October 2012 Archives

October 29, 2012
Posted by Sanger & Manes, LLP

Palm Springs, Palm Desert, Attorney for Canadian Snowbirds, Discusses More About The Amnesty Program Allowing Dual US/Canadian Citizens Residing in Canada to File Old US Tax Returns Without Penalty, Part 1.

What we're talking about here are Canadians who had the legal requirement to annually file US tax returns and FBARs (reports of foreign bank accounts...ie, your bank accounts in Canada which had more than $10,000 (US) in them at any point in the year), but who haven't filed a US tax return or a FBAR in years (if ever). Which Canadians have the obligation to complete US tax returns? Those Canadians who are also US citizens primarily, or maybe a Canadian who obtained a US green card but did not relinquish the green card upon moving back to Canada.

What Does the Amnesty Provide?
Really, it provides peace of mind. You haven't been filing your US tax returns (or FBAR's) for years, you know you have that obligation, and you don't know how to "come clean". Under the amnesty program, for those who qualify, the IRS will not impose penalties nor conduct an audit.

What Must You Do To Comply With the Amnesty?

1) File all tax returns with appropriate related information returns required for the past three years (i.,e, 2009, 2010, and 2011);

2) File Foreign Bank Account Reports (FBARs) for the past six years (i.,e, 2006- 2011);

3) Pay any tax and interest if applicable on the unfiled returns (but odds are there probably won't be any US tax or interest, I will explain...);

4) Complete and sign under penalties of perjury a 20-question questionnaire (we will discuss some of the more interesting questions).

And that's it. All your worries about years of unfiled tax returns can be over. Go back and forth between the US and Canada free of concern that your unfiled taxes are going to be a problem, and maybe prevent you from visiting the US for a long time.

Let's Start Looking at Some Specifics in the Amnesty.

The taxpayer is "eligible" for the streamlined procedure if he or she meets certain factors, including the following factors:
1. The taxpayer has not resided in the US since December 31, 2008;
2. The taxpayer has not filed a US tax return since 2008;and
3. The taxpayer does not owe more than $1,499 in any of the tax years beginning in 2009 and ending on 2011.

Only Canadians Who "Reside in Canada" Can Take Advantage of this New Amnesty, What Does that Mean?

To be permitted to use the amnesty, the applicant must permanently reside in Canada, and must not have "resided" in the US prior from 2009 to present. But so many Canadian snowbirds live part-time (for several months a year) in Palm Springs, or La Quinta, or San Diego or Phoenix. So does living in the US just shy of 6 months a year qualify you to take advantage of the new amnesty? My guess is yes, that as long as you're not a US resident, you do qualify for the new amnesty (basically, if you're not in the US more than 6 months a year, and for the Canadian in the US between 4 to 6 months each year, that person must be careful to complete the Form 8840 (the closer connection form...closer connection to Canada) each year). So my guess is as long as you're not a US resident, you do qualify for the new amnesty. That's just a guess though, as there is no clear guidance on this point yet.

Note the Canadian who has been dutifully completing Canadian tax returns each year is unlikely to owe any (much less $1,500) US taxes for the past few years, due to the credit system between the two countries. We'll pick up this concept, and look at other factors of the new amnesty program, in Part 2 of this series.

October 22, 2012
Posted by Sanger & Manes, LLP

Indian Wells, Rancho Mirage Tax Attorneys comment further on: RELOCATING SERVICE CONTRACTS (for purposes of avoiding the California state tax...Part 2)

...To evaluate this, the distinction between Rule #1 (California income taxes incurred due to residency), as opposed to Rule #2 (California income taxes incurred due to sourcing) is extremely important. Taxpayers are more or less in control of their residency; they can pull up stakes and move. However, the source of income is not as easily controlled. In many cases, the operations that bring in the income rely on California's market, which is often the market the owner knows and understands. There is no point in moving out of state to avoid the application of Rule #1, if Rule #2 is still going to apply. The tax is the tax is the tax.

But let's look at the nuts and bolts. It's not unusual for a business owner to have a corporation and several related tax pass-through entities, such as limited liability companies or limited partnerships, which produce income by providing goods or services here in California. The corporation often provides the LLCs with administrative services, and charges accordingly. Generally, the owner will hold the corporate stock in a family trust. In case like this, creative relocation can have worthwhile tax benefits. Here's how.

First, remember Rule #1. Since the point of most business enterprises is to get money into the pockets of the owner, if the owner remains a California resident, relocating the corporation won't help a bit by itself. Assuming all the income from operations passes through the entities (including the trust) to the owner, it will be taxed by California because of Rule #1. All of a resident's income is taxable by California. So in situations like this, if a strategic relocation is in the cards, step one is for the owner to change residency to a lower tax or non-income tax state. Obviously that's a big step. It means major change. But if reducing state income taxes is the goal, it's the sine qua non.

Second, remember Rule #2: moving out-of-state won't change anything if the source of the income derives from California. The premise here is that the owner's market is in California, so he can't move the operations. Paying California income taxes on that is the price we pay for benefiting from the Golden State's large market. That said, what doesn't have to be performed here is the administrative services: the management, accounting, etc., that the corporation carries out for LLCs. The source of income from personal services is the location where the services are performed, and not where the nonresident lives, the location where the contract for services is entered into, or the place of payment. Cal. Code Reg §18662-5. Therefore, if the services aren't performed in-state, it's not California source.

Thus step two involves creating a new entity in a lower tax or non-tax state (or the owner can perform those services upon changing residency) to provide the administrative services. In that situation, neither Rule #1 nor Rule #2 applies to the fees charged by the corporation. The services are not rendered in California, so they are not California source. Neither the entity nor the owner are residents, so their global income isn't subject to California taxation.

Now, there are complexities with this, as with any tax situation.

The rule about location of performance is strict. If even some of the work is performed in California (say by the owner coming to California to inspect the business), the payment, or a portion thereof, will be deemed California source under special allocations rules. Cal. Code Regs.18 18662-2. Indeed, if the entity is performing other services in-state, or otherwise doing business in California, all the income from the services may be taxable by California. In the Matter of the Appeal of William-Sonoma, Inc., and Subsidiaries (June, 26, 2012). Therefore, to avoid the application of Rule #2, it is very important to "wall-off" any nonresident entity or person from doing any business in California.

Furthermore, new (and somewhat complex) rules went into effect in 2011 regarding what constitutes "doing business in California" for entities. Partnerships and LLCs are considered doing business in this state if they have general partners or members in this state. Likewise, partners and members are considered doing business in this state if the partnership or LLC is doing business in this state. Further, if a partnership or LLC has employees working in California, it might result in the entity being deemed doing businesses in California, even if most of its operations have nothing to do with California. The point is, depending on how the owner's entities are interrelated, one or all of them might be deemed "doing business in California" for taxation purposes. Therefore, relocators need to carefully scrutinize those relationships to insure none of them can be used to impute "doing business in California" to the nonresident entity.

It's also noteworthy that any equity distributions from the California entities to the out-of-state entity or the owner (and presumably they will be significant) derives from operations in this state. California applies a source-based concept of taxation for full-year nonresident partners. Appeal of Lore Pick, 85-SBE-066; (June 25, 1985), Appeal of George D. Bittner, 85-SBE-111 (October 9, 1985), Appeal of Estate of Marion Markus, 86-SBE-097 (May 6, 1986); FTB Legal Ruling 2003-1. Essentially, California requires owners of pass-through entities to treat items of income, deduction and credits earned by such entities as if the items were earned by the owners at that time.

Similarly, nonresident shareholders are taxed on the portion of their distributive shares of an S corporation's income or loss, which are derived from sources within the state. Valentino v. Franchise Tax Board (1993) 25 Cal.Rptr. 282; Rev. & Tax. Cd, §17951. This is a bright-line rule that can't be avoided. (Dividend income from C-corps is treated differently and generally is sourced not to operations but to where the recipient resides, but that's another story).

So, in my scenario, while you may be able to free service contracts from California taxation, the same isn't true for the profits of the companies engaged in operations.

October 12, 2012
Posted by Sanger & Manes, LLP

Palm Springs, Indian Wells, La Quinta Attorney for Canadians Notes US Now Collecting and Sharing New Information at the US Canada Border

Canadian visitors to Palm Springs, Rancho Mirage, Indian Wells and all of California may wish to take note of a new pilot program the US Department of Homeland Security and the Canada Border Services Agency is instituting for visitors from both countries crossing the US-Canada border. It's a pilot program, which is not the official policy for US-Canada border crossings yet. But could easily become that (and probably will).

Which US-Canada Border Crossings is the Pilot Program Being Tested?
The following border crossings are where the program is initially being tested:

1) Pacific Highway, Blaine, Washington / Pacific Highway, British Columbia;

2) Peace Arch, Blaine, Washington / Douglas (Peace Arch), British Columbia;

3) Lewiston-Queenston Bridge, Lewiston, New York / Queenston-Lewiston Bridge,

4) Ontario; and Rainbow Bridge, Niagara Falls, New York / Niagara Falls Rainbow Bridge, Niagara Falls, Ontario.

What Information Is Being Collected at These US-Canada Border Crossing Points?

It will include collecting and exchanging biographic information of third-country nationals, permanent residents of Canada, and lawful permanent residents of the U.S. There is no indication the collected information is all that different than the information collected prior to inception of the pilot program, Note also, the Canadian government is advancing plans to use biometrics for immigration and border security that would bring them in line with the U.S. and other countries.

So What's So Different About What's Going on in the Pilot Program?

The big new feature of the pilot program is the enhanced sharing of information between the US and Canada. It will now be easier for authorities on both sides of the border to identify those individuals who have overstayed their visa (which may have a detrimental effect on their ability to visit the other coutnry again any time soon). They can also more easily identify those individuals who have "removal orders" against them. In the past, the coordination between the two sides was so not so great.

What Does This Mean for Canadian Part-Time Coachella Valley Residents?
It's hard to see any direct impact. Palm Springs Airport is not one of the locations for the pilot program. I think the take-away is that a greater sharing of information between Canada and the US is going to become the norm. Monitor your days spent in the US, do not overstay the 6 month a year period (if you're here on a standard B-2 tourist Visa allowing you 6 months in the US a year). If you overstay, it's clearly getting easier for authorities on both sides of the border to figure it out, and for Canadians it will easily lead to a suspension of your rights to visit the US in the future. Also, for the Canadians who have some US source income (you sell or rent a house; you conduct some business in the US), make sure to do your US taxes each year by June 15 (for the prior year). Failure to properly file and pay required taxes is another reason you will be suspended from returning to the US. In this increasing era of shared information, more and more each country will know of the other's citizens who do not follow the rules.

October 8, 2012
Posted by Sanger & Manes, LLP

RELOCATING SERVICE CONTRACTS: THE RESIDENCY TAX PITFALLS (Part I)

It's no secret that California has a high state income tax rate. In fact the Golden State competes with New Jersey and New York for the highest rate in the nation. Nonetheless, despite somewhat overblown media reports, most Californians aren't in a position to tear their businesses up by the roots and transplant them to low or zero income tax havens like Nevada and Florida. Often those businesses have to operate in California, since that's where the market for the product or service is, and typically for small businesses, the owner has to be present here in state for the enterprise to grow.

But that's not always the case, especially when a taxpayer owns numerous entities and some of the income derives from service contracts (usually for management work) among the entities or between the entities and the owner. In that case, some strategic use of out-of-state entities can result in large tax savings that might make the major step of relocation worthwhile.

But before we can address the benefits and pitfalls of relocation, we need to first give an overview of California's income tax system relating to residency. California taxes residents with respect to their "global" income. This means that for a California resident, income from whatever source - whether in-state or out-of-state - is subject to California taxation. There may be credits for payment to other states, and there may be other mitigations of the taxes due. But leaving that aside, California residents generally must pay significant state income taxes on all the income they make, from whatever source. Let's call this Rule #1: taxation of all income based on the California residency of the taxpayer.

In contrast, nonresidents only have to pay California income taxes to the extent that the income is "California source." If a nonresident has no California source income, the taxpayer isn't liable for any California income tax. California source income means income derived from a business or real property with a situs in California, or from work performed here. That income is subject to taxation by California, even if the taxpayer is not a resident. Let's call this Rule #2: taxation based on the source of the income being situated within California.

The rules relating to who is a resident and who isn't get very complex and fact specific. I won't get into them here. See Christopher Manes' A GUIDE TO SUCCESSFUL (TAX-FREE) SNOWBIRDING and THE PART-TIME RESIDENT TAX TRAP, on the Sanger & Manes website. Suffice it to say that if a taxpayer follows the necessary steps, he can change residency to a lower tax state. The issue is, when is such a major relocation worthwhile? We'll review question that in Part II.

October 2, 2012
Posted by Sanger & Manes, LLP

I'm a Canadian Who Owns (or Plans to Own) California or US Real Estate, and I'm Worried About the US Estate Tax, How Should I Own the California/US Real Estate?

So, we get this question a lot in our Palm Springs law office. There is no one-size-fits all on this issue. Here's an overview of many of the most popular methods for Canadians to minimize the estate tax. If you want to get into specifics, email me at mbrooks@sangerlaw.com or call our office at (760) 320-7421.

Non-Recourse Mortgage

What is it? A non-recourse mortgage is a mortgage secured by the house, with no personal liability for the borrower.

What does it accomplish? It provides a dollar for dollar reduction in the value of the US house/assets for US estate tax purposes (difficult to find US lenders offering non-recourse mortgages to foreign citizens and they will generally only provide them for a percentage (say 50%) of the value of the home).

Insurance Pays for the US Estate Tax

What is it? Snowbird purchases life insurance to pay for US estate tax upon death.

What does it accomplish? The cost of insurance can be considerably cheaper than the estate tax itself.

US House owned via a Foreign (not US) Corporation.

What is it? When the Snowbird dies, he does not own a US house (which is subject to the US estate tax), but owns instead shares of a foreign corporation (specifically not subject to the US estate tax).

Pros
: Shares of foreign country's corporation is not part of a US estate, so very favorable for the US estate tax.

Cons:
(i) Shareholder benefit taxation in Canada and other countries (must pay tax on rental value).
(ii) Poor for US income tax purposes. When any corporation sells the house, the corporation pays 35% tax of the appreciation (instead of 15%).

US House owned via a Partnership (either US or foreign partnership).

Again, when the Snowbird dies, he does not own a US house (which is subject to the US estate tax), but an interest in a foreign partnership (which may or may not be subject to the US estate tax).
Pros: Partners are taxed as individuals. So upon sale, they are entitled to the low 15% capital gains rate.

Cons: Uncertainty on whether US estate tax is imposed on value of partner's interest. However, domicile of partners (presumably foreign) is a positive factor in partnership interest not being subject to the US estate tax, but where partnership is conducting business also important.

Important Final Partnership Note:
Partnerships may "check the box" and elect to be taxed as a corporation. Many practitioners believe a partnership electing to be taxed as a corporation is more clearly not subject to the US estate tax. However, the partnership checking the box is now subject to the higher 35% corporate tax when selling the house.

QDOT (Qualified Domestic Trust)

What is it? A trust which holds the Snowbird's US property.

What does it accomplish? Upon the death of one spouse, property in the QDOT is transferred free of tax to the other spouse (not otherwise available to non-US citizens). Avoids probate upon death of first spouse.

What are QDOT requirements? At least 1 trustee must be a citizen or bank (if QDOT holds more than $2 M, then the trust must be a US Bank, or the trustee can furnish a bond).

Only legally recognized spouse for Federal US purposes qualify (i.e. no same sex spouses).

No more than 35% of the value of real property in the trust can be outside the US.