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Slip into something more comfortable and delve into personal finance with Josh Sheluk and Colin White, experienced portfolio managers at Verecan Capital Management. Each episode demystifies complex financial topics, stripping them to their bare essentials. From investment strategies and financial planning to economic headlines and philanthropic giving, delivered with a blend of insight, transparency, and a touch of humour. Perfect for anyone looking to understand and navigate their financial future with confidence. Subscribe now to stay informed, empowered, and entertained.
Verecan Capital Management Inc. is registered as a Portfolio Manager in all provinces in Canada except Manitoba.
Welcome to Barenaked Money, the podcast where we strip down the complex world of finance to its bare essentials.
Matthew Kempton:Welcome, and thank you for joining us. I'm Matt Kempen. I'm here with my colleague, Devin Catalan. We're both portfolio managers in Canada and The U S here with Verecan. We work with business owners, executives, retirees, and families who have ties to both Canada and The United States, helping them coordinate their investments and financial plan on both sides of the border.
Matthew Kempton:Today's episode is for business owners who are thinking about moving between Canada and The US. We're going to be talking about what actually happens to your company, your tax bill, and the planning you've already done when you change tax residency. We're fortunate to be joined by the perfect guest to speak on this topic, Todd King, who leads the tax practice at Baker Tilly and specializes in cross border work. He works with business owners on both sides of the border every day. Today, we'll be walking through two journeys, a Canadian owner leaving Canada and a U S owner arriving in Canada.
Matthew Kempton:Todd, welcome, and please say hello to our listeners and share any more you'd like on yourself, your team and the specialized work you do.
Todd King:Thanks. And thanks for having me. I lead the tax practice at Baker Tilly, Nova Scotia. That's a group of about 30 people. 20 of us specialize in what I would call cross border private client services.
Todd King:So a lot of people crossing borders oftentimes with a lean towards the complex side of that business, whether it's sort of cross border entity planning, cross border estate planning, things of that nature. But we also have like a fairly sizable T1 1040 practice. A lot of US citizens resident in Canada, that type of focus.
Devin Cattelan:Well Todd, can you start a little bit, like start from high level in terms of the different tax regime between Canada and The US? Cause there's a different way that tax is exercised in both of those countries. And can you talk a little bit about the differences and how it may impact people depending on residency?
Todd King:Sure. Yeah. I mean, I think it surprises a lot of, I mean, are lot of very similar features to both systems. You know, it's a graduated rate tax system. So the more you make, higher tax rate you pay on that incremental income.
Todd King:But the foundation of the systems are fundamentally different in that Canada, like most countries in the world taxes its residents. So in Canada, doesn't really have a definition for residency. So it's sort of a facts and circumstances. Individuals who ordinarily reside in Canada are taxable on their worldwide income. So regardless of where earned.
Todd King:On The US side, they have what's called a citizenship based taxation system, but they also tax residents as well. So if you're a US citizen, regardless of where you live in the world, you're taxable on your worldwide income. If you're a US permanent resident, again, regardless of where you live, a lot of green card holders living in Canada, some of them have had green cards for thirty years and kind of forgotten about them. They're still taxable on their worldwide income to The United States. And then of course they do.
Todd King:They also tax residents, but The U S has more of a bright line definition of resident, which is a days based test, sort of a, there's a weighted average calculation over the last three years. If you exceed a certain threshold of days, then you're considered a resident for US tax purposes. Like any cross border situation, the treaty between two countries always comes into, comes to bear. In our case, we have a very robust Canada US tax treaty. There's a residency tiebreaker article which can modify what I just said.
Todd King:But generally not for Us citizens resident in Canada, which is probably the majority of the work that we do is for them.
Matthew Kempton:Someone may have forgotten about their green card, but the IRS hasn't forgotten about them. Basically the IRS, if you're a US citizen you're you're still filing required. Yeah and how do things change so someone someone moves they do change their residency how is especially for business owners why is that such a such a key pivotal moment tax wise and planning wise?
Todd King:What I say is you're not just doubling the complexity by moving to a new country. So you're a US citizen, you're moving to Canada. You're not just doubling the complexity. It's like a quadrupling of the complexity because you're not just managing within each system. You're trying to avoid double taxation by sort of integrating the two systems.
Todd King:It takes a lot of experience and a lot more sort of thinking in order to do that. So, I mean, the changing of residency, again, depends on your particular situation. Let's jump to Canada as an example, because Canada only taxes its residents. If you move to another country permanently or sort of indefinitely that you become a non resident of Canada and there are implications to that, right? So you stop paying tax to Canada, except on certain types of income, like income from real property or a business operated in Canada or employment exercise in Canada, but you're then taxed as a non resident.
Todd King:So when you cease residency, we have something that's a bit of a surprise. And I think we'll probably get to later on surprise for a lot of people. Have this departure tax Canada's sort of last kick at the can in terms of taxing you on everything when you depart, which is a bit of a gotcha for a lot of business owners in particular.
Devin Cattelan:What are some of the issues that particularly pop up with business owners when they leave Canada going to The US?
Todd King:Sure. Yeah. Mean, most people would be familiar with the concept of a capital gain. You have property, you've bought it for $100 you sell it for $200 you realize a capital gain of $100 And in Canada, we make it more complicated. So that gain is only half included in your income.
Todd King:We call that a 50% inclusion rate. And then that taxable capital gain is taxed at your marginal tax rate. When you depart, you're effectively deemed to have disposed of everything that you own at fair market value. So, which again, that sounds bad and it can be very bad. At the end of the day, things that are excluded from the departure tax is the sort of term we use to describe that tax implication or those rules.
Todd King:Canadian real property, obviously you can't take it with you. So Canada has a mechanism to tax non residents on the ultimate sale of, or income earned on Canadian real property. And also there are a bunch of things that are sort of scoped out called excluded rights or interests, things like TFSAs, RESPs, RRSPs, some interests and trusts, those types of things that would not be subject to departure tax. But if you're a business owner and you have a company that's worth $10,000,000 and you cease to be a Canadian tax resident, you're probably looking at a 33% tax bill. If you sort of paid nothing for those shares, they're now worth $10,000,000 notwithstanding any capital gains exemption claims or anything like that, which is a huge issue and a huge surprise.
Todd King:Oftentimes it's so significant that business owners were like, okay, that's too much. Right? I can't handle that because oftentimes the cash isn't there to pay the tax.
Matthew Kempton:This isn't a new taxes and kind of saying a tax grab. It's simply, this is you've, you've made a gain you you've earned and it's just, it's now that you're leaving. We want the money today.
Todd King:That's right. I mean, and it's, I mean, it's, it makes sense and it ties into this residency based taxation. It's like the other side of that rule. So if you're a US person coming to Canada or anywhere abroad really coming to Canada, you're deemed to have acquired everything at fair market value immediately before you become a Canadian tax resident. So we call that you get, and you get what's called a step up in cost base.
Todd King:So, if you're a US person and you have shares of Apple that have done very well over the last twenty years and you paid $100 a share for them and now it's worth whatever, 500 a share, then you now have a cost base for Canadian tax purposes of $500 a share. So Canada doesn't want to tax gains that accrue prior to commencing residency. They want to tax the gains that accrue during your residency period. But if you come in and then you leave, then you're subject to Canadian tax on that differential. Or if you're just born and raised Canadian, you've always been a Canadian tax resident and you depart, you're subject to any gains that accrue to you that have been unrealized up to the date of departure.
Devin Cattelan:So, I mean, that can be quite significant because a lot of business owners, they have the majority or a good chunk of their wealth in the operating business in the business itself. So trying to plan around that could, is, can be pretty important, especially like if you mentioned, you don't have the liquidity, like you said earlier. What are some of the ways that you can like navigate that? Like what are some of the planning techniques that you can do for someone who has an operating business or Holdco when they leave for Canada to The U.S.
Todd King:Yeah, I mean the bail, let's say stick with the operating business and you know, the silver bullet, let's say if it's a smaller operating business and a couple have owned the shares fiftyfifty and it's worth $2,000,000 and it is truly an active business. We have this capital gains exemption in Canada. That capital gains exemption can be very useful in this regard in that it is effectively, if you meet certain requirements, if you held the shares for the right length of time, and if the assets inside the company meet certain tests, then, and you have access to the capital gains exemption, you haven't used it before, then you can shelter up to, I think now it's about $1,300,000 per individual. But again, you mentioned planning, like that kind of planning has a very, very long lead time because you have to have the value in each individual's hands to kind of fit within that. And that takes planning.
Todd King:I mean, that's where something like a family trust, if it was implemented ten years ago would look brilliant. Trusts are very effective tools in this regard. Trusts have been falling a bit out of favor because of the complexity and reporting requirements associated with them recently. But the flexibility that they provide in a situation like this is significant. One, you basically can, if you have all of that value that I referred to has accumulated inside a trust, a family trust, discretionary family trust, you can effectively put that value in individuals' hands to line up with the available capital gains exemption and entirely shelter it.
Todd King:Right. You can also trusts are taxed as individuals and they are trusts are considered resident effectively where management and control resides. So to the extent an independent trustee managed that trust, it would be possible, not easy, but possible to maintain Canadian residency for the trust. So you could actually depart as a beneficiary of the trust and have the trust remain resident of Canada and entirely avoid the departure tax. Now, say avoid, defer the departure tax, right?
Todd King:Because eventually it's going to come to roost if you sell, if the trust distributes to you as a non resident, all of those scenarios. Or if the trust hits its twenty one, these trusts only survive for twenty one years without paying capital gains tax. So that's another sort of taxation moment that you'd need to be aware of in that planning. Outside of that, mean, there's a lot of sometimes if it's really small and maybe you have an investment portfolio and you're paying departure tax on all the gains that have accrued inside that, but maybe you haven't maxed out your RRSP room, then you can sort of cash out the investments, trigger gains, contribute to your RRSPs to shelter the tax. Like there are sort of more bespoke kind of techniques depending on the individual's situation.
Todd King:And then the other silver bullet, let's say is posting security. Like there is, there are rules that allow effectively you to post security for the departure tax. It sounds amazing. In fact, the tax, so effectively the tax gets triggered. The departure tax gets triggered at the time, but the tax doesn't get paid until the assets are sold.
Todd King:So if it's shares of a company, if they're ultimately sold, you'd pay the tax then. And it's a really good deal because there's no interest on that tax in the intervening period. So it sounds great. However, you effectively have to post a letter of credit with a bank, which is like you kind of have the cash if you're doing that, or you post the shares as security. They will accept and negotiate private company shares as security.
Todd King:But again, you can imagine you're effectively, you've got CRA as a shareholder in your company and a lot of business owners don't like the idea of that. So oftentimes that's
Matthew Kempton:the sort of like option of last resort. So exit tax can be a scary thing and it can be a significant thing, but calling your team early can planning can make a can have a very different result with good planning and long lead time. Sounds like you have maybe some stories, example, stories of a case where the call came too late and something could have been done and there could have been a different result in terms of an exit tax or ones that have gone very well. And the lead time has resulted in a, a very good outcome for the business owner making that departure.
Todd King:I've had sort of, let's say non clients. I would hope none of my clients we've had the conversations in the past would do something like this, but I've had calls from a new potential client and say, Hey, yeah, I departed last year and oh, by the way, the first thing we would ask for is, okay, send us your prior year's returns for yourself and the companies, but also send us a detailed net worth statement because this departure tax has the potential to impact every single thing that you Right. And then it's like, Oh, you had a $5,000,000 company. Did you know that? And then, of course, do they have a heart attack?
Todd King:We start looking at, well, okay, what other options are out there? Have you actually fully moved? Oh, well, no, I still have my residence here. That's available to me in Nova Scotia. So we look at like the facts around their residency position itself and maybe they didn't, maybe they haven't immigrated yet.
Todd King:And, know, so can we buy a little more time? Sort of the other thing that I mentioned just on the, on the corpse and this is where it can be a bit of a nightmare if they have gone, if they are subject to departure tax and that can't be unwound, there's a second tier of tax, right? So cause you're effectively paying tax on the gain on the shares of the company. But when you take money out of the company, you're paying another tier of tax. And so it's that double tax exposure that is a surprise to a lot of people.
Todd King:It's inherent in the Canadian tax system. We see it all the time. But there are techniques that you can use just like paying a dividend before you depart or simple things like that up to more complex things like crystallizing gains inside the company to avoid the double tax, right? The tax on the gain on the assets inside the company versus the tax on the gain of the shares of the company. It's kind of hard to get your head around, but avoiding double tax.
Todd King:We've had some horror stories in that regard where it's just people have walked unintentionally walked right into double taxation. In some cases, we do what we can, but we're not able to entirely eliminate it. I have another sort of story. Life insurance policies, of course, you know, and permanent life insurance can be very, very attractive as we know. And oftentimes it's more attractive, more compelling when it's held corporately.
Todd King:But of course there is value in these policies and a lot of insurance agents will say, well, you can access that value too. But the bottom line is life insurance policy in a corporation is value and that's going to drive the value of the shares. And if you depart owning shares of an investment holdco as an example, then that you could be paying departure tax on that value as well. That's sort of issue number one with respect to owning corporate owned life insurance in a corp where you're departing. And then the other piece is the illustrations that we see around permanent life insurance.
Todd King:A lot of them are baked in, you know, based on being able to flow the proceeds out tax free when the death happens, the death benefit generally the AC create capital dividend account in the company and that capital dividend can be paid out to a Canadian tax resident tax free. It can't be paid out to a non resident tax free. It would be subject to departure tax or not departure tax, but withholding tax, dividend withholding tax, depending on where you are. So that's another gotcha with these things. The concepts are fairly straightforward, but the devil is in the detail.
Todd King:There are all kinds of sort of complex issues. Especially when you start layering on entities, corporations, trusts, partnerships, life insurance, that kind of stuff.
Devin Cattelan:Yeah. And definitely it sounds like all the it's the solutions are very unique to these circumstances. No one circumstance is the exact same. They're all going to have their nuances and the solution is going to really depend on the the circumstance and the details like you said.
Todd King:Yeah. I mean, definitely people are surprised by the complexity of it. You know, oftentimes they're surprised by the cost of kind of giving them the proper advice to kind of work through it. So, I mean, I think the big takeaway is, is if you think it's a possibility in the near to even long term, you should be talking to your tax advisor and financial advisors upfront to keep as many options open as possible, right? Cause flexibility is king in these situations.
Todd King:Sometimes a little investment on the front end, take the family trust as an example, give you huge flexibility and tax savings on the back end.
Devin Cattelan:And so looking at it in reverse, let's say you have an American business owner coming to Canada. What changes there? So is it pretty much the same thing or does that scenario change quite a bit?
Todd King:No, I mean, it's quite different. And you know, I think that fundamentally one, I mean, obviously if you're a US citizen, you're still taxable on your worldwide income. So really nothing happens. If you move to Canada as a US citizen, you know, it may be the right to tax certain types of incomes changes, but otherwise, you know, nothing really happens. The US system, especially when it comes to companies.
Todd King:And I know we're kind of, we have a loose focus on business owners on this podcast. When it comes to companies and the taxation of companies in The United States, may have heard of like LLCs, limited liability corporations, or S corporations. Both of those entities, the default tax treatment is that the income of those companies is just the income of the owners of the companies. If it's one owner, it's disregarded. It's what we call a disregarded entity.
Todd King:So the company income just shows up on their personal tax return. If it's multiple owners, then it's a partnership. Again, the income just flows through and lands on their personal tax returns. That's fundamentally different than the Canadian system, which is what we call an integrated system. The Canadian system is you basically you have a corporation, if it's small business rate of tax, you pay about 10% in Nova Scotia.
Todd King:So you start with $100 you pay 10% tax, you have $90 As long as that equity stays in the company, you don't pay any more tax until you take the money out and then you pay dividend tax. And that sort of integrates what you would have paid originally, 54% top marginal rate in Nova Scotia, with what you pay on a flow through basis through the Corp. And that is the cause of a lot of confusion and complexity when you've got cross border entities. Canada, as an example, like if someone comes to Canada with an LLC and they just assume that things are going to be the same and they do nothing and they say the LLC is earning tons of income, but it's not making any distributions to them. If that's the case, then for US purposes, it's disregarded.
Todd King:So the LLC income shows up on their US tax return. They're paying US tax on that income every year. In Canada, generally speaking here, there'd be no income showing up on their tax return because Canada views the LLC as a corporation. The US views it as a disregarded entity. Only when the income is distributed to them as a resident of Canada does Canada tax it?
Todd King:And Canada would tax it as regular income. So 54% tax. So they've paid us tax a couple of years ago. They pay Canadian tax in the current year. There is limited, if no, possibly no foreign tax credibility, but certainly limited foreign tax credibility because of the way that the Canadian rules view that distribution and what the treaty says.
Todd King:So that is a huge trap because LLCs are just, you know, they're probably 10 to one LLC. Well, definitely 10 to one, probably 100 to one LLCs in The US versus corporations in Canada because they're so cheap and easy to set up and they're simple because if you're a business owner, it's just, I'll have four LLCs, no problem. Well, you come to Canada, you've got four controlled foreign affiliates that unlocks a whole bunch of tax reporting and a bunch of complexity in terms of how do we eliminate the double tax exposure. It's back to this double tax exposure, which really like from a cross border planning perspective, that's really our ultimate goal is to eliminate double taxation. That's what the treaty is supposed to do.
Todd King:But of course, the treaties are blunt force instruments. They're very high level. So when you start getting into all these different nuances and the different rules, these things are negotiated over decades. They're not going to keep up with the taxation systems in the two countries. And that's where we come in, right?
Todd King:Just to try to minimize the tax. Once in a while there's a miraculous opportunity, like the tax free zone, I call it. I don't know if I've explained that one to you before, but I had a client once who owned a public company, departed Canada at a time when, and moved to The U S at a time when the public company shares were very, very low value. So subject to departure tax, departure tax was pretty low because the value was low. They were in The U S for a few years and then they decided to move back and they, and they were going to sell their shares.
Todd King:Well, they didn't commence US citizenship. They didn't commence US permanent residency. When they ceased US tax residency, this days, substantial presence test, this days test I referred to, there is no departure tax in The US regime, but when they returned to Canada, they have a step up in cost base. Well, when they came back, the shares were worth like 20 times what they were worth. So now they have a very high cost base for Canadian purposes, which is all that matters because they're no longer U S taxpayers.
Todd King:They were loving me when I
Matthew Kempton:had that. Wow. Tax resell.
Todd King:I like to say it was all part of the plan. We would never say that because tax avoidance, but this, they sort of fluked into it, but it was a, sometimes my point is that sometimes there are really cool and unique opportunities to, to pay less tax than you would ordinarily pay. Yeah.
Matthew Kempton:Wow. That's an incredible one you shared when, when, you know, when The U S when Americans coming up to Canada, there isn't technically an event that's happening tax wise, but as you said, especially if you're moving to Nova Scotia, you're ultimately gonna be facing a 54% highest marginal rate, which is a scary number for most of the highest you're going pay in any jurisdiction here in North America. Is there something and often things that maybe they could or should be doing in terms of planning before that move, even though there is no real tax event at that move that might, it might create some value that doesn't have to then face an ultimate 54% marginal rate.
Todd King:Yeah. I mean, I think we're seeing people do sometimes is like, you know, Roth conversions are a big thing in The United States where they take a traditional IRA converted to a Roths or like TFSAs year. So we see some of that activity. I would say we don't really direct a lot of that activity, but we see some of that activity. We're meeting someone who is doing what we call like a relocation interview or an immigration interview and consultation.
Todd King:We always like, okay, just be clear here. Employment income as an example, even if it's US source income for US work, if it's paid to you while you're a resident of Canada, say you just came to Canada and like two days later you got a payment for a million dollar bonus, that's taxable to Canada. Right? So, I mean, to get as much of that kind of done and dusted because you know, 90 times out of 99 times out of a 100, the tax rate, even if you're in California, the effective tax rate is going be lower than here. Right.
Todd King:So you know, we try to get as much of that income realized as possible beforehand. Once you get here, you know, you're kind of into the Canadian system. You're into you're into TFSAs. A lot of people are told, a lot of US citizens are told that TFSAs don't work for them. It's not entirely true.
Todd King:You can make it work. It's just a bit of a nuanced plan and not huge dollars in TFSAs. So you kind of have to balance sort of complexity with practicality in that regard. And then, you know, if you're a professional, like one thing we're seeing a lot of these days, I think Nova Scotia in particular, we all know that we have a physician shortage in Canada. Nova Scotia has done an excellent job at recruiting physicians and Us physicians.
Todd King:I've met with over 60 Us physicians moving to Canada and moving to Nova Scotia in the last eighteen months. And one thing that is very attractive to them and might even say sort of like crucial in the recruiting process is the opportunity to incorporate, right? And that incorporation opportunity, like most, a lot of professionals in Canada incorporate. And I described our integration system with the 10% and the flow through, eventually you pay 54. That can work for US persons.
Todd King:So what that does is it affects for anything that they earn through. If you're a physician, you incorporate a professional corporation, you earn your income through that corporation. Obviously whatever you take out is going to be subject to effectively marginal rate tax, but everything else that you leave in, you're deferring tax on that. Of course, that works great for a Canadian only. It's a lot more complicated for a US citizen resident in Canada, but it can work.
Todd King:Oftentimes we use different corporate vehicles. Like we'll use these sort of relatively unknown tools called in corporations called unlimited liability corporations, which exist in Nova Scotia, PEI, Alberta, and BC. They are great tools for a situation like that because like an LLC in The United States, a ULC in Canada is a single member, single owner ULC, say the physician, is a disregarded entity for US tax purposes. So that means that all of its income just shows up on The US return. You might think, well, aren't you losing the tax deferral that goes along with the corporation?
Todd King:But because The U. Tax rates are so much lower and you're only subject to the federal rate of tax in The United States, the sort of the blended rate, you know, the blended Canadian tax, even if you're leaving a $100 a year in a Corp is lower than The U. Tax rate and you get credibility for the corporate tax and the individual tax you pay. So we sort of optimize the salary dividend mix for incorporated professionals to make sure that we're covering The US tax. So no incremental US tax, a lot more incremental US compliance, but that's what you have to balance is that sort of cost and complexity with the tax benefits of deferring whatever $40, $80, hundred-thousand dollars a year in tax and help them save for retirement.
Todd King:So that's, that's one that we're seeing a lot of these days. And that's not, I would say widely used probably because of the complexity, but that's an area that our practice really specializes in
Matthew Kempton:more miraculous planning. Guys are doing.
Todd King:Yeah. I mean, I would go as far as it's miraculous, but, it's pretty cool. And to be able to, as a professional, to be able to kind of provide a solution that we're actually making a meaningful contribution to our province. So oftentimes being a tax planner sounds sort of mercenary and sort of dollar focused, but in this case, we're actually making a meaningful difference for everyone in Nova Scotia by helping people kind of minimize tax and helping these people move to our province and provide great healthcare.
Matthew Kempton:Yeah. You mentioned Americans, you know, the business owners often have sub maybe an LLC structure, but what about the other structures they might have in place? They might have a trust where they're where prop some property might sit, or maybe they have some insurance like a Canadian might too. How do, how do those types of structures get managed on through this move? Should they be just unwound or how do you manage them?
Todd King:Yeah. I mean you know, we've seen a lot of us, Us estate and tax planners love their trusts and sort of in a different way that we do. And we didn't get into this yet, but you know, The US has a different taxation system on death. They have what's called an estate tax, and it's basically fair market value tax on everything that you own when you die. Right.
Todd King:And that at up to 40% of the fair market value of what you own. So it can be huge, but there's a huge lifetime exemption. It's about $15,000,000 U. S. Per individual or $30,000,000 for a couple.
Todd King:Right. So most Americans don't have more than that net worth. In Canada, on the other hand, we have this sort of we have capital gains tax, like departure tax on death, right? So those two different systems drive different planning. In The U S there are a lot of what are called revocable living trusts, which are loose equivalents to alter ego or joint partner trusts in Canada.
Todd King:However, you can set them up at any age, whereas the joint partner alter ego, it's 65, right? You have to be 65 to be able to contribute to it on a tax deferred basis. The revocable living trusts are like an LLC in a way, disregarded for US purposes. They're what they call grantor trusts, which means all of the income is just theirs. They don't really file a separate tax return or anything like that.
Todd King:But if you come to Canada with a revocable living trust, it's a real trust for Canadian tax purposes. So it, like you, immigrates to Canada if you're the trustee and you control it. Management controls in Canada. Remember, that's how we tie it. Trusts are taxed where resident and resident trust is a trust that's managed and controlled in Canada generally.
Todd King:So they have a step up in cost base of the assets. It's not, that's not the issue, but the compliance and complexity now of having to comply in Canada, you know, you have to file a trust tax return. You have to do all that investment accounting, even though for Canadian purposes, our reversionary trust rules might attribute the income to the individual anyway. That just creates a lot of complexity. It also creates complexity potentially on The U S side, depending on whether it's considered a foreign trust or not for U S purposes, which sort of depends on a number of factors.
Todd King:And it can also lead to potential double tax exposure on death because just because of the way Canada would tax, like if it's like the trust, as an example, may not pay tax on death in Canada. But for estate tax purposes, it would be includable in the individual's US estate. So now you've got estate tax. The treaty has a provision to sort of integrate the estate and death taxes and provide sort of a reciprocity and an offsetting of taxes. It's kind of like an apples and oranges thing, but it works.
Todd King:But it only, again, instruments, right? It only works if you meet the conditions of the treaty and the treaty hasn't contemplated things like having a trust in the middle of it. So it adds a lot of complexity. Then you have to ask, well, but what is it really accomplishing? Right.
Todd King:And is it even effective in the jurisdiction? Because most of those, like the revocable living trusts in The US are set up for sort of estate administration, probate avoidance type purposes. Right. And there's not really a tax. There's not an immediate tax advantage to them.
Todd King:Maybe there is down the road because they might kind of have some estate planning or estate tax planning built in, but that's one that we see a lot of. Our default advice is wind the thing up before you come to Canada. And let's immediately when, or maybe even before, let's start the conversation about what your Canadian based estate planning looks like. It's still going to have to be cross border estate planning because if you're a US citizen resident in Canada, you're subject to both regimes, but you need to have something that's more designed for your new situation versus the revocable living trust, which is probably like state focused and maybe no longer effective. Do you have an
Matthew Kempton:example of a business owner who was structured like that in The U. S. Did all the right things to for US estate planning purposes and tax purposes have has an LLC has a revocable trust and that has decided to make a move and you've got a call with time to plan and then what you the steps you took to prepare them for the the entry into the Canadian system.
Todd King:Yeah, I mean, have a client who provided online services, let's say, and they you know, we they they had an S Corp and an LLC. No, sorry. They had a C Corp and which is like a more of a regarded corporation, more like a Canadian concept of corpse. Pays its own corporate tax rate. Like Apple would be a C Corp.
Todd King:So they had a C Corp and an S Corp in The U S for U S domestic tax planning purposes. There's like a retirement planning kind of opportunity there. And they had this business that had a value associated with it. And so that business, you know, we knew that if they just brought that structure to Canada, it would be messy and not effective from a Canadian, from a, from a combined Canada, US tax perspective. So, so in that case we did you know, I think we effectively set up an LLC in advance and the S Corp sold, which is basically them, right?
Todd King:Because it's not disregarded because it was a partnership. It transferred the assets concurrent with the move and they sort of started in that sort of Canadian based structure. So I think we saved them a lot of pain by putting that structure in place as they moved, as opposed to after the fact. I think it would have been a lot worse for them had we done so after the fact, because then you're into like, you know, Canada, just like The U S looks at Canadian entities and says, what's going on in there? Like most developed countries have robust international tax rules, right?
Todd King:And those rules say, Hey, if you own a foreign entity, whether it's a trust corporation or whatever, we want to know everything we can about it. And we might actually take the income in it and make it your income for whatever US or Canadian purposes, both Canada and The US have rules like that. And so it's things like that, that you're trying to avoid that, which just of course like amplifies the double tax exposure. So, so that was a, that was one that, you know, I think they, I think their immigration lawyer referred them to us is how we met them, which is a good call. And you know, I think I would hope that they would say that they're very happy with the way that we manage that transition, but you know, that's probably more rare than the other alternative where people are just kind of showing up and it's like, Oh, I need to get my tax returns done.
Todd King:I'm going to talk to a tax preparer. And, you know, I don't really see ourselves. We prepare tax returns, but we're planners, right? We, where we want to play is the stuff that we're talking about here. And, you know, calling us six months after you've arrived is not helping yourself.
Todd King:You need to get in touch with us in advance.
Devin Cattelan:So let's say you have a business owner that's done a good job of accumulating assets, they've retained monies in the business, any concerns? Let's say they're a US citizen or tax resident in Canada, anything that they should do in terms of structuring what they hold or the assets that they hold within the corporation or even externally to avoid like double taxation or is there any concerns with the types of assets that they actually hold? Well, I
Todd King:mean, I think you guys certainly know that passive foreign investment corporations are really irritating from a cross border perspective. So yeah, if you're a US citizen and you have a company, let's say they talk to us and we put a ULC in place for them, they're incorporated physician, they've accumulated a million dollars inside that company. I think making sure that you have the right type of investments inside, because we're not going to give them investment advice, but we can weigh in on, these are the implications of the types of investments that you want to make. And my general observation is that shares of like directly owning shares of public companies seems to be a lot more manageable and straight forward than owning mutual funds from a US perspective, right? Because mutual funds would generally be considered these passive foreign investment companies, which, you know, even though my perspective is, is that not really the intention of these US PFIC rules to capture Canadian mutual funds, but it's generally acknowledged that they do fall into the rules and therefore you have to be mindful of those rules in order to avoid one, the compliance is really expensive.
Todd King:And then two, like the implications of not complying could be, could be very serious. Although somewhat distant in reality, in my view, because I don't really see the IRS out kind of auditing people with Canadian mutual funds. Again, back to the intent of the rules, but sometimes the intent of the rules and the reality of the rules don't line up. And this is one of those circumstances in my, in my view. So, so that's one like sort of avoiding PFICs if possible, but you don't want the tax tail to wag the dog either.
Todd King:So push the investment dog. Yeah.
Matthew Kempton:Is there anything you think we've missed? I mean, it's covered a lot here today in our conversation that a business owner on either side of the border should, should be thinking about if they're contemplating a plan or a plan to move.
Todd King:Yeah, I think the one big one that we didn't cover is The U S expatriation rules. And so that's something that's like an awareness issue for people. And I do want to, I want to explain a bit about, and there is an article that I've written recently that's out there. I think if you just Google like Todd King, 877A, you might hit it. The U S has rules that punitively tax people who are exiting the U S tax regime.
Todd King:And you might ask, well, how could I exit the U S tax regime? If I'm a U S citizen, I'm taxable on my worldwide income, regardless of where I reside, but you can renounce. And so if you're a U S citizen and you renounce, or if you're a green card holder that has had your green card for eight of the fifteen years preceding the year that you relinquish it, it's what's called a long term resident. It's not just a green card holder. You have to be a green card holder that have had, you've had the green card for eight years of the last fifteen, you know, looking back from the time that you used the green card, but think about these orphan green card holders.
Todd King:It expired ten years ago, but they've never really officially abandoned it. We've seen this pop up with them. So if in either of those situations, US citizen or green card, long term resident green card holder, eight and fifteen years, those two, if you renounce or relinquish, you're considered an expatriate under these rules. And that's fine. Being an expatriate is okay.
Todd King:You just don't want to be what's called a covered expatriate. And the covered expatriate is an expatriate who fails one of three tests. And the tests are, is your net worth more than US $2,000,000 If so, you're a covered expatriate, bad things happen. Two is your average tax liability in The U S over a certain threshold for the last five years. I think it's around $215,000.
Todd King:Don't don't quote me on that. It's something it's indexed. So I don't know the exact number, but which is a pretty big number, but if we've seen people that would fall into this, saw there's an asset test, net worth test, and then there's a tax test. And then there's also what they call a compliance test. And the compliance test is you have to be able to certify five years full compliance with US tax rules for the five years preceding the year in which you relinquish.
Todd King:If you fail any of those tests, you are a covered expatriate and you're subject to among other things, a mark to market disposition, basically the same as Canadian departure tax. You're deemed disposed of everything you own at fair market value, which there is an exemption. It's a pretty healthy exemption. It's almost 1,000,000 now, I think, but it's still, you know, if you're high net worth, you're obviously high net worth if you exceeded the net worth test. But you know, you could be subject to a lot of Us tax there and that's bad.
Todd King:You know, there's some other rules around trust interests and retirement accounts, those types of things. And the big one, that's a bit of a sleeper. They have what they call a donee tax. And it's essentially a proxy for the U S estate tax and that U S estate, you U S estate tax 40% fair market value on whatever you own at death. Right?
Todd King:So if you're a covered expatriate, you've tripped one of those rules and you ever during your lifetime or at death give or leave anything to another Us person. Now you're a former Us person, right? But you have a kid that's still a Us citizen as an example, or a spouse that's a US citizen. That gift is subject to 40% share market value tax with no exemption. So I mean, which is absolutely enormous, right?
Todd King:I mean, I will be honest, I've actually never seen anyone subject to it. We do everything we can to avoid covered expatriate status. There are a few of them floating out around there in our practice and they've accepted it knowing that they're probably never going to give anything to a US person. And the mark to market test wasn't an issue for them, but that is one that could be catastrophic and, know, it's like a time bomb, right? It's like it's down.
Todd King:It could be in there if you're a covered expatriate and who knows what's going to happen down the road. So that's one that I think keeps me up at night and one that you really want to be aware of. So if you're considering renouncing, if you're considering abandoning your green card, you really want to make sure that you're not subject to those rules. The good news is, is there are there are exemptions from the net worth tax test for people who are essentially born dual. Like, so if you're, if you were born in Canada to two U.
Todd King:Parents and through the parents you acquired U. Citizenship, but you've always lived in Canada, then you would not have to meet those first two tests, the net worth and the tax test. You'd only have to work meets the compliance tests. But again, that's one that I wanted to table just because it's so catastrophic if it applies.
Matthew Kempton:Yeah, absolutely. Wow. So The U S really doesn't want to lose their, their big taxpayer basis.
Todd King:Yeah. That's, which is why there are only 4,000 U S citizens pronounced every year, which is a pretty low number. Right?
Devin Cattelan:Well, I mean, we covered a lot. I think that's a great place to end it. So really appreciate the time and for joining Todd. And I think if there's one key takeaway from today's discussion, it's that planning and planning early really, really makes a difference because each circumstance is very unique. So best to people making the move from Canada to The US or US to Canada or have cross border complexities to reach out to a tax professional like yourself early on before some of those issues kind of
Matthew Kempton:pop up or compound down the road.
Todd King:Absolutely. Yeah. Thanks for having me. This has been fun.
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