A record number of American expats are renouncing their U.S. citizenship, citing the high costs for annual tax filing, the risk of double taxation and potentially expensive estate taxes that can put money in the hands of Uncle Sam rather than their heirs.
“The juice sometimes isn’t worth the squeeze for a lot of individuals,” said Alexander Marino, a U.S.-born tax lawyer who heads up the repatriation practice group at Calgary-based Moodys Gartner.
Marino said over the past five and a half years, a record number of people have renounced their U.S. citizenship, sparked by the Foreign Account Tax Compliance Act (FATCA), which came into being in 2010, a move basically designed to prevent offshore tax evasion by U.S. taxpayers.
FATCA requires American financial institutions and corporations to disclose if any of their employees or clients are U.S. citizens living in Canada. Along with many other governments, Canada agreed in June 2014 to set up a simplified reporting process whereby Canadian financial institutions report on their U.S. clients to Canada Revenue Agency (CRA), which then sends the information to the U.S. Internal Revenue Service (IRS).
“U.S. citizens are now being found in record numbers,” said Marino.
The United States and Eritrea are the only two countries in the world where its citizens or U.S. green card holders are taxed on their worldwide income. “This means it doesn’t matter where you live – if you have never stepped foot on U.S. soil, you’ve never lived there, you’ve never worked there – if you are a U.S. citizen you should be filing [tax] returns every year. You are taxed on your worldwide income – the same as green card holders – until you properly renounce that citizenship, terminate that green card or die.”
For U.S. citizens living in Canada, that means filing to Canada Revenue Agency first on their worldwide income and then again to the IRS. Filing to the IRS means paying a U.S. accountant a minimum of about US$3,000-$4,000 a year even though about 95 per cent of U.S. citizens living in Canada will owe nothing on their tax returns because of the foreign tax credit.
There are additional filings as well as taxes that U.S. citizens living in Canada face. Even what many Canadians consider to be “ordinary” investments can cause headaches for U.S. citizens living here.
Tax-Free Savings Accounts
Canadians can own a Tax-Free Savings Account (TFSA) and, as the name suggests, not have to pay any tax on the investment. But TFSAs are taxable for American citizens, said Jamie Golombek, managing director, tax and estate planning, at CIBC Financial Planning & Advice. In fact, said Golombek, the IRS views TFSAs as foreign trusts, meaning not only a potential tax, but another complicated filing.
Much is the same when it comes to RESPs: not only are there complex filings every year, but the IRS will tax the income and government grants within the RESP each year. Golombek said the common advice to U.S. citizens living in Canada is that they should not be the subscriber of an RESP for their children. Instead, he suggested that if there is a non-U.S. citizen spouse, that he/she be the RESP subscriber.
“Even mutual funds are considered problematic [for U.S. citizens living in Canada] because they are considered to be passive foreign investment corporations with very onerous reporting,” he added.
“It really is a huge burden to a U.S. citizen living in Canada. So our advice generally is to renounce – unless you have a strong inclination that you might want to move to the U.S. to work.”
New rules pop up every now and then. One of them, effective this year, may hit U.S. citizens who own a Canadian controlled private corporation with a one-time transitional tax of up to 15.5 per cent of retained earnings, said Marino.
Taxes on the capital gains on the sale of a principal residence are generally exempt for Canadians, but can measurably affect a U.S. expat in Canada. The United States only allows US$250,000 exclusion on capital gains on the sale of a principal residence. Anything over that $250,000 is subject to a 20 per cent tax – a number that can translate into big money given the skyrocketing values of many homes across Canada over the past few years.
And while Canada allows an inflation-indexed lifetime capital gains exemption of just under $850,000 for qualified property, the United States does not, said Marino.
“I am renouncing more people selling real estate in Vancouver, Toronto, London [England] – because if we renounce you the day before, you keep it all,” said Marino.
There is also a U.S. estate tax that can mean less going to beneficiaries. Each year the U.S. Congress determines a number called the unified credit. Every dollar of the fair market value of the deceased U.S. expat above the unified credit is subject to a 40-60 per cent tax. Right now, that unified credit number US$11.2 million. The unified credit fluctuates, often depending on who is in power in the U.S.
For example, before the most recent U.S. election, the unified credit was $5.4 million. Hillary Clinton wanted to lower that to $2 million.
“So you can see where this is a very difficult game to play. It’s family succession Russian roulette for high net worth individuals,” he said.
Canadian professionals – lawyers, accountants and those in financial services – need to be aware of whether their clients are indeed U.S. citizens. Marino said many people don’t realize they fall under the complicated definition of a U.S. citizen and need to talk to those well versed in this area to determine their standing.
Should a person decide to renounce, there is a cost of US$2,350 and a four-to-six month wait time.
Marino noted that those who intend to renounce their U.S. citizenship should make sure they possess another nationality, otherwise there could be problems on everything from travelling to employment.
In lieu of renouncing, some say the best idea is to work with a knowledgeable expert who knows the rules in both Canada and the U.S.
Simply failing to file is not suggested. The IRS has severe penalties for non-compliance.
Benefits of keeping U.S. citizenship
- Protection of U.S. citizens abroad
- Consular services
- The right to vote in U.S. elections
- Access to the U.S. job market
Benefits of renouncing U.S. citizenship
- No more U.S. tax filing and reporting obligations
- Eliminate exposure to future U.S. tax law changes
- Reduce or eliminate U.S. estate and gift tax exposure
- End of risk of double taxation on common Canadian transactions