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How a U.S. resident can receive tax-free alimony from a Canadian

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While most people know that alimony is normally taxable income to the recipient and tax deductible by the payer, in the case of cross-border taxes, alimony can be received tax free while the payer still gets a tax deduction.

Let’s look at an example where this would apply.

Sarah is a U.S. Citizen who has been transferred to Toronto for a job opportunity. While living in Canada, she meets and falls in love with John, a Canadian citizen. After a few years of dating, Sarah and John decide to get married and live together in Toronto. Five years into their marriage, due to irreconcilable differences, they decide to divorce. Sarah chooses to return to the U.S. to live close to her family. As part of the divorce settlement, John must pay Sarah alimony.

Since John is a Canadian tax resident, he will be able to deduct the alimony payments to Sarah on his Canadian tax return. But with the right cross border tax planning, Sarah can exclude her alimony from U.S. tax. How? By including specific language required by the IRS in the divorce agreement. In our couple’s case, they would include language along the lines that John agrees not to deduct the alimony payments for U.S. tax purposes. Since John is a Canadian tax resident only, he is still able to deduct the alimony on his Canadian taxes and is not affected by the agreement.

While this is a very simplified example – the rules to make this legitimate are more complex – the fact remains that in Sarah’s case, a U.S. resident can receive alimony tax free for U.S. tax purposes. In John’s case, he also gets to reap the tax benefits from this strategy, unless he decides to take up a job in the U.S. and become a U.S. tax resident.

Income Tax Implications of RRSP Withdrawals as a Non-Resident of Canada

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A large number of the clients that we work with are those that move from Canada to the United States. In these cases, we spend quite a bit of time making our clients aware of the income tax implications of leaving Canada and establishing tax residency in the U.S. We have written many publications on this topic, including a recent article, “Moving from Canada to the United States: What You Need to Know.”

For many of these people transitioning from Canada to the U.S., some of their larger financial assets are held within their registered plans (RRSPs, LIRAs, RRIFs, etc.). Given that our firm is properly registered and licensed in both Canada and the U.S., we can provide ongoing financial planning, tax and investment management for our clients who choose to leave their registered assets in Canada.

By leaving these assets in Canada, continued tax deferral in Canada and most U.S. states will continue. The State of California, however, has a different set of tax rules that relate to registered plans that remain in Canada. See our article, “California Residents: Does Your Financial Advisor Tax-Manage Your RRSPs?”

As we develop our clients’ comprehensive Canada/U.S. financial plans, discussions and decisions with respect to taking distributions from their RRSPs for future lifestyle or retirement planning purposes are reviewed. For the vast majority of our clients, RRSPs continue to be managed by us through our Canadian institutional custodian until clients retire or are required to convert their RRSP to a RRIF.

However, what if one was looking to take a distribution from their RRSP as a non-resident of Canada prior to retirement, i.e. for the down payment on a new U.S. home or to meet current lifestyle requirements?

Let’s first review the tax impact of de-registering a Canadian RRSP before becoming a U.S. tax resident. As a resident of Canada, distributions from an RRSP are be subject to ordinary income tax rates depending on the province of tax residency. The bank or custodian holding the RRSP would be obligated to withhold tax upon the RRSP distribution at the following rates:

Withdrawal Amount % Federal Tax Withheld
From $0 to $5,000 10% (5% in Quebec)
From $5,001 to $15,000 20% (10% in Quebec)
Greater than $15,000 30% (15% in Quebec)

The withholding tax rates above would only be applied for those individuals who would still be considered tax residents of Canada. If one were to become a U.S. tax resident or non-resident of Canada, the Canadian withholding tax imposed on distributions would be 25%. Under Article XVIII(2) of the Canada-U.S. Tax Treaty, distributions from RRSPs/RRIFs can be reduced to 15% under certain and very specific guidelines. This would generally only be the case if one was to convert their RRSP to a RRIF and take periodic distributions from the RRIF. Under the Canada-U.S. Tax Treaty, this would include payments out of a RRIF where the total amount paid in the current year does not exceed twice the “minimum amount” and 10% of the value of the RRIF at the beginning of the tax year. The “minimum amount” is determined by a percentage factor based on the RRIF holder’s age at the beginning of the tax year.

Some Canadian financial advisors and individuals believe that the above table of withholding tax rates would be applied irrespective of Canadian and U.S. tax residency, which is incorrect. If the departure planning is done properly, then the Canadian institution should have the correct U.S. address on record and the tax residency indicated as a non-resident of Canada. This would generally be acknowledged by the bank or custodian via the completion of CRA Form NR301 and IRS W-9 form at the time the account becomes tagged as a non-resident of Canada account. Therefore, a 25% Canadian withholding tax would apply for lump-sum distributions.

If the individual or advisor still maintains a Canadian address on the account while claiming to no longer be a tax resident of Canada, they are opening themselves up for a number of issues. For example, the ability of an advisor to properly and legally manage registered accounts can be problematic, and so can the indication to CRA that Canadian residency is maintained (though the use of a Canadian address) when a previously filed Canadian tax return indicates a date of departure from Canada.

In some unique situations, former residents of Canada might be able to file a Canadian income tax return as a non-resident under Section 217. Filing a return under this election allows a non-resident to file a Canadian tax return if it would be beneficial for them to do so. In this case, the non-resident taxpayer would be able to claim the same deductions and credits as that of a traditional Canadian taxpayer. There are limited reasons for a non-resident to make this election. One reason is when an individual has a non-working spouse in the U.S. with, for example, $50,000 in their RRSP. In this case, the individual could withdraw the RRSP tax free over five  years without paying any Canadian income tax. Conversely, if the non-working spouse withdrew the $50,000 in a lump sum, there would be a 25% withholding tax imposed at the time of distribution.

As part of our comprehensive wealth management process, and based on our clients’ specific financial planning objectives, we can provide an RRSP distribution analysis to review the options available and the related Canada and U.S. income tax results. Further, because we manage our investment and retirement accounts on a Canada/U.S. tax-effective basis (we understand tax!), we can ensure that withholding tax paid in Canada can be recovered over time through proper portfolio and tax management.

 

 

Thinking About Moving to Canada? What You Need to Know

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Irrespective of where you stand politically, the circus currently playing out in the contest for the next President of the United States has a number of Americans—both Democrats and Republicans—looking at options that might include leaving the United States and moving to Canada.

Indeed, by midnight of March 1—Super Tuesday in the United States—searches for “How to move to Canada” had spiked by 1,500%, according to Google Trends.

For some, leaving the country might seem rather extreme. However, we get it!

At Cardinal Point, many of us have a stake in the direction of our political system in both Canada and the United States. And we are intimately aware of the unique immigration, financial, tax, investment and estate-planning implications of becoming an American in Canada. We understand the immigration options and the challenges those decamping for the north might face.

Before Americans hop into their cars, fill their gas tanks (in gallons) and make their way to Canada, they first need to be aware that one can’t simply show up at the Canadian border and expect to live and work in Canada. Like the United States, Canada has a formal immigration process that must be adhered to.

In order to live and work in Canada, you might be able to secure your immigration via one of a number of business and family categories.

Canada’s family immigration laws differ from those of the United States. Notably, you cannot just marry a Canadian citizen and expect to automatically become a Canadian citizen. A formal process must be adhered to before a spouse of a Canadian citizen can live permanently in Canada and ultimately seek Canadian citizenship.

http://www.cic.gc.ca/english/helpcentre/answer.asp?qnum=357&top=5

If you are already employed in the United States, your occupation might qualify you for one of Canada’s Skilled Worker Entry programs. This would entitle you to a visa to live and work in Canada. And depending on your work or trade, you might be entitled to the new Express Entry application process.

http://www.cic.gc.ca/english/immigrate/skilled/index.asp

If you are self-employed in the United States, you might be able to qualify for business immigration to Canada under the Self–Employed Person program. If you have a specific occupation that fits into the Government of Canada’s Arts and Culture or Technical and Skilled Occupations in Art, Culture, Recreation and Sport, you might be able to immigrate to Canada under that program.

http://www.cic.gc.ca/english/immigrate/business/self-employed/index.asp

Under the Provincial Nominee Program (PNP), Canadian provinces and territories are allowed to nominate persons who wish to immigrate to Canada and who are interested in settling in a particular province. Each Canadian province – except Quebec – have agreements with Citizenship and Immigration Canada (CIC) that have developed programs to welcome certain nominees to settle and work in the province and contribute to the community.

http://www.cic.gc.ca/english/immigrate/provincial/index.asp

If you would like to start a business in Canada, you might be entitled to apply for the Start-up VISA. You would have to have a Letter of Support from a designated angel investor group, venture capital fund or business incubator. You must also meet specific ownership requirements in the business. Get scores of at least 5 in the Canadian Language Benchmark test in either English or French and finally meet sufficient settlement funds based on the size of your family.   You also must be able to secure a minimum investment of $200,000 from a designated Canadian venture capital fund or $75,000 from a designated Canadian angel investor group. No investment is required if you are accepted into a Canadian business incubator program.

http://www.cic.gc.ca/english/immigrate/business/start-up/eligibility.asp

The immigration process is definitely the first hurdle that you would have to overcome before entering Canada. It is a process and for some could be a rather costly one as well.

Working with appropriate Canadian immigration counsel, the advisors at Cardinal Point are well-positioned to assist you in partnering with the right attorney through this process.

But beyond the immigration hurdle, if you remain a U.S. citizen, you would still be considered a resident of the United States for income, gift and estate-tax purposes. So if you were hoping to avoid the tax policies of the previous and next administration, I’m afraid you’re out of luck.

As a U.S. citizen, you would be required to continue to file U.S. income-tax returns on your worldwide income (even if that income is only now in and from Canada). And you would have to comply with a number of other foreign reporting and compliance requirements.

Furthermore, as a resident of Canada, you would also be subject to tax in Canada on your worldwide income, including any income that might continue to trickle in from the United States.

Although both countries would have the right to tax you on your worldwide income, you would be entitled to apply foreign tax credits against the same source of income to help to reduce the perceived exposure to double taxation. However, without proper tax planning upon entering Canada, and without continued ongoing planning, you could find yourself exposed to double taxation and a number of nasty tax surprises.

Fortunately, we have the unique expertise to assist you so that you can enjoy the Canada-U.S. lifestyle.

To that end, we would encourage you to request our Cardinal Point White Paper: Manage your Canadian and U.S. cross-border lifestyle.

This paper will provide you with additional insight into how a Cardinal Point cross-border financial advisor can assist you with your unique cross-border financial planning complexities.

And if it does not make sense to move to Canada, bear in mind that our offices in the United States can provide you with comprehensive, U.S.-only wealth management services.

Estate Planning: Uncle Sam’s Nasty Surprise for Non-U.S. Citizen Spouses

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Are you a U.S. citizen married to a non-U.S. citizen? Or, are you and your spouse both green card and/or U.S. visa holders living in the United States?

If so, then you’ll want to be aware of U.S. estate-tax rules that, without proper planning, can result in an outsized tax bill.

married-taxes Recently, we started working with an American client who has a significant estate and lives and works in the United States. His wife is a Canadian citizen and U.S. green card holder, but not a U.S. citizen. The couple does not have kids.

In a recent tax-planning session, our American client was shocked to learn that any gifts between he and his wife may be subject to tax rates as high as 40%. The same high tax rate may apply to any inheritance left by a deceased spouse to the surviving spouse. Our client’s surprise was understandable, because the rules are very different for couples who are both U.S. citizens.

Most Americans leave the bulk of their estate to their surviving spouse, because most of it can be transferred without tax consequences. In particular, under the “unlimited marital deduction,” if a person leaves his or her estate to a spouse, there is no estate tax on the transferred property, regardless of the size of the estate.

Simply put, the IRS is willing to wait until the second spouse dies before levying an estate tax. Similarly, married couples are free to make unlimited inter-spousal gifts without incurring gift taxes.

By the way, because of the U.S. Supreme Court’s recent DOMA decision, same-sex couples can now join heterosexual couples in transferring as much of their estate as they like to their spouse, free of gift or estate taxes. The catch is that both spouses must be U.S. citizens.

The IRS sees things differently when it comes to transfers in which one spouse is not a U.S. citizen. The “unlimited marital deduction” treatment does not apply to a foreign spouse because the IRS is afraid the non-citizen spouse will move to another country, thus avoiding U.S. gift and estate taxes altogether.

Without the availability of the marital deduction, current law permits the first $5,430,000 (adjusted for inflation) of assets to be transferred tax-free. In other words, an inheritance left to a non-citizen spouse is subject to a 40% estate tax after the $5,430,000 lifetime exemption is used up.

So what should you do if you are married to a non-citizen and your estate is above the exemption threshold?

Let’s use our clients as an example. The wife could become a U.S. citizen prior to the husband’s death. Or they could establish a qualified domestic trust (QDOT). A QDOT defers the estate tax until the death of the foreign spouse, and allows for an annual income stream to be paid to her. Moreover, it can buy time for the surviving spouse to acquire U.S. citizenship.

Gifting strategies can also be used to transfer a certain amount of assets to the non-citizen spouse each year (the 2015 limit is $147,000). This will gradually reduce the size of the U.S. citizen’s taxable estate while protecting them from federal gift-tax liability.

Alternatively, if certain conditions are met, our clients can take advantage of the marital credit under the Canada-U.S. tax treaty. This option, however, can’t be used in conjunction with the QDOT deferral.

As our clients learned, there are certain planning strategies and legal structures that, if set up in advance, can help cross-border couples avoid losing up to 40% of their wealth through unnecessary taxes.

If you would like more information about this topic, or to discuss your own unique situation, please contact us today for a confidential consultation.