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Nothing brings a new law home like some examples, let’s take a look:

1.) A single individual with a salary of $210,000, which exceeds the $200,000 threshold, could be subject to the 3.8% tax IF he also has “net investment income.”

2.) A married couple with a combined income of $275,000, which exceeds the $250,000 threshold, could be subject to the 3.8% tax IF they also have “net investment income.”

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Beginning January 1, 2013, a new 3.8% unearned Medicare income tax will be levied under IRS Section 1411(a)(1) on some “net investment income.” This tax is designed to raise an estimated $210 billion to help fund Medicare and health care reform. The tax will apply to the lesser of “net investment income” or the dollar excess of “Modified Adjusted Gross Income over the applicable threshold amount”. The 3.8% tax applies in addition to any other taxes that otherwise would apply to the associated income.

It is not true, as some frightening emails have suggested, that the new tax is a sales tax on the total sale price, nor is it true that it will affect all home sales or even most home sales. It is not true, as the emails have reported, that it would cost an additional $3,800 (3.8% x $100,000) in taxes to sell a $100,000 home.

What is Net Investment Income?

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Frequently at gatherings I’m asked tax questions related to Canadians and their tax issues in the US. At a recent holiday gathering, a nice gentleman, who is a terrific interior designer in Calgary I believe, asked about the possibility of doing some interior design work for Canadians who also had a second home in California (most likely in the Palm Springs area). So he asked me, if he did some interior design work for Canadian customers in their California homes, would he be subject to US (and California for that matter) tax?

A terrific question, so let’s review….

First, Is it a Big Deal if the Canadian has to Pay US Tax to Do Business in the US? I Don’t Think So…

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On December 8th and 9th, Sanger and Manes spent a terrific weekend as sponsors at the CanadaFest at the Palm Springs Convention Center. I was amazed at how many Canadians came up and kept asking me the same question: “how many days a year can I stay in the US?” And frequently they would follow up with this supplement:”I heard if I leave the US and then return to the US in less than 30 days (like so many Canadians are doing right now as they go back to Canada for Christmas, but will soon come right back to the US in early January), then the days that I’m out of the US count in my six month computation, is that true?” Boy oh boy I thought, what is the Canadian rumor mill up to now? This is complete nonsense.

But was I right?

I Assumed They Were Asking About How Many Days a Canadian Could Stay in the US Under the US the Tax Law

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If you read my most recent post on the importance and (I think really) necessity that Canadian snowbirds obtain US individual taxpayer ID numbers an “ITINs”. Remember, Canadian snowbirds must complete an IRS Form W-7 to get a taxpayer ID number, but there’s only certain occasions when the IRS will actually comply and issue you one (such as when you fill out a US tax return or when you want to be relieved of the awful mandatory US tax withholding obligation on renting or selling US real estate). It’s now a good time to review the process for how the Canadian actually gets an ITIN.

What Documents Must the Canadian Snowbird Submit to Get an ITIN?

An original valid passport is the best document you can give. If you submit that, that’s all you need to give. If you don’t submit a passport, you’ll need multiple documents to prove both your foreign status and identity. The documents must be current, verify your identity (that is, contain your name), and support your claim of foreign status (that you’re from Canada). Among the group of documents which you may use are national I.D. cards, visas issued by U.S. Department of State, U.S. or foreign military identification card, civil birth certificates, medical and school records, U.S. state or foreign driver’s licenses, U.S. state identification card, foreign voter’s registration card and U.S. Citizenship and Immigration Services photo identification. Again, you’ll need multiple documents if you’re not using the passport.

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We are asked constantly by Canadians why they have to go through the pure drudgery of getting a US taxpayer ID number. And apparently, drudgery is absolutely the correct word as now the IRS wants to review either your actual passport, which is the best stand alone document you can provide (which means it may be out of your possession in the hands of the IRS for a few weeks), or a combination of a series of additional documents. We’ll talk in our next blog post about how you actually get the taxpayer ID number (via the Form W-7). But why does the Canadian snowbird need to get it? The answer is simple- it will cost you money if you don’t.

You will Need A Taxpayer ID Number to Avoid Mandatory 30% Withholding When You Rent Your US Property.

Without a taxpayer ID number, the Canadian Snowbird who rents US real estate must have the tenant or property manager withhold 30% of gross rent payments (and forward these amounts to the IRS). If the tenant or prop manager fails to withhold, the IRS will look to the Canadian for the withholding tax. However, if the Canadian snowbird completes a Form W-8ECI withholding certificate (which requires a US taxpayer ID number to get) and gives it to the tenant or property manger instructing them not to withhold, and then files the Form 1040NR tax return by June 15 of the next year, no withholding is required. This is a great option for the Canadian snowbird because it: (A) Allows the taking of deductions (e.g., property taxes, mortgage interest and depreciation) and (B) the tax rate is likely lower, much lower, than 30%.

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We continue our discussion on 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 many years (if ever). Again, this amnesty program offers really is peace of mind. If you haven’t been filing your US tax returns (or FBAR’s) for years, maybe you know (now) you have that obligation, but you don’t know how to “come clean”. This new amnesty program is your chance. Under the new amnesty program, for those who qualify, the IRS will not impose penalties nor conduct an audit. In order to “come clean” you must: (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 (there probably won’t be any US tax or interest); and (4) Complete and sign under penalties of perjury a 20-question questionnaire. In Part 1 of this series, we discussed how only Canadians who “reside in Canada” could take advantage of this new amnesty. In Part 2, let’s review some more of the unusual conditions of the new amnesty program.

The Taxpayer Cannot Owe More Than $1,499 in US tax in any of the tax years beginning in 2009 and ending on 2011.

We suspect this requirement generally won’t be problematic. Although the US does impose tax on income earned by its citizens and residents no matter where they earn it anywhere in the world (e.g., Canada), due to the tax credit system and the relief offered by the US-Canada Tax Treaty, as long as the taxpayer has been paying the appropriate tax in Canada he or she probably (although not certainly) won’t owe any US tax. So owing not more than $1,499 in US tax in any of the tax years beginning in 2009 and ending on 2011 is probably not a difficult hurdle to overcome.

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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.

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…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.

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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: