The Most Common Cross-Border Tax & Financial Planning Mistakes. What Advisors Need to Know

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1 The Most Common Cross-Border Tax & Financial Planning Mistakes. What Advisors Need to Know The Canadian Institute of Financial Planners 6 th Annual National Conference Terry F. Ritchie, CFP, RFP, EA, TEP Certified Financial Planner (US) Registered Financial Planner (Canada) Enrolled to Practice before the U.S. Internal Revenue Service Trust & Estate Practitioner (STEP) Transition Financial Advisors Group Calgary, AB & Phoenix, AZ

2 Learning Objectives U.S. Income, Estate & Gift Tax Basics New Developments in U.S. Estate Tax Cross-Border Estate Planning The Implications of Giving up U.S. Citizenship Other Common Planning Issues you need to be aware of Questions

3 Living Desired Lifestyle Values, Beliefs, Goals, Objectives Client, Spouse, Children, Grandchildren, Relatives Financial Advisor Comprehensive Overview Cash Mgmt Income Tax Independence & Education Planning Risk Mgmt Estate & Charitable Planning Investment Planning Customs Planning Immigration Planning - Currency Exchange - Mortgage broker -Banker -Realtor -Auto Dealer -CPA/CA -Tax Attorney - Bookkeeper - IRS/State - Canada Revenue Agency - Province -Actuary - Administrator - Social Security -Custodian - Social Development Canada - Insurance Agents: Prop./Casualty Life Disability Health Long-term Care - Provincial healthcare -Medicare - Estate Planning Attorney -Trust Administrator - Estate/Gift tax Accountant -Charities -Custodian -Trustee - Mutual fund manager/co. - Brokerage firm - Investment Manager -US Customs - Canada Customs & Revenue Agency - Moving Co. -Immigration attorney -US Citizenship & Immigration Services -Citizenship & Immigration Canada Transition Financial Advisors Group

4 Where was your Client Born? If born in the US, irrespective of where they physically live or die: Considered resident of US for income, gift & estate tax purposes Taxed on worldwide income Taxed on FMV of worldwide estate at death Subject to US gift tax on the transfer of property by gift, direct or indirect, in trust or otherwise.

5 Income Tax - US Citizens Subject to tax on worldwide income Required to annually file IRS Form 1040 Foreign earned income exclusion U$85,700 Foreign tax credits Specific tax treaty elections Alternative minimum tax Additional onerous tax filing requirements

6 Estate Tax - US Citizens Subject to tax on FMV of worldwide estate at death Presently entitled to an exemption of U$2 million $2,000, $3,500, Estate tax repeal? I ll come back to this $1,000,000

7 Estate Tax - US Citizens Presently subject to highest rate of 45% for estates greater than U$1,500, % Top individual rate %

8 Gift Tax - US Citizens Annual exclusion of U$12,000 Lifetime exclusion amount of U$1,000,000 Gifts to US non-citizen spouse subject to an annual exclusion of U$128,000 Filing of US gift tax return - IRS Form 706 Either: Pay the US gift tax - preserve exemption amount Reduce exemption amount available at death because of taxable gift

9 The Future U.S. Estate Tax Year of Death U.S. Taxable Estate of $4 Million U.S. Estate Exclusion U.S. Estate Tax 2008 $2,000,000 $900, $3,500,000 $225, Repealed? $ & Beyond $1,000,000 $1,495,000 How do you plan for this?

10 U.S. Estate Tax Uncertainty There are now 7 Bills before the U.S. House and 4 before the U.S. Senate to repeal the Estate Tax Further, there are 7 Bills before the House and 1 before the Senate to modify the Estate Tax Proposed Exemption Changes (currently $2M): $3M (HR 4235, 4242) $3.5M (HR 4042, 4172, 4242) $5M (HR 3475) from $3.75M to 5M by 2016 Proposed Tax Rates (currently 45%): Reduce rates by 20% (HR 4235) Back to 47% rate (HR 4242) Keep at 45% (HR 4042)

11 U.S. Estate Tax Uncertainty Why we likely will not see an Estate Tax Repeal Loss of revenue Iraq, global terrorism, economy sucks, etc. Decline of lifetime charitable donations Loss of capital gains tax revenue The elderly would likely keep assets until death, than sell them prior to death

12 Cross-Border Will Planning Issues US citizen couple resident in Canada Leaving all assets outright to the surviving spouse causes the first spouse s Unified Credit to be lost Tax Planned Will should focus on: Utilizing the decedent s Unified Credit Unified credit represents the tax on the exemption amount ($780,800 tax = $2,000,000 exemption) Often through the use of a Credit Shelter Trust Can be achieved in a Canadian Will

13 US Citizen Couple in Canada A/B Trust Planning (aka Credit Shelter Trust, Bypass Trust, Marital Trust, Family Trust) A TRUST (Surviving Spouse s Trust) DEATH OF THE SECOND SPOUSE HEIRS (Beneficiaries) DEATH OF THE FIRST SPOUSE B TRUST (Deceased Spouse s Trust)

14 Cross-Border Will Planning Issues Canadian married to a US citizen Often may wish to leave all assets to the surviving spouse This causes those assets to be subject to US estate tax upon the subsequent death of the surviving spouse Therefore, Canadian decedent s assets could ultimately be taxed as part of the US surviving spouse s US estate

15 Cross-Border Will Planning Issues Canadian married to a US citizen Tax Planned Will should focus on: Keeping the Canadian s assets out of the US citizen surviving spouse s estate Often through the use of a Spousal Trust The terms of the Spousal Trust must be limited in order to keep the trust from being included in surviving spouse s US gross estate May provide for annual income to surviving spouse Principal distributions at trustee s discretion - surviving spouse cannot be given unfettered access

16 Cross-Border Will Planning Issues US citizen married to a Canadian citizen No US Unlimited Marital Deduction is available if a US decedent s assets pass to a Non-US citizen Possible immediate US estate exposure

17 Cross-Border Will Planning Issues US citizen married to a Canadian citizen Tax Planned Will should focus on: Funding of Bypass Trust up to the exemption amount available in the year of death Excess should pass to a Qualified Domestic Trust (QDOT) Election can be made through will or on decedent s estate tax return QDOTs create administrative hassle, but allow for deferral of US estate tax until: Corpus is distributed from the QDOT to the non-us citizen surviving spouse, or Until the death of the surviving spouse

18 Incorrect Use of Beneficiary Designations Based on the Will planning issues that we just discussed: It may be more appropriate to name the estate as beneficiary Ensures that the trust planning within the Will will be achieved Bypass trust planning

19 My Client is a Dual Citizen Individual is both a citizen of the US and Canada Not directly recognized through US Immigration (USCIS) Client would be a dual resident for income tax purposes Required to file both Canadian and US income tax returns on worldwide income Considered resident of the US for estate and gift tax purposes

20 Client Should Just Give Up US Citizenship U.S. tax law changes of Oct. 04 introduced substantial changes to expatriating individuals U.S. citizens who renounce citizenship Reed Amendment although never yet enforced, may bar expatriating U.S. citizens from re-entering the U.S. Long-term residents Green Card holder in at least 8 of last 15 years Residency under Substantial Presence Test Provision applies for a period of 10 years following date of expatriation Referred to as the Alternative Tax Regime

21 Client Should Just Give Up US Citizenship The Alternative Tax Regime: Requirement to file IRS Form 1040NR along with IRS Form 8854 annually for 10 years Failure to file penalty of U$10,000 Includes US source income under special sourcing rules Cannot be physically present in the U.S. for more than 30 days of the 10 calendar years after expatriation: Worldwide income tax Gift tax Estate tax (don t die in that year!)

22 Client Should Just Give Up US Citizenship The Alternative Tax Regime applies to any expatriate who: 1. Had an average tax liability in previous 5 years of $139,000, or 2. Has a net worth of U$2M or more, or 3. Has not filed U.S. tax returns for the prior 5 years Number 3 is generally where most U.S. citizens in Canada will get caught!

23 Client Should Just Give Up US Citizenship Last July 18, the U.S. House introduced legislation which includes a proposed exit tax for individuals who expatriate from the U.S. Deemed sale of property upon expatriation Generally applies to all property interests, exclusive of U.S. real property and special rules in the case of trust interests. Fairly generous exemptions are proposed on gains not exceeding U$600,000 ($1.2 M for expatriating married couples) Canada are you listening!!!!!

24 Jointly Held Assets Could compromise estate planning opportunities under tax planned Will Presumption is that 50% of value forms part of the first to die s estate True for US citizen couple Not true for non-resident aliens Tracing rule would apply Gift deeding could make sense Be aware of annual gift tax exclusion guidelines Be careful of jointly held assets with children

25 My Clients Are Applying for US Green Cards Canadian departure planning is critical Timing of departure to coincide with Canadian non-residency tax status When are spouse and children leaving Canada? Determination of Cdn residency is a facts and circumstances test Deemed disposition of assets for Canadian tax purposes Physically sell assets to step-up cost basis for US purposes Treaty relief now Crystallization of RRSPs Can client maintain Cdn investment accounts as a nonresident of Canada?

26 My Clients Are Applying for US Green Cards US Entry Planning Cost base of certain property is the same as original cost in Canada unless specific elections are made Timing of US income tax residency relative to Canadian departure Specific first year US income tax elections should be considered Family US Individual Taxpayer Identification Numbers (ITINs) need to be acquired US residents for gift and estate tax purposes? Role of Inter Vivos Trusts in the US

27 Issues Related to Life Insurance Need to be aware of the US rules related to incidents of ownership to avoid life insurance proceeds from forming part of the decedent s worldwide estate: The right to change beneficiaries or their shares, The right to surrender their policy for cash or cancel it, The right to borrow against the policy reserve, The right to assign the policy or revoke assignment Could form part of the non-resident decedent s worldwide estate Could therefore minimize US pro-rated unified credit Consider alternative ownership arrangements Utilize an Irrevocable Life Insurance Trust (ILIT) Subject to 3 year rule

28 My US Citizen Client Does Not File US Taxes US tax rules are clear with respect to US income tax residency for citizens In majority of cases, nothing more than an administrative burden Foreign earned income exclusion (U$85,700) Foreign tax credits Loss of specific Tax Treaty elections Penalties for non-compliance Family member requires or desires US immigration sponsorship Become beneficiary of US assets Desire to retire or spend greater time in the US Automated Entry/Exit System? IRS/USCIS start sleeping together?

29 My Client Wants to Buy US Real Estate Vacation vs. Commercial Property Income type objective: Rental and/or capital gain Canadian tax issues New purchase vs. existing real estate

30 My Client Wants to Buy US Real Estate US income tax on rental income US branch tax on unreinvested income US capital gains tax on sale US estate tax on death

31 My Client Wants to Buy US Real Estate Generally, a trade-off based on results Non-US investors in US real estate typically have to decide to: 1. Pay higher US corporate taxes (to insulate from US estate tax), OR 2. Accept some level of US estate tax risk for current US income tax savings 39% (Corp) vs. 15% (US LTCG Rate)

32 Additional Issues US tax compliance related to RRSPs held by US citizens Sale of US real property by non-resident US withholding tax issues Income tax filing and reporting (Canada & US) Bringing US retirement plan assets to Canada US citizen/cdn resident with a CANCO Estate freeze in Canada US anti-deferral rules Cross-Border Social Security Benefits Stock Options

33 Our Suite of Resources Call (480) or check out

34 Thank You Terry F. Ritchie, Calgary Office Arizona Office 116 Mt. Apex Green SE 20 W. Juniper Ave., #101 Calgary AB T2Z 2V5 Gilbert AZ 85233

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