Top 5 Tax Issues for Canadians with a Biden Presidency
Nobody knows yet who is going to win the U.S. presidential election on November 3rd and that may be uncertain even then. The polls show Joe Biden will win, but they weren’t right in 2016. Biden has identified his plans to change U.S. tax policies, several of which may significantly affect Canadians.
This article considers the top 5 tax issues that Joe Biden has raised that would affect Canadians
Topics:
- U.S. Estate Tax
- U.S. Corporate Tax Rates
- U.S. Personal Income Tax Rates
- Financial Transaction Tax
- U.S. Social Security Tax
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1. U.S. Estate Tax
The Issue?
Biden plans to reduce the U.S. estate tax exemption from $11.6 million to $3.5 million. Currently, U.S. citizens and residents are subject to U.S. estate tax on the portion of their worldwide estates that exceeds $11.6 million (all amounts in $US unless otherwise noted). Canadians are subject to U.S. estate tax on their U.S. assets including securities issued by U.S. corporations.
Why Does it Matter?
- The exemption reduction triggers a need to review assets to confirm whether additional tax planning is required to minimize or avoid US estate tax
- Biden’s plan could result in U.S. assets held by Canadians being subject to both U.S. estate tax and U.S. capital gains tax, in effect double taxation. Unlike Canadian tax law and pre-Biden U.S. tax law, pre-death appreciation will be subject to U.S. capital gains tax in addition to any U.S. estate tax applicable.
Scenario 1: Canadian Owns Home in the U.S.
Canadian owns a $500,000 U.S. home. His/her worldwide estate is $7 million. Under current U.S. tax law there would not be any U.S. estate tax on his/her death. Under the Biden tax plan, U.S. estate tax could be approximately $70,000.
Scenario 2: Canadian Estate Sells Decedent’s U.S. Home (Double Taxation)
The U.S. home in Scenario 1 was bought for $400,000 and is sold by the estate for $500,000. Under existing U.S. law no U.S. tax would apply to the appreciation prior to the death of the owner. Under Biden’s tax plan there would be no “step-up” of the property’s tax cost to fair market value at death and the U.S. tax on the gain would be as high as $20,000 ($23,800 for U.S. citizens or residents). There would be no Canadian tax on the sale provided the foreign exchange rate hadn’t changed because Canadian tax rules follow the existing U.S. rules.
Scenario 3: Canadians Owning U.S. Securities
Canadian owns $200,000 in U.S. securities in his/her Registered Retirement Savings Plan. His/her worldwide estate is $8 million. Under current law U.S. estate tax would be zero, but under the Biden plan it would be approximately $40,000.
What is the Solution?
- Canadian residents who own U.S. real property should determine if the reduction in U.S. estate tax exemption from $11.6 million to $3.5 million proposed by Biden would expose them to U.S. estate tax on their U.S.-situs assets. These assets include U.S. real property, personal property located in the U.S. (art, vehicles, jewelry, etc.) and securities issued by U.S. entities.
- There are multiple solutions to avoid or reduce exposure to U.S. estate tax including the use of Canadian entities like corporations, partnerships and trusts, non-recourse debt, life insurance, selling the property prior to the owner’s death, etc. Some of these solutions have their own limitations and adverse tax results. For example, a transfer of U.S. real property to a trust may result in U.S. gift tax. U.S. gift tax may also apply to monies gifted to a trust or another person where the recipient is required to buy U.S. real property. Generally, the application of U.S. gift tax is a worse result than being subject to U.S. estate tax.
- Being subject to U.S. estate tax and capital gains tax on unrealized appreciation prior to death exposes the owner to double taxation. U.S. estate tax may be avoided using one of the strategies identified above. The owner of U.S. real property would only be subject to U.S. capital gains tax on the sale of their property.
2. U.S. Corporate Tax Rates
The Issue?
Biden says he will increase U.S. federal corporate income tax rates from 21% to 28%.
Why Does it Matter?
The Trump tax reform in 2017 dropped U.S. federal corporate income top marginal tax rate of 35% (38% in some cases) to 21%. In combination with state income tax, Canada’s tax rates were no longer an advantage to Canadian businesses. Corporate tax rates were about equal between the two countries so other factors became relevant to investment and business structure decisions. An increase in U.S. income tax rates to 28% federally will make Canada a more attractive business location.
Scenario 1: Canadian Corporation with U.S. Subsidiary
$100,000 of corporate taxable income in the U.S. would trigger U.S. federal and state income tax rates of up to $37,000 plus another $3,000 (5%) to repatriate the earnings to Canada. The combined Canadian federal and provincial corporate income tax on the same income could be as little as $9,000 for qualifying small businesses or up to $27,000.
Scenario 2: Canadian Corporation with U.S. Business Activities
Canadian corporations that conduct business in the U.S. will not be subject to U.S. federal income tax if they meet the requirements of the Canada-U.S. tax treaty. Even where their U.S. activities subject them to U.S. state income tax, those taxes could be fully creditable against the Canadian tax otherwise payable.
Scenario 3: U.S. Corporation Deciding Where to Invest
Canadian corporate income tax rates would be more attractive than in the U.S. and could result in additional corporate investment in Canada. In addition to attractive income tax rates, Canada features a highly educated workforce, single-payer health care that forces cost control onto government and away from businesses, and salaries are lower than the U.S., especially in fields like technology and professional services.
What is the Solution?
Canadian corporations with U.S. subsidiaries should return to tax strategies employed prior to the Trump tax reform which encouraged businesses to realize taxable profits in Canada rather than the United States. Strategies include intercompany charges for Canadian management activities and support services, pricing on goods and services sold between the two countries, and other transfer-pricing strategies.
Canadian business can avoid U.S. federal income tax under the Canada-U.S. tax treaty by avoiding having a permanent establishment in the U.S. The tax treaty defines a permanent establishment to be an office or place of business but also includes certain other scenarios including concluding contracts in the U.S. or providing services in the U.S. if certain thresholds are met. Service and technology businesses often don’t need a physical U.S. office and may just have a virtual office without creating a permanent establishment.
3. U.S. Personal Income Tax Rates
The Issue?
Current U.S. federal personal income tax rates range from 10% to 37% on ordinary income and 0% to 20% on capital gains. Biden has indicated support to repeal the 2017 Trump tax reform and increase U.S. federal personal income tax rates on ordinary income and capital gains up to 39.6%.
Why Does it Matter?
Like U.S. corporate tax rates, when U.S. federal and state personal tax rates are combined and the 3.8% net investment income tax is applicable, U.S. personal tax rates could rise as high as 56.7% in California. (A recent California tax proposal that was not passed would have increased the top marginal rate in the state to 60.2%).
Scenario 1: Canadian Planning to move to the U.S.
In addition to a larger economy and milder winter temperatures, Canadians have been attracted to the U.S. by a more attractive income tax rate structure. Under the Biden tax plan the tax incentive is reduced.
Scenario 2: Canadian Investment in U.S. Real Property
Generally, Canadians have invested in U.S. real property directly or through a partnership structure to allow them to take advantage of preferential long-term capital gain tax rates in the U.S. Even when combined with state income taxes, these rates were often less than Canadian tax on capital gains and either partially or fully offset the Canadian tax otherwise payable. The proposed Biden tax rate of 39.6% on capital gains over $1 million plus state income tax, would result in an additional tax on capital gains that may discourage investment in U.S. real property.
What is the Solution?
Even where U.S. personal tax rates exceed Canadian tax rates, the tax rate structure in the U.S. is much more attractive. To get to the top marginal tax rate of 56.7% in California a taxpayer filing jointly would need to have over $1 million of taxable income. The top U.S. federal personal income tax rate proposed by Biden of 39.6% would start at $400,000 of taxable income. In contrast, the top personal marginal tax rates of approximately 53.5% begin at C$220,000 (approximately US$167,000).
If you’re a professional athlete in California like LeBron James earning $37 million of salary per year, you would likely pay less tax living in Canada or a no-tax state like Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington or Wyoming.
If the Biden plan to tax capital gains in excess of $1 million at 39.6% (20% under current law) is implemented, Canadian investors should evaluate using alternative structures for investments that could deliver gains subject to these provisions.
4. Financial Transactions Tax
The Issue?
Both Biden and his running mate, Kamala Harris and several other Democrats, have championed a Financial Transactions Tax (FTT) ranging from 0.05 to 0.2% on securities (equity, debt and derivatives) transacted in the U.S.
Why Does it Matter?
The FTT has been framed as a tax on Wall Street, but analysts have described it as a tax on the average American. Over half of Americans are invested in the stock market directly or indirectly. Similarly, U.S. financial markets have significant investments from Canadians. The FTT would come directly or indirectly out of pockets of both Americans and Canadians
Scenario 1: Canadian Employee with U.S. Investments
Virtually all Canadian investment plans including Canada Pension Plan, company pension plans, Registered Retirement Savings Plans, Tax-Free Savings Plans or non-registered accounts have direct or indirect investment in U.S. securities. US securities markets represent over 44% of the world’s market capitalization. It is almost five times larger than the next largest (China). Most Canadian investment funds including mutual funds and exchange-traded funds (ETFs) hold U.S. securities.
What is the Solution?
The imposition of the FTT may depress the U.S. securities markets and the individual securities on them, especially where other markets don’t have a comparable tax. It may also impact the general U.S. investment climate and make other securities markets more attractive. This may be an opportune time to consider reducing investment in U.S. securities and consider alternative investments in other jurisdictions.
5. U.S. Social Security Tax
The Issue?
Biden wants to increase the employment (and self-employment) earnings subject to U.S. Social Security Tax to amounts over $400,000 in addition to the current limits.
Why Does it Matter?
Current law imposes a 12.4% U.S. Social Security Tax split evenly between the employee and employer on employment earnings up to $137,700. There is no limit on Medicare Tax of 2.9% on all employment earnings split equally like the employee and employer. An Additional Medicare Tax of 0.9% applies to employees with employment earnings over $200,000 ($250,000 if married filing jointly). The same rates and limits apply to self-employment income.
Under current U.S. law, an individual earning $500,000 would be subject to $18,487 of U.S. Social Security and Medicare Tax. His or her employer would be required to match that amount less the $2,700 for Additional Medicare Tax. Under Biden’s proposal the U.S. Social Security and Medicare Tax would increase to $24,687, a 33% increase.
Scenario 1: Canadian Employee Transferred to U.S.
With very limited exceptions, U.S. employees must pay U.S. Social Security and Medicare Tax. Based on the example above, an employee with $500,000 in earnings would be subject to U.S. Social Security and Medicare Tax of $24,687. That employee’s tax under Canada Pension Plan based on the same earnings as in the U.S. would have only been C$2,898 (US$2,200), a tenth of the U.S. equivalent or a $22,487 difference.
Scenario 2: U.S. Employee Transferred to Canada
The same rules apply in reverse to U.S. employees transferred to Canada.
What is the Solution?
Many Americans and Canadians express great enthusiasm about the social security systems in both countries. For individuals in both countries that cannot save for their retirement, these programs are probably a godsend. For everyone else they are a savings program that is so poor that all covered individuals are required to contribute to it. If it was an attractive investment there would be no requirement to force contributions to it. The only advantage that Canada Pension Plan has is that it is less of a bad investment and therefore should be more attractive to individuals that have flexibility between the two programs.
Canadian employees temporarily transferred to the U.S. are required to continue their coverage under Canada Pension Plan. Absent an employment agreement of over five years, most transferred employees may stay on Canada Pension Plan for up to five years. In the example given above, that could result in savings of up to $112,435 (5 x $22,487). At the end of the five-year period, qualifying individuals who continued to reside in the U.S. may be able to extend their Canada Pension Plan coverage or be required to be covered prospectively by U.S. Social Security and Medicare.
Similar strategies may be available to U.S. employees transferred to Canada.
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Further information
If you want more information on any of the above issues or others, please contact any the following:
Warren Dueck, Partner T: 604-242-1401 or 587-390-1610
E: warren.dueck@ca.Andersen.com
Steven Flynn, Partner T: 604-242-1416
E: steven.flynn@ca.Andersen.com
Krista Rabidoux, Principal T: 587-390-6568
E: krista.rabidoux@ca.Andersen.com
Emily Yu, Principal T: 604-242-1405
E: emily.yu@ca.Andersen.com
Catherine Shen-Weafer, Senior Manager T: 604-242-1407
E: catherine.shen-weafer@ca.Andersen.com
