Failure to count days. Canadians who spend time in the United States, absent an exception, must be mindful that the number of days they spend in the United States could make them tax residents here. The result of becoming a United States tax resident is that all of the individual’s worldwide income is taxed here and the individual is subject to penalizing reporting and taxing regimes relating to interests in non-U.S. accounts, investments, retirement plans, companies, and trusts, among others.
The tipping point for becoming a tax resident in the United States is reached by obtaining a permanent resident visa (a green card), electing to be taxed like a resident, or failing the substantial presence test. The substantial presence test is where the days matter. The test is failed if the individual is present in the United States for more than 183 days during the year. With some exceptions that are beyond the scope of this post, each day in the United States counts, regardless of the amount of time spent here. The 183 number is reached by actually being in the United States for 183 or more days in one year, or meeting that amount on an averaging basis that takes all days in the current year, one third of the days in the first prior year, and one sixth of the days in the second prior year into account. The math works out that 122 or more days in the United States for three consecutive years will cause one to fail the test.
Thus, counting days is a must. Failure to monitor days present in the United States can have very negative tax results that are easy to avoid if one is aware of the issue.
Mismanaging real estate. Many Canadians purchase vacation property in the United States in their individual names. Though it is perfectly legal to do so, how the property is purchased has dramatic legal consequences that should be considered. First, ownership of property in one’s individual name exposes the property to the prospect that if the owner becomes incapacitated it may not be possible to sell or manage the property without court or legal intervention. Second, while some Canadians rely on a Canadian power of attorney to name an agent to step into their shoes should they become incapacitated, the effectiveness of the power of attorney may depend on United States considerations. Because the real estate is in the United States, the legal authority of the agent and thus the legal effectiveness of the power of attorney may be governed by the law of the State where the real estate is located–not Canada. Also, title companies in the United States, in the author’s experience, are reluctant to accept a power of attorney that is not specific to the exact real estate involved. And, title companies largely dictate the closing of real estate sales in the United States.
Renting out real estate. There is nothing illegal about Canadians renting out real estate in the United States, as a general matter. But, the tax effects of doing so can be harsh. When an owner is foreign and earns money from rent, special tax rules apply. First, the rental income is subject to a flat 30% tax on the gross amount of the rent that the renter is required to withhold and pay to the IRS. Second, absent an election to the contrary, the owner may not deduct expenses or depreciation against the 30% tax. An election can be made to treat the rental income as income from a United States trade or business (a so-called 871(d) election), but the owner must then file a United States tax return each year to report the rental income and claim deductions. The election is not automatic; the owner must make it affirmatively on a federal tax return. Failing to make the election can mean paying higher than necessary taxes in the United States on rental income.
Making gifts. The United States imposes a roughly 40% federal gift tax on all gifts of tangible property located within the United States. Residents of the United States (for gift tax purposes this means individuals domiciled here) and United States citizens are afforded a lifetime $11.4 million exemption from the federal gift tax (in 2019). That means United States residents and citizens can currently give up to $11.4 million in gifts without paying federal gift tax. Not Canadians. They can get away with giving up to $15,000 in gifts to each recipient each year of United States located tangible property and after that they are subject to the 40% federal gift tax. Gifts to non-United States citizen spouses are excluded from federal gift tax up to $155,000 (in 2019). These thresholds can be fairly low. For example, buying a car for a child now living in the States from their local dealership could trigger federal gift tax. One spouse purchasing an Arizona vacation home and putting it in the other spouse’s name could trigger federal gift tax. And, the tax is imposed on the giver of the gift, not the recipient.
Failing to plan for the estate tax. The estate of a deceased Canadian resident who owned property located in the United States is generally subject to the federal estate tax if that property is worth more than $60,000. The federal estate tax is roughly a 40% tax on the value of the United States located property worth over $60,000. A resident of the United States (meaning an individual domiciled here) or a citizen of the United States is afforded an $11.4 million exemption (in 2019) from the federal estate tax, meaning their estate can be worth up to that amount before they have any federal estate tax liability. The United States and Canada have an income tax treaty that attempts to resolve this disparity. The treaty provides that a Canadian resident is able to use a pro rated amount of the exemption that a United States resident or citizen gets. The pro rated amount is calculated as a fraction: date of death value of U.S. located assets/date of death value of worldwide assets.
There are three key issues. First, depending on the value of the deceased Canadian’s worldwide assets, the treaty may not afford a sufficient exemption to cover the value of the United States assets. Second, the treaty benefits must be claimed on a federal estate tax return (IRS Form 706, due 9 months after the date of death unless a 6-month extension to file is requested) that includes an IRS Form 8833 (the form used to claim the treaty benefit of the pro rated exemption amount). Third, in order to claim the benefits of the treaty, the estate must reveal the deceased Canadian’s worldwide assets to the IRS. Not all Canadians are thrilled with the idea of making that disclosure to a foreign government. The bottom line is, the federal estate tax is not a straightforward issue to handle and the failure to plan for it can open the Canadian estate up to federal estate tax liability.
Summary. While the United States welcomes Canadians (and their money) to its markets, Canadians should seek out competent tax and legal advice in the Untied States to avoid foot faults. Some of the foot faults are listed above, but there are others and they are not always apparent without familiarity with the legal and tax rules at play.