Wealthy Americans living in Canada appear to have few tax-planning options available to them to get around a new U.S. surtax on investment income that kicked in at the beginning of this year. That surtax – an extra 3.8% hit on investment income for high-earning American citizens – has been introduced to help fund the provisions in the new U.S. health-care law.
“It appears to be just another pain and real cost to high-income U.S. persons living in Canada,” says Jamie Golombek, managing director of tax and estate planning with Canadian Imperial Bank of Commerce’s private wealth-management division in Toronto.
The sticky issue with the new surtax – because of how it has been written into the U.S. tax code – is that American citizens living abroad probably won’t be able to apply foreign tax credits against it, as they normally would for their other U.S. income taxes.
That means American citizens living in Canada soon may find themselves writing cheques to the U.S. government for amounts owed related to the surtax, even if none of their income was earned in the U.S.
“I don’t know of anybody who’s come up with a brilliant idea for how to get around this,” says Peter Megoudis, partner with Deloitte & Touche LLP’s tax practice in Toronto. “I haven’t.”
Unlike most countries, the U.S. taxes its citizens on their worldwide income based on citizenship, not residency. That means American citizens and holders of green cards who live in foreign countries – including an estimated one million Americans in Canada – must file a tax return each year and comply with all their other U.S. tax-related reporting obligations, even if they earn none of their income in the U.S.
Normally, because of provisions in the U.S./Canada tax treaty intended to prevent double taxation, Americans in Canada do not end up having to pay taxes to the U.S. That’s because they can claim foreign tax credits in the U.S. against the income taxes they pay under the Canadian tax system. As tax rates in Canada typically are higher than in the U.S., Americans in Canada usually do not have to make a U.S. tax payment – although they must still file a return.
However, with the passage of the Patient Protection and Affordable Care Act – colloquially known as Obamacare – American citizens who earn more than US$200,000 in 2013, or couples who file jointly and who earn more than $250,000 collectively, will pay a 3.8% surtax on their net investment income, which includes interest, dividends and capital gains.
@page_break@ The surtax will be levied against the amount that is the lesser of the taxpayer’s investment income or the excess of total income above the threshold amount.
For example, Megoudis explains, if a couple, filing jointly, reports $300,000 in combined income, including $40,000 in investment income, then the surtax applies to the $40,000. If the couple were to have $60,000 in investment income, the surtax would apply to the $50,000 difference between their income and the threshold amount.
As the surtax appears in a part of the U.S. tax code for which foreign tax credits are not applicable, high-earning Americans living abroad will have a tax liability for the surtax on their investment income.
There may be some limited tax relief if the investment income is from a U.S. investment source, because a foreign tax credit could be available on the Canadian tax return. This relief would not be available for any Canadian-source income, however.
Cross-border tax specialists say they are still in the early days of considering all the implications created by the surtax for high-income-earning expatriate U.S. taxpayers and what possible tax-planning options may be available to them. However, they agree that the surtax adds a new layer of complication to cross-border tax planning and, to some extent, uncertainty because these experts can’t be sure whether the U.S. authorities will offer applicable tax credits in the future.
“We’re sort of hoping that this becomes part of a treaty negotiation, so that this can be addressed in the treaty,” Megoudis says. “Or that there is some guidance from the [Internal Revenue Service] that gives some relief.”
The fact that high-income American taxpayers in Canada now may have an actual tax liability to the U.S. government – as opposed to what effectively would be just a reporting requirement -could have a negative consequence on those taxpayers’ possible qualification for the current amnesty program from the U.S. government if they have not been keeping up with their U.S. tax-filing requirements and are looking to come in from the cold.
“You have this year to catch up for prior years and benefit from the amnesty program,” says Jerry Alberton, a tax services partner with PricewaterhouseCoopers LLP in Toronto. “Once you start owing money, you may no longer qualify for that amnesty program.”
© 2013 Investment Executive. All rights reserved.