NEW BURDEN FOR CANADIANS WITH U.S. CITIZENSHIP

There are many reasons as to why a person may want to maintain dual citizenship with another country. It may be to allow for easier travel, or ability to work without acquiring a special visa, or ability to stay in the country for an extended duration for family reasons. Whatever the reason, the latest tax changes in the U.S. may once again force some to reconsider maintaining the U.S. citizenship.

Taxation based on citizenship

U.S. is one of the countries that bases its taxation on citizenship instead of residency. Consequently, a person living in Canada that has U.S. citizenship still has an obligation to file U.S. tax returns and comply with U.S. tax obligations notwithstanding that the person may not have visited U.S. in a very long time or ever. In the past, U.S. may not have been stringent on enforcing some of the compliance rules. Based on my understanding, the trend has changed in the recent years and the U.S. Internal Revenue Service (“IRS”) is looking for people to “pay up”. If you are a U.S. citizen and have never dealt with any tax filings in the U.S., you should consult a qualified advisor as soon as possible.

New Tax

In addition to the headaches that U.S. citizens living outside of the U.S. already faced dealing with tax compliance, introduction of the tax measures effective 2018 bring even more complexity. One of the new tax measures is a transition tax (“Transition Tax”). Although the Transition Tax was really aimed at preventing large corporations from “hiding” their profits outside of the U.S., it also catches the small- to medium-sized businesses just the same. The Transition Tax will affect any U.S. citizen who controls a non-U.S. corporation or who owns an interest in a non-U.S. corporation controlled by U.S. persons (whether alone or together with other U.S. persons). Consequently, this includes an owner-manager single person private corporation in Canada where the owner-manager is a U.S. citizen. The result is that the business owner will now need to pay a one-time tax on the retained earnings of the Canadian corporation. The look-back period is significant – the retained earnings to be taxed are going back to 1986. If the business owner has been attempting to save for retirement by investing in the corporation, that nest egg may quickly disappear due to this new tax.

Payment Period

The tax can be paid as a lump-sum or in installments over 8 years. The taxpayer must elect to pay in installments. There are various provisions where installments will be accelerated and beyond the scope of this article.

Canadian Tax Issue

While it is welcomed that there is some allowance for installment payments, many will be surprised to find out that the Transition Tax paid in the U.S. will not reduce future tax obligations in Canada, as no tax credit will be available in Canada. At the 2018 Society of Trust and Estate Practitioners (STEP) conference held in Toronto, the representative of the Canada Revenue Agency (“CRA”) confirmed that a Canadian resident shareholder’s Canadian tax liability would not be eligible for a credit to offset the Transition Tax paid. Consequently, the Canadian business owner will face (unfortunate) double taxation. Although it is possible that the Canadian government will provide some relief from double taxation in the future, I am not currently aware of any proposed measures or legislation that will help the business owner in 2018.

Next Step

Some may think that renouncing U.S. citizenship is a simple solution. “I will just renounce the citizenship and avoid dealing with it”. Not so fast. My understanding is that a person cannot renounce the citizenship without first complying with all of the past tax obligations. Accordingly, a person will need to deal with the Transition Tax even if the person plans to renounce the citizenship. If you have U.S. citizenship and have a controlling interest in a Canadian corporation, you should seek advice regarding the impact of the Transition Tax from a qualified U.S. tax advisor as soon as possible. I cannot assist you with any U.S. matters but if you need an U.S. tax advisor, feel free to contact me and I will do my best to connect you with a couple people that will be able to help you.