IRS publication 4732, Federal Tax Information for U.S. Taxpayers Living Abroad, illustrates the complexity of the

filing requirements. It refers to at least eight other relevant IRS publications, totaling 563 pages, and the additional

documents referred to by these other publications include 4,727 pages of instructions, 667 pages of forms, and

another 1,928 pages of form instructions, or 7,322 total pages.”

Therefore, tax form immersion is a good idea, sooner rather than later. Taxpayers and their advisors

would be wise to take note of the summary of some of the more relevant forms which may need to be

filed below, all in addition to their regular tax return Form 1040, “U.S. Individual Income Tax Return”.

This is especially so for U.S. taxpayers living abroad.

FinCEN Form 114, “Report of Foreign Bank and Financial Accounts (FBAR)”

The filing of an FBAR is governed under the U.S. Bank Secrecy Act of 1970 (“BSA”). It is not part of the

Internal Revenue Code (“IRC”). FBARs must be filed electronically on the Financial Crimes Enforcement

Network (“FinCEN”) website http://bsaefiling.fincen.treas.gov.

Generally FBAR reporting applies to each United States person who has a financial interest in (directly or

indirectly), signing authority or any authority over, foreign (non-U.S.) financial accounts that have an

aggregate value exceeding US $10,000 at any time in the calendar year.

Note that the US $10,000 threshold is in aggregate, it is not US $10,000 per account. The FBAR does not

report taxable income. The form reports those individuals who can control the flow of funds in non-U.S.

bank accounts and is used, in conjunction with other law enforcement tools, to track down money

laundering, organized crime, terrorisms, etc.

http://bsaefiling.fincen.treas.gov/


Since it is not a tax form, its scope goes beyond just the personal accounts of the filer. As such U.S.

persons who may be corporate officers or trustees would be required to report the corporate or trust

accounts, in addition to their personal accounts, on their FBAR filings.

If an individual fails to file the FBAR, the IRS can impose one of two civil penalties:

- A non-willfulness penalty, not to exceed US $10,000, may be imposed on any person who

violates or causes any violation of the FBAR filings and recordkeeping requirements; or

- A willfulness penalty may be imposed on any person who wilfully fails to file the FBAR, with the

penalty being the greater of $100,000 or 50% of the balance in the account at the time of the

violation.

Criminal penalties may also be applied.

Questions, ascertaining the need to file an FBAR, are asked on Schedule B “(Form 1040A or 1040),

Interest and Ordinary Dividends”, Part III Foreign Accounts and Trusts.

Form 926, “Return by a U.S. Transferor of Property to a Foreign Corporation”

Generally, a U.S. citizen or resident, a U.S. domestic corporation, or a U.S. domestic estate or trust must

complete and file Form 926 to report transfers of certain property to foreign corporations.

For example, where a U.S. citizen resident in Canada has undergone a corporate reorganization and, as

part of that reorganization, has transferred property (i.e., shares) to a new Canadian entity, form 926

may be required to report the transfer.

If the taxpayer fails to comply, the penalty will be equal 10% of the fair market value of the property at

the time of the transfer (note that it is the FMV not an elected transfer price). The penalty is limited to

US $100,000 unless the failure to comply was due to intentional disregard.

Form 3520, “Annual Return to Report Transactions With Foreign Trusts and Receipt of Certain Foreign

Gifts”

This form is filed when a U.S. person has a transaction with (i.e., a contribution to or distribution from) a

non-U.S. trust or receives a gift or bequest from a non-U.S. person. The initial penalty for not timely

filing Form 3520 is the greater of US $10,000 or 35% of the gross value of property transferred to the

foreign trust or 35% of the gross value of distributions received from a foreign trust.

For U.S. tax purposes, a TFSA, RESP, and RDSP may be considered foreign trusts (a question of fact).

RRSPs, however, are specifically excluded. Legitimate Canadian resident family trusts would be caught

under these rules if distributions are made to a U.S. resident beneficiary. For example, if a Canadian

resident family trust makes a distribution of $50,000 to a beneficiary who had moved to the U.S. and the

U.S. beneficiary failed to file Form 3520, a penalty of $17,500 may be assessed.

Form 3520-A, “Annual Information Return of Foreign Trust With a U.S. Owner”


This form is filed when a U.S. person is considered to be the owner of a foreign trust under the U.S.

grantor trust rules. This would apply when a U.S. person (citizen, green card holder, or resident alien)

transfers property to a Canadian trust in such a manner that they are considered to still own the trust

assets. A Canadian alter-ego trust may be one such example since the settler maintains control of the

property and the property can revert back to the settler at any time.

The initial penalty is the greater of US $10,000 or 5% of the gross value of the foreign trust’s assets

treated as owned by the U.S. person under the grantor trust rules.

Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations”

This form is filed when a “United States shareholder” (defined as a United States person with at least

10% of the combined voting stock of the foreign corporation) has a reportable interest in a controlled

foreign corporation (a CFC being a non-United States corporation where more than 50% of the votes or

more than 50% of the value is held by “United States shareholders”).

This form would be required, for example, where a U.S. citizen Canadian resident has established their

own incorporated family business.

The initial penalty for not timely filing Form 5471 is US$10,000 but may be increased to US$50,000 if the

form is not filed within 90 days of an IRS request to file. If the United States person is an entity, the IRS

automatically imposes the penalty. If the United States person is an individual the IRS does not

automatically (yet) impose the penalty but there is a risk that the penalty could be applied.

Form 5472, “Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation

Engaged in a U.S. Trade or Business”

Form 5472 is similar to Canadian form T106, “Information Return of Non-Arm’s Length Transactions with

Non-Residents”, in that it reports transactions with foreign related parties. Unlike Form T106, which has

a Cdn $1,000,000 filing threshold, there is no de minimis threshold. A $10 loan from a Canadian

shareholder to a U.S. subsidiary may require that Form 5472 be filed.

This form allows to IRS to examine possible transfer pricing issues.

A penalty of US $10,000 will be assessed on any reporting corporation that fails to file the form when

due and in the manner prescribed. An addition penalty of US $10,000 can be assessed if the form is not

timely filed after notification by the IRS.

Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships”

This form is the partnership equivalent of Form 5471. Depending on the category of the filer the

penalties can range from US $10,000 (up to a maximum of US $50,000 after an IRS request to file has

been received) to a penalty equal to 10% of the fair market value of property contributed to the

partnership (subject to a potential US $100,000 limit unless the failure is due to intentional disregard).


Form 8938, “Statement of Specified Foreign Financial Assets”

Form 8938 is essentially the income tax equivalent of an FBAR. Since an FBAR is not filed with the IRS, a

taxpayer can be fully FBAR compliant but still not report the associated foreign income on their tax

return. Form 8938 is meant to prevent that.

There are two main differences between Form 8938 and the FBAR. While the FBAR reports other’s

accounts (i.e. signing authority or other authority) Form 8938 will only reports the taxpayer’s accounts.

In addition, the FBAR only reports financial accounts while Form 8938 reports financial assets, which is

broader.

Private company shares are one example of a foreign financial asset which is not a foreign financial

account. Other possible foreign assets may include an interest in a foreign trust, a foreign estate, a

foreign pension plan or a foreign deferred compensation plan.

Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified

Electing Fund”

A U.S. person that is a direct or indirect shareholder of a passive foreign investment company (“PFIC”)

may be required to file Form 8621 for each individual PFIC that they have an interest in (there are

actually five conditions under which filing is required). There is no minimum ownership requirement.

Having 1 share of a PFIC would result in a potential filing obligation.

A foreign corporation is a PFIC if either (i) 75% of more of the corporation’s gross revenue for its taxable

year is passive investment income or (ii) at least 50% of the average percentage of assets held by the

foreign corporation during the taxable year are assets that produce passive income or are held for the

production of passive income.

Many Canadian mutual funds trusts, mutual fund corporations, exchange traded funds, and corporate

class investments may be considered to be associations/corporations for U.S. tax purposes and, as such,

would be classified as PFICs.

Penalties associated with Form 8621 can vary depending on the exact PFIC regime which applies. In

general, a minimum penalty of US $10,000 may apply.

Dean Smith is one of Canada’s foremost experts on Canada-U.S. tax matters, a partner with Cadesky and

Associates LLP, President of Cadesky U.S. Tax Ltd., and a faculty member of Knowledge Bureau.

Knowledge Bureau is Canada’s leading educational institution for the continuing professional

development of financial advisors and their clients, and a strategic educational partner with Dynamic

Funds.

©Knowledge Bureau, Inc. All Rights Reserved.

REPORTING FOREIGN INCOME AND ASSETS

As Canadians look to maximize their investment returns and diversify their portfolio risk, it is not unusual to look

for investment opportunities outside of Canada. However, this opportunity comes with some important tax

consequences, which if ignored, can quickly erode away returns. There are several steps to getting it right and

enjoying the most after-tax returns on these investments.

Income Reporting on the T1 Return. First, Canadian residents must know they are required to report world wide

income earned, annually, on their personal income tax returns. That foreign source income, including pensions

and investment income and any capital gains, must be reported in Canadian dollars using the appropriate foreign

exchange rate.

In addition, aside from the income reporting requirements, it’s important that the existence of foreign investment

assets to be reported to the Canada Revenue Agency (“CRA”) on a separate tax form, as explained below.

Form T1135, “Foreign Income Verification Statement”. Although many Canadian investors may think this is a new

requirement, there is some interesting history to it. Codified in the Income Tax Act (the “Act”) as section 233.3 as

part of the February 27, 1995 budget, the filing rules were to apply to returns for taxation years and fiscal periods

that began after 1995 (though there were subsequent changes to delay certain filing deadlines to April 1999). As

such, the requirement to file Form T1135 has been around for over 20 years.

What has changed in recent years, however, is the focus of tax authorities to collect the information. There has

been a concerted effort, globally, to combat international tax evasion and aggressive tax avoidance. This can be

seen in the United States with their Offshore Voluntary Disclosure Program (“OVDP”) going back to 2009 and their

Streamlined Compliance Filing Procedures program which goes back to 2012.

Canada, too, has jumped on the off-shore compliance bandwagon. The CRA launched the Offshore Tax Informant

Program (OTIP) in 2014 as part of this crackdown. In addition, CRA has, over the last few years, made changes to

Form T1135 and increased their compliance focus on the filing of this form to combat “international tax non-

compliance.”

Who must report? Canadian resident individuals, Canadian resident corporations, Canadian resident trusts (with

some exceptions) and certain partnerships are potentially caught under these rules. These “reporting entities” will

be “non-compliant” if they have failed to declare (, for example,

- Canadian taxable income that has been transferred outside of Canada;

- foreign taxable income;

- ownership of “specified foreign property”; defined below;

- participation in tax avoidance schemes that involve offshore transactions; and

- trusts held offshore in respect of which federal income has not been declared.

Form T1135 must be filed when the aggregate cost of all specified foreign property owned exceeds $100,000 at

any time during the tax year. Note that it is the “cost” that is relevant here, not the fair market value. Form

T1135 reports the cost at two different points in time: the maximum cost at any time during the year

and the cost at the end of the year. Differences between the two “costs” would reflect additions and/or

dispositions during the year. A lower cost at the end of the year would reflect a disposition and the CRA

would be able to reconcile the disposition against reported capital gains.


Also, many taxpayers make the error of believing the Cdn $100,000 threshold is by asset. That is not the case; it is

the aggregate of all specified foreign properties (defined below) that must be reported.

What is Specified Foreign Property? Investors who own “Specified foreign property” must file this form if they

meet the $100,000 threshold. The Act defines “specified foreign property” to include (among other items)

- Funds, including funds in foreign bank accounts situated, deposited or held outside Canada

- an interest in a non-resident trust (i.e., foreign mutual funds)

- indebtedness owed by a non-resident person (i.e., foreign bonds, debentures, mortgages and notes

receivable)

- An interest in a foreign insurance policy

- Precious metals, gold certificates and futures contracts held outside Canada

- Intangible property, or for civil law, incorporeal property, such as patents or copyrights, situated,

deposited or held outside Canada

- tangible property, or for civil law, corporeal property, situated outside Canada; (specifically including real

estate)

- shares of non-resident corporations (other than foreign affiliates)

- an interest in a partnership that owns of holds specified foreign property

- an interest in, or right with respect to, an entity that is non-resident

In general, only those assets which generate or are used to generate investment income are reportable. Personal

use foreign assets, i.e. a Florida vacation home, are therefore not reportable if they are used “primarily” for

personal use. Some of these properties, therefore, could be included in the reportable category.

The CRA defines “primary” to mean more than 50%. The test is based on the use of the property

throughout the entire year. Therefore, it is entirely possible, for example, that a vacation property may

be required to be reported in one year (because it was rented out more than 50% of the time) and not

reportable in another year (because it was NOT rented out more than 50% of the time). The

determination of whether a personal-use property is reportable or not is based on the facts as

determined on a case-by-case basis.

In addition, depending on the assets owned and the level of ownership, other tax reporting forms may be required

to be filed, in addition to or instead of Form T1135: Form T1134, “Information Return Relating To Controlled and

No-Controlled Foreign Affiliates”; Form T1141, “Information Return in Respect of Contributions to Non-Resident

Trusts, Arrangements or Entities” and Form T1142, “Information Return in Respect of Distributions from and

Indebtedness to a Non-Resident Trust”.

Filing due date. Form T1135 is required to be filed by the “regular” tax filing due date of the taxpayer (defined

below), typically April 30, along with the T1 tax return.

What happens if I don’t file these forms or file late? A late filed T1135 is subject to a late filing penalty of $25 per

day up to a maximum of 100 days ($2,500) with a minimum penalty of $100. In addition, where a person

knowingly fails to file or files under circumstances amounting to gross negligence, additional penalties equal to

$500 per month may be assessed (up to a maximum of $12,000). Where the Minister has issued a demand to file,

those penalties may be doubled.


Where a late filing penalty has been assessed and the return is filed more than 24 months late, a penalty equal to

5% of the greatest total costs can be imposed.

In addition, the tax assessment period can be extended to 6 years, from the normal 3 year period, if the T1135 has

not been filed or filed late and income from a specified foreign property has not been reported on the tax return.

Options – Voluntary disclosure. All, however, is not lost. Taxpayers who have not yet filed (and who have not yet

received a demand to file from the CRA) may file under the CRA Voluntary Disclosure Program to being their

delinquent filings up to date. Acceptance, under the program, means that the CRA will not assess any late filing

penalties on Form T1135 requirements.

However, to be clear, all foreign income and gains must still also be disclosed on the T1 tax returns, which will

attract an alternate set of penalties for non-compliance. Voluntary disclosure here too can provide important

financial relief in the case or errors or omissions.

Conclusion. Taxpayers, in conjunction with their investment advisors and tax advisors, must annually review their

investment portfolios (and other investment assets) to determine if they have exceeded the Cdn $100,000

threshold on their foreign-based investments. Filing Form T1135, if required, should become an annual part of

their routine tax filings.

Failure to do may result in unanticipated penalties, interest and head-aches in today’s global tax environment.





Funds.


TIPS FOR SNOWBIRDS: AVOIDING TAX AND BORDER ISSUES IN THE UNITED STATES

With the increased scrutiny of both the U.S. Internal Revenue Service (“IRS”) and the U.S. Customs and Border

Protection (“CBP”), many snowbirds are unsure of what U.S. tax filing obligations, if any, they may have. It also

needs to be emphasised that there are two distinct branches of the U.S. government involved, and that their rules

are very different. What works for one branch (say, the IRS) may not work for the other branch (say, CBP).

Individuals should also be advised that, with respect to immigration issues, they should consult a qualified U.S.

immigration attorney. The objective of this brief is to address some of these issues.

Am I a U.S. tax resident? The determination of one’s U.S. residence status is factual. You become a U.S. tax

resident, under U.S. domestic tax law, if you obtain lawful permanent resident status (obtain a “green card”) or

you spend a significant amount of time in the U.S., such that you meet the “substantial presence test”. In other

words, for most snowbirds, the issue is strictly a “days counting” test.

Under the substantial presence test, an individual will become a U.S. (tax) resident if the number of days, under

the test, exceeds 183. First, however, the individual must have at least 31 days of physical presence in the current

year. If that condition is met, the number of days can then be computed as follows:

The number of days in the current year + (the number of days in the first prior year x 1/3) + (the number of days in

the second prior year x 1/6)

In general, for the purpose of any U.S. days counting test, any part of a day counts as a day. So, for example, if an

individual crosses into the U.S., say Buffalo via the Peace Bridge, at 11:50 PM they will have one day of physical

presence.

The average number of days to be under the threshold is approximately 120. We can see as follows

120 + (120/3) + (120/6) = 180 < 183

Certain days and individuals are excluded from the test. Such individuals would include foreign government-

related individuals (i.e., those in the U.S. on a diplomatic status or visa), teachers or trainees, students and some

professional athletes (competing in a charitable event). Excluded days would be for commuters, days in transit

between two foreign points, crew members temporarily present in the U.S., and certain medical conditions that

arose while in the U.S.

For snowbirds, however, these exceptions should not apply, meaning that all days of presence are counted. To

check back at your travels across the border, consider checking the I-94 website (https://i94.cbp.dhs.gov), which

provides a (somewhat incomplete) record of an individual’s entry and departure dates in the U.S.

Not a US. Resident for tax purposes. If you do not meet the substantial presence test, you are not a U.S. resident

for tax purposes. If you have no U.S. source income, you would not be required to file anything. You would only

have to file a Form 1040NR, “U.S. Nonresident Alien Income Tax Return”, or Form 1040NR-EZ, “U.S. Income Tax

Return for Certain Nonresident Aliens With No Dependents” if you had U.S. source income and the appropriate

withholdings had not been made.

If you exceed the 183 days you are a U.S. tax resident, under U.S. domestic taw law, from the first day of physical

presence in the current year.

https://i94.cbp.dhs.gov/


The Closer Connection Argument. If you exceed 183 days but remain a bona fide resident of another country (say

Canada), another form may help you avoid tax filing in the U.S. As long as you do not exceed 183 days in the

current year alone, you may rely on the “closer connection” argument to state that you are not a tax resident of

the United States. This declaration is made by filing Form 8840, “Closer Connection Exception Statement for

Aliens”.

If Form 1040NR or Form 1040NR-EZ, is being filed (because you have U.S. source income), Form 8804 should be

attached to the return and filed by the regular due date (usually June 15th) including extensions (December 15th). If

neither Form 1040NR nor Form 1040NR-EZ is being filed, the due date is the same as if you had filed Forms

1040NR or Form 1040NR-EZ.

Form 8804 reports the number of days of physical presence (over the current and prior two years) and what your

ties are between the country of residence and the United States. Such ties would include the location of your

permanent residence and vacation homes, location and type of investments, location of personal belongings (such

as cars, furniture and clothing), current social, political and cultural or religious affiliations, business activities,

driver’s licenses, health coverage and the jurisdiction where they vote.

If you factually have a closer connection to the other country then, under the Internal Revenue Code, you are not a

U.S. tax resident.

Beyond 183 days in current year. If you exceed 183 days in the current year alone, you can not rely on the closer

connection argument. Instead you must rely on the residency tie-breaker rules contained in the appropriate

income tax treaty, such as Article IV of the Canada-United States Tax Convention (1980). You would be required to

file either Form 1040NR or Form 1040NR-EZ and attach Form 8833, “Treaty-Based Return Position Disclosure Under

Section 6114 or 7701(b)”. Failure to file a treaty based position on a timely basis can result in a U.S. $1,000

penalty.

A treaty is used to reduce or eliminate any potential U.S. tax liability. Reliance on a treaty does not, however,

eliminate the requirement to file any information returns that may be required based on the individual’s facts.

Such forms may include Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign

Corporations” and Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or

Qualified Electing Fund”. There are severe penalties for not filing these information returns on a timely basis.

As such it is extremely important that snowbirds do not exceed 183 days of actual physical presence in any calendar

year.

Immigration issues. Snowbirds usually enter the U.S. under a B-2 Tourist Visa. Though no paper document may

actually be issued, that is the status that a non-immigrant visitor would enter under. Under a B-2 visa, the

maximum length of stay is 6 months less a day at a time. The immigration officer at the point of entry, however,

determines how long each visitor is allowed to stay in the U.S. It is a question of fact as to how long you must be

outside the United States before you can re-enter on a “new” B-2 visa.

Individuals who over-stay their welcome may be banned from returning to the U.S. on subsequent trips. The ban

may be anywhere from three to ten years. Those wishing to re-enter the U.S. would then need to apply for some

form of waiver resulting in extra costs and delays with no guarantee of success.






Funds.


U.S. CITIZENS, RESIDENT ALIENS AND NON-RESIDENT ALIENS

Despite the fact that many U.S. citizens living in Canada might prefer to take the “ostrich approach” to

their U.S. tax filing obligations and ignore them entirely, that’s a really bad idea, especially in the current

cross-border environment. The consequences and penalties can be truly enormous. A much better

approach is to understand and determine your filing obligations and then deal with them as quickly as

possible in an effort to preserve family wealth.

Readers are cautioned that if they are unsure of their United States filing status (in the U.S. there are

four different filing statuses depending on your personal situation being (i) married filing joint,(ii)

married filing separate, (iii) head of household or (iv) single) they should consult a United States

immigration lawyer (with respect to citizenship) or their U.S. tax advisor (with respect to tax residence).

Who must file U.S. returns? The requirement to file U.S. tax and information returns is based on two

factors: (i) whether you are a United States citizen and (ii) if you are not a United States citizen, whether

you are a “resident alien” or not.

In general, individuals those who are either U.S. citizens or resident aliens are required to file Form

1040, “U.S. Individual Income Tax Return” and report their world wide income (as determined under U.S.

tax law). This does not mean, however, that they will necessarily be subject to U.S. taxation; only that

they have a filing obligation.

Income is sourced to a jurisdiction, meaning the country of source has the first right to tax that income.

The other country has a “residual right”. For example, let’s assume a Canadian resident has received

U.S. source dividends. The dividend would be considered U.S. source income, meaning that the U.S.

would have the first right to tax the income. If the recipient is not a U.S. person, the U.S. tax would be

limited to the 15% nonresident withholding tax under the Treaty. Canada would then also have a right

to tax the income, since the recipient is a Canadian resident. The Canada Revenue Agency would then

allow a foreign tax credit for the U.S. tax already paid in order to eliminate any double taxation.

The claiming of the Foreign Earned Income Exclusion and foreign tax credits however, may reduce or

eliminate the ultimate U.S. tax liability. The foreign earned income exclusion is a deduction, of up to US

$102,100 (2017), in computing taxable income. In general, it applies to non-U.S. source employment

income and self employed income.

A nonresident alien (“NRA”), on the other hand, would be required to file Form 1040NR, “U.S.

Nonresident Alien Income Tax Return” only if they had U.S. source income. If the NRA had U.S. source

income for which the proper amount of U.S. nonresident tax has been withheld, they may not required

to file anything more in the U.S. These filing requirements may apply to certain Canadian residents,

commonly, snowbirds, or those with business or rental assets in the U.S.

Who is a United States citizen? Section 301 of the U.S. Immigration and Nationality Act (“INA”) outlines

the conditions by which an individual is a United States citizen at birth. Under these provisions, an


individual does not elect to become a United States citizen; they are United States citizens

automatically, together with their inherent tax filing requirements.

For Canadian residents, who are U.S. citizens, three conditions may be relevant:

(i) A person was born in the United States...;

(ii) A person born was outside of the United States...of parents BOTH of whom are citizens of

the United States and one of whom has had a residence in the United States or one of its

outlying possessions, prior to the birth of such person; or

(iii) A person was born outside the geographical limits of the United States and its outlying

possessions of parents one of whom is an alien, and the other a citizen of the United States

who, prior to the birth of such person, was physically present in the United States...for a

period or periods totaling not less than five years, at least two of which were after

attaining the age of fourteen years.

Conditions (ii) and (iii) above catch those individuals who were born in Canada to one or two U.S. citizen

parents. Note that the residency requirement provides an “end” to inherited citizenship such that

grandchildren may not be U.S. citizens at birth if their Canadian-born U.S. citizen parent(s) never resided

in the United States.

Who is a U.S. resident? When a non-U.S. citizen is defined as a U.S. (tax) resident is determined under

Internal Revenue Code (“IRC”) §7701(b). An alien individual shall be treated as a resident of the United

States with respect to any calendar year (if and only if):

(i) Such individual is a lawful permanent resident of the United States at any time during such

calendar year; that is, they have obtained a green card and have commenced residency.

(ii) Such individual has meet the conditions of the substantial presence test; or

(iii) Such individual makes the first year election.

Substantial presence test. The substantial presence test is a three year rolling average test which

counts the number of days of actual physical presence in the United States (regardless of the reason). In

general, for the purpose of any U.S. days counting test, any part of a day counts as a day. So, for

example, if an individual crosses into the U.S., say Buffalo via the Peace Bridge, at 11:50 PM they will

have one day of physical presence.

Certain days and individuals are excluded from the test. Such individuals would include foreign

government-related individuals (i.e., those in the U.S. on a diplomatic status or visa), teachers or

trainees, students and some professional athletes (competing in a charitable event). Excluded days

would be for commuters, days in transit between two foreign points, crew members temporarily

present in the U.S., and certain medical conditions that arose while in the U.S.

To fall within this test, the taxpayer must first have at least 31 days of physical presence in the current

year. The formula is then =


The number of days in the current year + (the number of days in the first prior year x 1/3) + (the number

of days in the second prior year x 1/6)

If the total exceeds 183 then the individual is a U.S. tax resident from the first day of physical presence

in the current year. 120 days is used as a guideline as the average amount of time a NRA can spend in

the U.S. without becoming a U.S. resident.

120 + (120/3) + (120/6) = 180 < 183

If the taxpayer exceeds 183 days, under the formula, but has not spent more than 183 days in the

current year alone, they can then rely on the “closer connection” argument that they are not a U.S. tax

resident in the current year. Form 8840, “Closer Connection Exception Statement for Aliens” would be

required to be filed.

If the taxpayer spent more than 183 days in the current year alone then the closer connection argument

can not be made. Instead the taxpayer would be required to rely on the residency tie-breaker rules

contained in a U.S. tax treaty (for example Article IV of the Canada-United States Tax Convention

(1980)). In these situations the taxpayer would be required to file Form 1040NR along with Form 8833,

“Treaty-Based Return Position Disclosure Under Section 6114 or 7701(b)” to disclose their reliance on a

tax treaty.

There is significant risk in that, as a U.S. tax resident, a number of information returns may be required

to be filed in addition to their personal income tax return. While the treaty may reduce or eliminate any

potential U.S. tax, the treaty does NOT eliminate the filing of additional information returns.

First-year election. Since the determination of residence is a question of fact (physical presence) an

individual who moves to the U.S. late in the year may not qualify as a tax resident. Certain itemized

deductions and filing statuses are only available to residents.

For example, if a Canadian took a transfer to the U.S., effective November 1, 2017 and purchased a

home in the U.S. he would not be able to deduct the associated mortgage interest nor property taxes as

he is not a U.S. resident for tax purpose as he would only have 61 days of physical presence under the

substantial presence test. In these situations, the taxpayer may elect to be treated as a resident, as of

November 1.

This election can be made if (i) the taxpayer was also not a U.S. resident for the immediate preceding tax

year (2016) and (ii) would be a resident, under the substantial presence test, in the following year

(2018).

A brief note on penalties. Failure to file penalties can be big and add up quickly. If you owe any U.S. tax

the penalties can easily be up to 50% of the balance owing PLUS interest. The penalty for not filing

various information returns can be US $10,000 for each failure. While the IRS has the statutory

authority to abate penalties they can not abate interest charges. For any abatement request to be

effective, the taxpayer must have a “reasonable cause” which gave rise to the failure to file. Be sure to

talk to your financial advisors for a strategy that will stave off family wealth erosion from filing failures.






Funds.


U.S. ESTATE TAX – A PRIMER

“Will I have to pay estate taxes on my property in the U.S.?” It’s a common question Canadian

snowbirds may have for their advisors, and the primer below can be helpful in both easing anxiety and

guiding important wealth management conversations.

In addition to an income tax, the U.S. imposes a wealth transfer tax system which is comprised of three

parts:

• the estate tax,

• the gift tax and

• the generation skipping transfer tax (GSTT).

The gift tax and the GSTT were not imposed to raise revenue so much as to provide a back stop for the

estate tax. For example, if someone on their death bed were to give everything they own away, they

would have no estate subject to estate tax! It was precisely because of this potential problem for the

American tax department that the gift tax was introduced as a permanent feature of the transfer tax

system in 1932.

The Estate Tax

Some history. The U.S. has had a long history with respect to inheritance and estate taxes.

• A temporary stamp tax was enacted on July 6, 1797 to help pay for naval rearmament (to fund a

potential war with France). It was repealed four years later when the need for the revenue had

passed.

• The Revenue Act of 1862 (during the U.S. Civil War) imposed a direct tax on inheritances. This

tax was abolished on July 14, 1870.

• The War Revenue Act of 1898 (to fund the Spanish-American War) imposed an estate tax at a

top rate of 15% on estates over US $1 million. A US $10,000 exemption was provided to exclude

small estates. In addition, bequests to surviving spouses were also excluded. This tax was

subsequent repealed on April 12, 1902.

The current version of the estate tax was originally enacted as part of The Revenue Act of 1916. The tax

set a top rate of 10% on estates over US $5 million with an exemption level of US $50,000. The rate was

raised to 25% for estates over US $10 million.

The Republicans have tried, since the election of President George W. Bush, to eliminate the estate tax.

The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001 provided for the phase out of

the estate tax as of January 1, 2010. Under President Obama, however, the estate tax returned

(retroactively in some cases) with the enactment of The Tax Relief, Unemployment Reauthorization, and

Job Creation Act of 2010 on December 17, 2010.

Why is this relevant, you may ask? President Trump (and other Republican members of Congress) has

proposed repealing the estate tax. The next mid-term elections are in 2019 and it possible that the


Democrats may regain the majority in both the House of Representatives and the Senate. Even if the

estate tax is repealed, there is a risk that it could be re-instated in subsequent years. As such, advisors

should still consider potential U.S. estate tax exposure when advising clients on various investments.

Current law. Over the years, the estate tax rates and exemption amounts have fluctuated greatly. The

current top rate is 40%. The exemption amount is US $5,490,000 (2017 – the threshold is indexed for

inflation and is adjusted annually) and the “applicable credit” is US $2,141,800 (which represents the

estate tax on an estate valued at US $5,490,000).

The estate tax is actually imposed on a decedent’s taxable assets. First, it is necessary to determine the

fair market value of the decedent’s gross estate. The Internal Revenue Code and Regulations provide

guidance on what to include and how to value certain assets. Deductions are then allowed in computing

the decedent’s taxable estate.

Such deductions include funeral expenses, expenses incurred in administering property, claims against

the estate, debts of the decedent, charitable bequests, and property transferred to a (U.S. citizen)

surviving spouse.

A “gross estate tax” is then computed based on the (graduated) transfer tax rate schedule. Once the tax

has been computed, applicable credits will be applied. For a U.S. person (U.S. citizen or someone who is

domiciled in the U.S.) the “applicable credit” is equal to U.S. $2,141,800. Because of the math, someone

who’s net worth at the time of death, is less than the current year exemption amount, will not be

subject to any U.S. federal estate tax.

Canadian residents who are not U.S. citizens. A non-domiciliary of the United States would only be

subject to U.S. estate tax on U.S. situs assets (known as “property within the United States”). Such

assets include, but are not limited to, real property located in the U.S. (i.e., that Florida vacation home),

tangible property located in the U.S. (i.e. a luxury yacht moored in Florida, furniture and fixtures), and

stock of U.S. domestic corporations (i.e., IBM, McDonald’s).

Certain assets, though located in the U.S., are considered to be “property without the United States” and

would not be subject to U.S. estate tax. Such property would include, but not limited to, proceeds of a

U.S. life insurance policy, bank deposits in a U.S. financial institution, certain U.S. debt obligations, works

of art on loan for exhibition and stock in a U.S. regulated investment company (“RIC”).

Canadian mutual fund trusts, Canadian mutual fund corporations, Canadian exchange traded funds, and

Canadian corporate class investments are not U.S. situs assets for U.S. estate tax purposes even if they

hold U.S. investments. In IRS Chief Counsel Advice (CCA) document 201003013, the IRS was asked

whether shares of Canadian mutual funds that, in turn, owned shares of U.S. corporations, would be

included in the gross estate of a non-citizen nonresident decedent. The document stated:

“If the Canadian mutual funds held by the Decedent’s RRSP are classified as corporations

for U.S. tax purposes, the shares of the mutual funds would not constitute U.S. situs

property under §2014(a) and would not be includible in Decedent’s U.S. gross estate. (The


underlying assets also would be excluded from Decedent’s gross estate.) You indicated

that the RRSP held shares in several mutual funds that are organized as trusts. However, a

mutual fund may have been formed as a “trust” under Canadian law, but be properly

classified as a corporation under U.S. law. Based on the information provided, it appears

that all the Canadian mutual funds held by the Decedent’s RRSP would be classified as

corporation for U.S. tax purposes.”

While CCA 201003103 is fact-specific and can not be used or cited as a precedent, it does provide some

guidance as to how the IRS would treat Canadian mutual funds, et al.

The Tax Treaty Helps. Under the Internal Revenue Code, itself, the estate tax exemption amount for a

non-U.S. person is U.S. $60,000 which translates into an applicable credit of $13,000. Canadian

residents, however, can look to Article XXIX-B of the Canada-United States Tax Convention (1980) for

relief.

Under the treaty, a Canadian resident has access to the applicable credit amount (exemption) available

to a U.S. person. The allowable credit is based on a pro-ration of the decedent’s U.S. situs assets

divided by their world wide assets.

Similar to a U.S. person, the first step is to determine their (U.S.) gross estate. Deductions are then

allowed in computing their U.S. taxable estate. Deductions that are not directly allocable to a particular

U.S. asset (i.e., a non-recourse loan on the Florida vacation home) are allowed pro-rata based on the

ration of U.S. assets to world wide assets.

For example, assume that a Canadian resident has a net worth of $25 million on death. He is single and

has no debts. Within his world wide estate he has a Florida vacation home worth $3,500,000 and he has

$275,000 of U.S. stock in his RRSP (RRSPs are “look through vehicles” for U.S. estate tax purposes as they

are considered to be a foreign grantor trust).

His U.S. gross estate would be $3,755,000

The preliminary (gross) U.S. estate tax would be $1,447,800

The applicable credit (for 2017) would be computed as follows

$3,755,000 (U.S. situs assets) / $25,000,000 (world wide assets) x $2,141,800 (applicable credit) =

$321,698

Deducting the credit against the gross estate tax results in a final U.S. estate tax liability of $1,126,102.

Though this may be claimed as a foreign tax credit against the Canadian capital gains tax on death (with

certain potential provincial limitations), the estate tax is based on the fair market value of the estate,

not the inherent gain. If there is no associated capital gain on the decedent’s Canadian return, there is

no basis to claim a foreign tax credit.


Where the property is left to a surviving Canadian resident spouse, an additional credit may be claimed

equal to the lesser of (i) the applicable credit claimed under the treaty (the $321,698 per above) or (ii)

the remaining estate tax balance. In the above example, if the taxpayer were married and all of the

property was transferred to a Canadian resident non-U.S. surviving spouse the ultimate estate tax would

be $804,404 ($1,126,102 – the lesser of (i) $321,698 or (ii) $1,126,102).

Tax Form Filing is Important. Whenever a person relies on a treaty provision to reduce or eliminate U.S.

tax (income or estate), a treaty-based filing must be done. As such, a Canadian resident (not a U.S.

person) would be required to file Form 706-NA, “United States Estate (and Generation-Skipping

Transfer) Tax Return”. The due date is 9 months after death, though an extension for an additional 6

months may be filed by the original due date. The extension, however, does not extend the payment of

any tax only the filing date of the return. If the full tax balance is not paid by the original due date, late

payment penalties and interest will accrue.

Gifts

For a non-U.S. person, there is no gift tax exemption under either the Internal Revenue Code or the tax

treaty. The provisions, under Article XXI-B, only apply to U.S. estate tax not to U.S. gift tax. Care must

be exercised when Canadians gift U.S. certain U.S. property. For example, if a parent gifted a piece of

U.S. real estate to one of their children, the U.S. gift tax would apply to the full value of the gift.

The take away

When advising client on their investment choices, advisors and clients need to understand the potential

U.S. estate tax implications, particularly if the direct holding of U.S. assets is recommended for client’s

portfolios.

Advisors, instead, may wish to consider Canadian investment vehicles, such as mutual fund trusts or

exchange traded funds that mirror the U.S. market.





Funds.

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