January 2012 Archives

January 31, 2012
Posted by Michael Brooks

Canadian Snowbirds Who Spend Too Much Time in the US May Become US Tax Residents. All US Tax Residents Must Disclose Their Non-US Bank Accounts, or Face Possible Draconian Penalties.

We've discussed previously how, if the Canadian visitor to Palm Springs is not careful, he or she can inadvertently find themselves subject to US taxation on income earned anywhere in the world (worldwide income). In any calendar year in which a foreign citizen stays in the US over 183 days, the person may become subject to tax in the US on their worldwide income (the person may become a US resident for tax purposes at least for that year, but the US-Canada Tax Treaty does offer potential relief for the Canadian citizen being deemed a US tax resident in this scenario). Also recall that if over a three year period the Canadian citizen is in the US so much that he or she fails the "substantial presence" test (and does not file the closer connection Form 8840...big mistake), the individual may also be considered a US tax resident for that year. On the plus side, even if the Canadian is deemed a US tax resident for the year and the US taxes the Canadian citizen on all his or her worldwide income, there's a good chance Canada will credit most (if not all) the US taxes paid. So for the Canadian who stays a little too long in the US there probably won't be much, if any, double tax between the US and Canada (although the individual could easily end up paying the higher rate of tax between the two countries).

What else does being a US tax resident for a given year mean? Many people are surprised to find out it means you must provide the US Department of Treasury information about all your foreign bank accounts. Well, for the Canadian snowbird visiting the Coachella Valley, there's a good chance most if not all his or her bank accounts are in Canada, so this becomes a significant required disclosure.

US Citizens or Tax Residents Must File a FBAR Annually

US tax citizens or residents must file a "FBAR"( a "Report of Foreign Bank and Financial Accounts") annually, provided the US citizen or tax resident has over $10,000 in financial account(s) which are not located in the United States (which will be a certainty for the Canadian snowbird). The term financial account is broadly defined and includes any bank, securities derivatives, or other financial instrument accounts. It also includes any savings, demand, checking, deposit, or other account maintained with a financial institution in addition to certain annuity and life insurance contracts, commodities and precious metals and safe deposit accounts. The FBAR is filed on a US Treasury Form TD F 90-22.1. The FBAR is filed with the US Department of Treasury by June 30 of the year after the US citizen or resident had a non-US account. That means, in any year in which a Canadian snowbird is deemed a US tax resident, he or she must file a Form TD F 90-22.1 by June 30 of the following year.

What are the Penalties for Failure to File a FBAR?

For a "non-willful" failure to file a FBAR, the penalty will not exceed $10,000 per violation. In the case of a non-willful violation, no penalty should be imposed if the failure is due to reasonable cause and the account was properly reported. We will discuss what constitutes a "non-willful" failure to file in future posts. For each willful violation, the maximum penalty that may be imposed is the greater of $100,000 or 50% of the aggregate value of the non-US account(s) at the time of the violation. THAT'S CORRECT, FAILURE TO FILE A FBAR CAN LEAD TO A PENALTY OF 50% OF THE AGGREGATE VALUE OF THE NON-US ACCOUNT(S) AT THE TIME OF THE VIOLATION!!! Not 50% the taxable amount, 50% of the account balance!!

Wow, for a "willful" failure to file a FABR, the US can (try) to take 50% of the Canadian citizen's account balances of non-US accounts for a given year. As you can see, the potential damage is staggering for the Canadian snowbird who spends a little too much time in Palm Springs (or anywhere in the US) in a particular year or years (if the failure to file is deemed "willful", to be discussed...). There is, however, currently an IRS amnesty program for the non-FBAR filer, which we will discuss in the next post.

January 10, 2012
Posted by Michael Brooks

How Can Canadians with Houses in Palm Springs (and all of the US) Be Subject to the US Estate Tax, Part II

So let's get into some real detail on the US estate tax, and how the IRS imposes it on Canadians with homes and other assets in Palm Springs (and the entire US). The estate tax is imposed only on the value of US assets (not the value of worldwide assets) of Canadians (provided they are not "domiciled" in the US). This will be most Canadian snowbird visitors to the Coachella Valley. But is it imposed on every dollar's worth of assets a Canadian dies with in the US? No. Canadians (and Americans) are permitted to exclude a certain amount of assets from the estate tax.

How Much Assets May an American Exclude From the Estate Tax?
For 2011 and 2012, American citizens and residents may exclude their first $5M in worldwide assets (notice the distinction again here as Canadian snowbirds will only be subject to the estate tax on their US assets). What this means generally is that an American who dies in 2012 with $2M is total worldwide assets must recognize $0 estate tax. And, as you will see, a Canadian who dies in 2012 with $2M is total worldwide assets (even if they're all in the US) must also recognize $0 estate tax.

How Much May a Canadian Exclude From the Estate Tax?
If an American can exclude $5M in (worldwide) assets from the estate tax, how much can a Canadian exclude in (US) assets? At least for the year 2012, if a Canadian citizen were to die with worldwide assets of less than $5M, that individual is not subject to the US estate tax. This high (generous) threshold will surely go down in future years. But again, at least in 2012, a Canadian snowbird with worldwide assets of less than $5M and is not subject to the US estate tax (even if all the assets are located in the US).

Ok fine, but what about the Canadian who dies in 2012 with worldwide assets worth 10M and US assets (a house) worth 1M. How much of the $5M exemption available to Americans can the Canadian citizen use? The US Canada Tax Treaty tells us to use a simple mathematical formula to derive the answer- $5M (for 2012) total possible exemption multiplied by a fraction: the numerator of which is the Canadian citizen's total US assets ($1M) and the denominator of which is the Canadian citizen's total worldwide assets ($10M). In our example the formula is: $5M x ($1M / $10M) or $5M x 1/10= $500,000. So the Canadian citizen with a US home worth $1M who dies in 2012 can exclude $500,000 from the US estate tax, but the other $500,000 is subject to the tax. Taxed at a 35% rate means an actual tax paid to the IRS of approximately $175,000. The 35% is a gradual rate maximizing at 35% (taxed at a lower rate for the lower portions of the taxable estate, so the actual estate tax is likely less than $175,000).

And the Estate Tax is Scheduled to Get Much Worse

Note that in 2013, the exemption amount is scheduled to go back down to $1M, and the highest rate of estate tax is scheduled to return to 45%. So after 2012 the US estate tax will likely impact many more Canadians (and Americans).

January 3, 2012
Posted by Michael Brooks

How Can Canadians with Houses in Palm Springs (and all of the US) Be Subject to the US Estate Tax, Part I

In a previous post, we introduced the concept that Canadians with property located in the US are potentially subject to the US estate tax upon their death. This is true even though the Canadian snowbird may never spend enough time in the US to make themselves US residents for tax purposes. In fact, this can be true of the Canadian who spends almost no time in the United States. That's because the US levies its estate tax on a foreign citizen's property located in the US. Ultimately, it's the US location of the property that matters. But note, not all property located in the US is included in the estate tax computation.

What's Included?
Canadians are generally subject to US estate tax on their assets located within the US (US "situs property") upon their death. The following types of property constitutes US situs property for the purposes of the US estate tax:
1) All real estate located in the US (this is generally the big one);
2) Tangible personal property located in the US (these are objects which can be moved touched or felt, such as jewelry, boats and art (which the Canadian citizen might hang in their US home));
3) Shares of stock of a US corporation; and
4) Golf Club Memberships.

What's Not Included?
Not all property located in the US is subject to the estate tax. Property located in the US, but not included in the computation of the US estate tax, includes:
1) Money kept in US bank accounts, either checking or savings, up to certain limits (any funds protected by the FDIC is exempt); and
2) Life insurance issued by a US insurer.

Also, very important, nonrecourse debt (debt where the only security is the house; the borrower is not personally liable) is subtracted from the value of the house in determining the value of the total US estate subject to the estate tax. This gets us to an interesting planning discussion on how to best avoid the estate tax, which we will discuss in a later post.

Americans Who Die in 2011/2012 Are Permitted to Exclude Their First $5M in Assets From the Estate Tax
One of the most hotly contested issues in American politics is how much an individual should be able to exclude from his or her estate for the estate tax computation. In 2011 and 2012, the answer is $5M. That means generally that each individual who dies with $5M or under in 2011 and 2012 will owe no estate tax. Note, before 2011 the exclusion limit was $3.5M. It is possible after 2012 the exclusion amount will drop significantly, perhaps to as little as $1M or even $0 (which would mean, if changed to $1M, people who die in 2013 with assets over $1M would be subject to the estate tax ...i.e., it is quite possible in the future a lot more estate taxes will be going to the IRS).

So How Are Canadian Snowbirds Affected by the US Estate Tax?
As we discussed before, the IRS will count the Canadians included assets (see above) in the US estate tax computation. So the real question is, how much of the $5M exclusion amount (again, this amount could go down significantly in the future) can a Canadian citizen (non-US resident) claim? That answer is governed by the US-Canada Tax Treaty, and is the subject of our next post.