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Financial advisors prepare clients who are US persons living in Canada and Canadians who own US assets for proposed changes in US tax law that could materially affect the portfolios of these investors.
The administration of US President Joe Biden has proposed a handful of changes aimed at getting richer US people to pay more taxes. The main suggestions include:
- Increase in the top tax rate from 37 percent to 39.6 percent for US persons with a personal worldwide annual income of more than $ 400,000.
- Increase in the highest return on capital for those with annual income greater than $ 1 million from 20 percent to 39.6 percent. (Not including the 3.8 percent “Obamacare tax” on investments, which increases the return on investment ratio from 23.8 percent to 43.4 percent.)
- Abolition of an existing tax relief in the event of death (known as a “step-up-in-basis”) that allows for tax-free transfer of valued assets to heirs. The proposal stipulates that any gain in excess of $ 1 million per taxpayer will be taxable, plus an additional $ 250,000 gain for a primary residence.
- Restore US inheritance tax exemption to $ 3.5 million as it was in 2009 from the current $ 11.7 million, a rate that will expire in 2025; and decoupling the lifetime gift tax exemption from US inheritance tax and setting the exemption at $ 1 million.
The proposals were not approved by Congress and adoption is far from certain. Nonetheless, advisors are developing strategies with clients who may be affected by these or other suggestions that may arise as governments seek ways to raise funds to fund pandemic spending programs.
“We have told our clients that they need to prepare for a general increase in taxation and additional tax complexity and innovation,” said Darren Coleman, senior vice president, private client group and portfolio manager, Coleman Wealth, a division of Raymond James Ltd . in Toronto.
One of the misunderstandings among investors is that they believe the proposed tax changes will only affect the ultra-rich, he says.
“Some of these proposals will be fundamental changes to US tax laws that will involve a tremendous number of [U.S. persons], and I don’t think many of them will see any of them coming. “
One example is the removal of the “step-up-in basis,” which is the altered value of an inherited asset in order to minimize the beneficiary’s capital gains tax, which Coleman says can affect more middle-class and ultra-rich people.
Shlomi Levy, partner and attorney at Montreal-based cross-border tax and estate advisory firm Levy Salis LLP, says U.S. residents living in Canada would be subject to U.S. capital gains tax on the unrealized capital gains on their global wealth, like U.S. inheritance tax, even if they died in the event of death.
The proposed US capital gains tax rules would likely apply to Canadians who own US assets, including real estate and securities, even if they are held by a Canadian bank or investment firm.
And while the Canada-US tax treaty may include foreign tax credits to avoid double taxation, it still requires filing a US tax return and mandatory reporting of assets greater than $ 60,000 in the event of death.
The proposed hike in capital gains tax could have a dramatic impact on US wealthy residents living in Canada who are selling assets during their lifetime, Levy adds.
That’s because its top tax rate of 43.4 percent would be almost twice the top Canadian tax rate on capital gains, which is closer to 27 percent today. He also notes that the change would be retroactive to May 28, 2021.
Although the Canada-US tax treaty has a number of exemptions, deferral mechanisms, and foreign tax credits that may be available to reduce exposure to the new U.S. capital gains tax rules in President Biden’s proposals, Levy says their complexity requires a great deal of additional tax planning and tax filings .
Terry Ritchie, vice president and partner in the Calgary office of Cardinal Point Capital Management Inc., believes the polarization within US Congress is unlikely to change gift and inheritance tax laws in the near future.
However, he says increasing the highest income tax rate and capital gains rate, including removing the “step-up-in-base” in the event of death, could stand a chance of going through a process known as a budget reconciliation that will allow a Senate majority to Enforce laws.
The process has been used multiple times in the past, including by former presidents: Bill Clinton to raise taxes and Donald Trump to lower taxes. President Biden has used it once so far to pass a $ 1.9 trillion pandemic relief package.
While all suggestions are in the air, Mr. Ritchie has helped clients who may be affected consider various planning options, including asset sales or adding to “tax-deferred accounts” that US persons have access to, such as z and Retirement accounts.
“We have to adjust to many moving goals here,” he says.