By: James W. Spencer, CPA, Director of International Tax Services; and Jeffrey M. Mutnik, CPA/PFS, Director of Taxation and Financial Services; both from Berkowitz Pollack Brant

   
Jim Spencer and Jeff Mutnik

The 2017 Tax Cuts and Jobs Act is the broadest Tax Reform in the U.S. since 1986. Below are some of the provisions of the Act that may have applicability to Canadians.

Enhanced Estate tax unified credit

Estates of Canadian domiciliaries that own U.S. situs assets such as U.S. real property or shares in U.S. corporations can now claim a larger pro-rated unified tax credit against U.S. estate tax. If the worldwide estate of the Canadian domiciliaries is no more than US$ 11 Million, then the U.S. estate tax will be zero. Previously, the threshold was US$ 5.49 Million.

Enhanced Estate tax marital deduction

Estates of married Canadian domiciliaries that own U.S. situs assets can now claim a larger marital deduction against U.S. estate tax. The marital deduction coupled with the unified credit (see discussion above) can result in the estate being subject to zero U.S. estate tax whether the worldwide estate is no more than US$ 22 Million. Previously, the threshold was US$ 11 Million.

Reduced individual income tax rates for Nonresidents

For nonresident alien individuals such as Canadians who are not U.S. citizens or green card holders and do not spend excessive days in the U.S. during a calendar year, the top income tax rate on ordinary income has decreased from 39.6% in 2017 to 37% in 2018. The long-term capital gains maximum rate of 20% has not changed.

For U.S. citizens or resident aliens such as Canadians who are dual citizens, green card holders or do spend excessive days in the U.S. the top tax rate on ordinary income (including the Net investment income tax of 3.8%) has decreased from 43.4% to 40.8%. The long-term capital gains tax rate of 23.8% has not changed.

Personal exemptions for Nonresidents and Residents

Nonresident aliens will no longer be able to claim the personal exemption of US$ 4,150 after 2017.

U.S. citizens and Resident aliens will no longer be able to claim the US$ 4,150 exemption for themselves, their spouses or their dependents after 2017. As somewhat of a trade-off the standard deduction of US$ 6,500 (US$ 13,000 for married couples) has been increased to US$ 12,000 (US$ 24,000 for married couples) starting in 2018.

Home mortgage interest

Canadians that are tax residents of the U.S. and have their principal residence located in the U.S. may claim deductions for the interest paid on their home mortgage up to a limitation. The limitation for 2017 and prior years was US$ 1,000,000 plus US$ 100,000 for home equity loans, resulting in a total of a US$ 1,100,000 limitation. For 2018, that limitation has been reduced to US$ 750,000 for mortgage loans entered into after December 15, 2017. The US$ 1,000,000 Home mortgage loan limitation still applies to interest paid in 2018 and subsequent years on loans entered into prior to 2018.

In addition, those Canadian taxpayers will still be able to deduct property taxes on their home in the U.S. along with state income taxes or alternatively state sales tax, however, such deductions will be limited to US$ 10,000.

Moving Expenses

Canadians that move to the U.S. after 2017 will not be able to claim the deduction for any of their moving expenses, including the cost of transporting their belongings.

U.S. Real Estate Investment

Canadians that earn profits from U.S. rental real property will be able to claim a deduction equal to 20% of the rental profits if their adjusted gross income (AGI) is below US$ 157,500 (US$ 315,000 for married couples). This would have the effect of reducing the highest tax rate of 37% to 29.6%. If their AGI is above these limits they will be able to claim the deduction up to a limitation equal to 2.5% of their investment in the real property (assuming there are no wages paid to employees out of the rental profits).

Upon selling the property after a holding period of more than one year, the highest tax rate on the gain from such sale would be the maximum long term capital gains tax rate of 20% plus the net investment income tax of 3.8%.

Business interest deductions

Corporations and other businesses will generally be able to deduct business interest expense up to a limit of 30% of EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) for years 2018 through 2021. Afterwards, the deduction will be limited to 30% of EBIT (Earnings before Interest and Taxes). There are exceptions for real estate (see discussion above), farming and automobile dealerships. To qualify for the real estate and farming exception, businesses must accept a deduction based on a slower rate of depreciation on depreciable property in the business.

Ownership of U.S. corporations

Canadian companies and individuals that own shares in U.S. corporations will enjoy more after tax profits that may translate to higher dividends from those corporations. Due to the top U.S. tax declining from 35% (approximately 38% including state taxes) to 21% (approximately 25% including state taxes) the after tax profits will be substantially higher than under previous law.

However, to the extent that such U.S. corporations generate Net Operating Losses (NOLs) in years after 2017, those loss carryforwards will only be available to offset 80% of future corporate taxable income. That means the U.S. corporations will always pay U.S. tax on at least 20% of their taxable income despite how large their post-2017 NOL carryforwards are. Pre-2018 NOLs are not subject to this limitation.

Depreciation

Depreciation deductions are more generous under expanded section 179 expensing limitations and bonus depreciation.

Controlled Foreign Corporations (CFCs)

The U.S. has for many years had a CFC Regime somewhat similar to the Canadian Controlled Foreign Affiliate (CFA) Regime. The U.S. Subpart F rules have been somewhat similar to the Foreign Accrual Property Income (FAPI) rules in Canada. However, until now the U.S. has not had anything remotely similar to Canada’s Exempt Surplus Regime. Starting in 2018, U.S. Corporations (but not Individuals) that own CFCs will be able to claim a Participation Exemption for dividends from those CFCs up to a certain level. The Participation Exemption Regime may be equated somewhat to Canada’s Exempt Surplus Regime.

Individuals that own CFCs are not able to claim foreign tax credits for the underlying corporate income tax imposed on Canadian corporations that are considered CFCs. However, there is an election for an individual to pay tax on CFC income at corporate tax rates and thereby claim foreign tax credits. However, this election must be looked at carefully before being executed.

However, in order to transition to the Participation Exemption Regime, U.S. Corporations and Individuals (including Canadians that are also U.S. citizens or U.S. Resident Aliens) that have direct or indirect ownership in CFCs will have to pay a one-time toll charge tax on all of the earnings of those CFCs that have been accumulated from 1987 until 2017 (Pre-1987 Earnings are not subject to the tax).

In order to somewhat ease the burden of this one time toll charge tax, Congress has provided for two things; (1) a favorable tax rate of between 17.5 percent and 8 percent depending on (a) the type of taxpayer and (b) how much of the CFC’s earnings have been reinvested in liquid vs. non-liquid assets and (2) an election to spread the payment of the one-time tax over an 8 year period with no interest charges on the deferred tax liability.

The first installment of the tax payments in year 1 (2018) of the 8 year period is equal to 8% of the toll charge. This first installment must be paid generally on or before April 15, 2018. Once the election has been made and the first installment has been paid, the taxpayer may take all of the pre-2018 earnings out of the CFC in the form of dividends even though much of the payment of the toll charge tax has been deferred to subsequent years.

Nonresident Alien individuals that are also U.S. citizens or U.S. Resident Aliens may want to consider transferring their CFCs to a U.S. corporation to take advantage of the participation exemption for a certain amount of dividends received from the CFC as well as a 50% deduction for profits attributed to Global Low Taxed Income. However, this strategy is not expected to be viable for most Canadians and even if it is in certain cases, it should not be employed without consulting with a U.S. International Tax advisor.