With the mobility of clients who hopscotch frequently between Canada and the U.S. due to family obligations, retirement or employment opportunities, you may find yourself counseling clients with cross-border financial planning issues. Among many possibilities: One may have recently moved to the U.S. from Canada; another may be a Canadian citizen but not a U.S. citizen; they might be "snowbirds," who escape the cold Canadian winter to a second home in the U.S., or one could be a U.S. citizen living in Canada. In any case, they may find retirement investments (IRAs, RRSPs, RRIFs) stranded in one country when they are resident in the other. In a global economy, it pays to become an international expert.
For Canadians who move to the U.S., one big "gotcha" is that the IRS does not automatically recognize the Canada Revenue Agency's tax-deferred status of Registered Retirement Savings Plans (RRSPs--Canada's version of an IRA) or Registered Retirement Income Funds (annuitized RRSPs). This means that these accounts in Canada must be reported on the U.S. tax return.
Under the Canada-U.S. Tax Treaty, a specific election taken in a timely manner on IRS Form 8891 to defer the taxation of a Canadian RRSP or RRIF is available until your client takes a distribution from the plan. However, your client's state of domicile may not recognize this treaty election. For example, the state of California requires that taxpayers declare any accrued income (adjusted for U.S. dollars) inside their RRSP or RRIF on their state return annually.
Another heads-up for U.S. advisors occurs when withdrawals are taken from an RRSP or RRIF. According to IRS rules, a portion of the withdrawal may be considered basis and not taxable in the U.S. In addition, the IRS permits a foreign tax credit for any tax paid to the Canadian Revenue Agency upon the partial or complete distribution of your client's RRSP or RRIF.
Another common mistake we often see happens when Canadians new to the U.S. set up a Living Trust within the first five years of U.S. residence, and name Canadian residents as beneficiaries. Under Canadian non-resident trust rules, this U.S. trust is deemed resident in Canada for income tax purposes--even though your client is no longer a resident of Canada! A Canadian Form T-3 Trust tax return must be filed annually, and the income declared in Canada. This is particularly punishing because in Canada, trusts are not a "flow-through" entity and income held within a trust is taxed at the highest marginal rate on the first dollar of income. For the unwary, this could create an unnecessary tax liability and additional IRS filing requirements.
Many Canadians have decided to take advantage of the slumping real estate market to purchase a second home in a sunshine state.
What these unwary Canadians don't realize is that they could be subjecting themselves to U.S. non-resident estate taxes. The most common American assets subject to U.S. estate taxes include: U.S. real estate, tangible personal property located in the U.S. (boat, automobile, etc.), shares of U.S. corporations held in Canadian accounts, and money market accounts at U.S. brokerage firms. Specific Treaty provisions include a pro-rated unified credit that ranges from $13,000 to as much as $780,800 in 2008--depending on the client's financial situation.
Of course, travel goes both ways. When an American moves to Canada, one major hurdle is the fact the IRS still requires U.S. citizens and green-card holders to file Form 1040 tax returns annually. Unfortunately, many Americans or permanent residents believe the IRS tax is based on residency, not citizenship. In fact, you can derive U.S. citizenship through U.S. parents and not even be aware that you have a tax-filing requirement in the U.S. Since Canada bases its taxes on residency, U.S. citizens with worldwide income who reside in Canada are required to file in both Canada and the U.S. It takes specific planning and tax filing requirements to remove the potential for double taxation for these kinds of clients.
U.S. citizens and green-card holders continue to be subject to U.S. estate and gift tax rules as well. One big, common mistake is Americans entering Canada with a U.S. Living Trust intact. For U.S. purposes, the living trust makes sense, but in Canada, it is subject to the punishing trust tax rates outlined earlier. Furthermore, be cautioned that there is a "deemed disposition" for Canadian purposes on any assets moved into or out of the trust. On the other hand, clients with large estates should consider a Canadian immigration trust. Established before their move, this trust can provide a five-year holiday from Canadian taxes for first-time residents of Canada.
The final word? Whichever side of the border you're on, you should talk to your clients before they cross it.
Brian Wruk MBA, CFP(US), CFP(Canada), TEP and Terry Ritchie CFP(US), RFP(Canada), EA, TEP are the co-authors of The Canadian in America and The Canadian Snowbird in America. They operate Transition Financial Advisors Group (www.transitionfinancial.com).
