With Donald Trump now the 45th president of the U.S., it's just a matter of time before he attempts to proceed with his U.S. tax reform proposals. But how could they affect Canadian clients? The short answer is that any changes in the U.S. are unlikely to affect most ordinary Canadians, but two changes could have a positive impact on your high net-worth (HNW) clients.
First, President Trump's tax plan calls for a reduction in the number of U.S. federal income tax brackets to only three from the seven that exist today. These would include a 12% rate (from US$0 to US$37,500), a 25% rate (from US$37,500 to US$112,500) and a top rate of 33% for individuals with income greater than US$112,500 annually. This top tax rate would be almost seven percentage points lower than the current top U.S. rate of 39.6%, which applies for a single individual with income exceeding US$418,400. Of course, most states also impose a state income tax, with California's rate being the highest, at 13.3%; however, seven states, most notably Florida, have no personal income taxes whatsoever.
The question some high-income clients have been asking is whether Trump's proposed top tax rate reduction could put pressure on Canada's federal or provincial governments to lower our top tax rates?
You'll recall that, in Canada, we have five federal tax brackets for 2017: $0 to $45,916 (15%), $45,916 to $91,831 (20.5%), $91,831 to $142,353 (26%), $142,353 to $202,800 (29%) and anything above that is taxed at 33%, which is the new high-income bracket the federal government introduced in 2016.
Each province also has its own set of provincial tax brackets. The effect of combining federal and provincial taxes means that the top marginal tax rate for high-income earners is more than 50% in seven provinces, with Nova Scotia taking the top honours at a combined top marginal tax rate of 54% in 2017.
Much has been written about how high the tax rate can go before it becomes a psychological barrier to work. For example, the 1966 Carter Commission concluded that once the top rate exceeded 50%, it threatened productive effort.
For highly-skilled Canadian workers and professionals who are mobile, a new, lowered top U.S. federal tax rate compounded with a strong U.S. dollar could make Trump's America more attractive — at least from a financial point of view — to Canada's top talent. Take, for example, an high-income medical specialist in Ontario paying taxes at 53.5% on her income above $220,000 who's contemplating job offer at a Miami hospital. By relocating to Florida, not only could she be paid in U.S. dollars, but that income would be subject to taxes at a top rate of 33%, which is more than 20% lower than her current, combined federal/Ontario income tax rate.
Although lower taxes wouldn't be enough for most people to consider a move to the U.S. — in fact, much of the recent immigration discussion has been of Americans moving north — Trump's tax cut could put some pressure on our governments to lower rates to ensure Canada remains competitive and can continue to attract and retain top talent.
The other area that President Trump has promised to reform is the estate tax system as he plans to repeal the estate tax altogether. Unlike Canada, the U.S. has an estate tax that applies to the fair market value of an American's assets upon death. The U.S. estate tax was enacted in 1916 and was already repealed once, in 2010 before returning on Jan. 1, 2011. There's an exemption equal to US$5.49 million in 2017, indexed annually to inflation, such that very few estates actually owe any estate taxes.
Canada doesn't have an estate tax on death. Instead, we tax only the unrealized appreciation of assets (other than a taxpayer's principal residence) upon death as well as the fair market value of his or her RRSP/RRIF.
HNW U.S. citizens living in Canada — including dual citizens and non-U.S. citizens who own "U.S.-situs property," such as U.S. real estate or shares in U.S. companies at the time of death — may be subject to U.S. estate taxes. If Trump follows through on his promise to repeal the U.S. estate tax, then much of the complex planning currently being done, often involving setting up trusts and corporations to get around the estate tax, will no longer be necessary.