Brunton's U.S. Taxletter for Canadians-Fall 1996

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Covering U.S. Tax, Immigration, and Financial Matters Affecting Canadian Nonresident Aliens of the United States*
FALL 1996/Vol. 12, No. 3

The first non-immigration question your or your Canadian employee may ask is "how will my taxes change when I work in the U.S.?"

Tax considerations can often make or break a transfer to the U.S. These tax equalization issues can come squarely within the responsibility of the HR Manager. (See a complete checklist of all HR issues relating to Canada to U.S. employee transfers.)

Richard Brunton has answered these tax questions for over twenty years. His newsletter is the best source of current information for your relocating employees.

We are pleased (and honored) to share our Web site with Mr. Brunton.

We urge you to take out a regular subscription to the newsletter for yourself. Consider securing a subscription for each of your transferring employees. Large tax savings can result.

LAW OFFICE OF JOSEPH C. GRASMICK, Business ImmigrationContents-Brunton

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About The Author And How To Subscribe

Photograph of Richard Brunton, Author of BRUNTON'S U.S. TAXLETTER

Richard Brunton holds a Masters degree in Taxation/Accounting, in which his primary interest has been international taxation. He has been a resident of Florida for the past 22 years.

Mr. Brunton's firm assists these Canadians who:

His firm also assists U.S. citizens or U.S. Green Card holders, living in Canada.

Brunton's U.S. Taxletter for Canadians is published three times per year by Tax Reports Inc. It is available for US $30 per year. Please contact Mr. Brunton's office if you wish to subscribe:

Richard Brunton, CPA
4710 NW Boca Raton Blvd. Suite 101
Boca Raton, Florida 33341, U.S.A.
Voice: (561) 241-9991
FAX: (561) 241-6332
Additional Florida office conference facilities in Naples, Sarasota and Tampa

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Remarkable New U.S. Tax Rules Implemented

In a flurry- of activity during August, the U.S. Government enacted many astonishing new laws affecting Canadians (including U.S. citizens living in Canada). The IRS also recently implemented new rules. These developments are described in various articles in this Taxletter, including "IMPORTANT NEW TAX TERMINOLOGY - "LONG TERM" OF THE U.S.", "NEW U.S. TAX NUMBERING SYSTEM FOR CANADIANS", and several sections addressing the new expatriation ("exit tax") rules that are applicable to certain U.S. citizen and green card holders.

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"Important New Tax Terminology - "Long-Term Resident" Of The U.S.",

As part of the legislation enacted in August, we have an important new definition in the U.S. tax law. Certain green card holders will now be classified as "long-term residents". Breathtaking new rules potentially apply to "long-term residents" who cease being taxed as U.S. residents.

A "long-term resident" is an individual (other than a U.S. citizen) who was a lawful permanent resident of the U.S. (held a green card) in at least 8 of the last 15 years. You generally will not be treated as a lawful permanent resident for any year you claimed a treaty-based position to be taxed as a nonresident of the United States. For a summary of the new U.S. tax implications for "long-term residents" ceasing to be taxed as U.S. residents, (and U.S. citizens renouncing U.S. citizenship), please see the articles "HOW THE EXIT TAX EFFECTS YOUR U.S. INCOME TAX", and "HOW THE EXIT TAX IMPACTS YOUR U.S. GIFT AND ESTATE TAX"

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IRS Enforces Late Filing Rule!

Subscribers are aware, if you are required to file a U.S. tax return for business or rental income but you miss the filing deadline, you may not be able to claim your expenses and therefore you may be required to pay U.S. tax on your gross income rather than the net profit. Apparently the IRS has commenced enforcing this tough rule.

In one situation, a nonresident alien reportedly rented out his U.S. real estate but did not file U.S. tax returns. Evidently the individual thought the returns were not necessary because there was no profit. At the time of the sale of the real estate the IRS discovered that tax returns had not been filed. The IRS then reduced the individual's cost base by depreciation that should have been claimed on U.S. tax returns under U.S. rules, and taxed the entire profit using the lower cost base. In addition, the IRS assessed tax on the gross rental income for prior years (without allowing expense deductions) since the deadline for claiming expense deductions had passed.

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An Alternative To Living Trusts For Your U.S. Securities?

By Mark D. Rich and Michael Rosenberg, Attoneys
Tel: 305-665-3311

If you die while solely owning U.S. securities in a U.S. securities account your estate may be subject to U.S. court probate. To avoid court probate, many individuals consider transferring their securities to a living trust. However there may be another alternative for you - "transfer on death" (TOD) registration of the securities.

In 1994, the Florida Legislature passed the Florida Uniform Transfer-on-Death Security Registration Act (the "Act"). Prior to the passage of the Act, Florida's statutory provisions did not specifically authorize the registration of securities in transfer-on-death form. Although securities could previously be registered in a right of survivorship form, this type of registration usually entailed a sharing of ownership and control of the securities during the owner's lifetime. Transfer-on-death registration permits the designation of a beneficiary without affecting the owner's interests in the securities during the owner's lifetime.

The Act provides that only individuals whose registration of a security shows sole ownership by one individual, or multiple ownership by two or more with right of survivorship, rather than as tenants in common, may obtain registration in beneficiary form. Beneficiary form is defined as registration of a security which indicates the present owner of the security and the intention of the owner regarding the person who will become the owner of the security upon the death of the owner. The Act further clarifies that multiple owners of a security registered in beneficiary form hold such security either as joint tenants with right of survivorship, as tenants by the entireties, or as owners of community property held in survivorship form, but not as tenants in common.

A security, whether evidenced by certificate or account, is registered in beneficiary form when the registration includes a designation of a beneficiary to take the ownership at the death of the owner or deaths of all multiple owners. Registration in beneficiary form may be shown by the words "transfer on death" or the abbreviation "TOD", or by the words "pay on death" or the abbreviation "POD" after the name of the registered owner and before the name of a beneficiary. However, the designation of a transfer-on-death beneficiary on a registration in beneficiary form has no effect on ownership until the owner's death. A registration of a security in beneficiary form may be canceled or changed at any time by the sole owner or all of the then-surviving owners without the consent of a beneficiary.

On the death of a sole owner or the last to die of all multiple owners, ownership of securities registered in beneficiary form passes to the beneficiary or beneficiaries who survive owners. On proof of death of all owners, and compliance with any applicable requirements of the registering entity, a security registered in beneficiary form may be registered in the name of the beneficiary or beneficiaries who survive the death of all owners. If no beneficiary survives the death of all owners, the security belongs to the estate of the deceased sole owner or the estate of the last to die of all multiple owners.

The Act provided that a registering entity (i.e., a brokerage house) is not required to offer or to accept a request for security registration in beneficiary form. In addition, the Act does not limit the rights of creditors of the security owner against beneficiaries and other transferees under other laws of the State of Florida.

The Act thus permits individuals to transfer their interest in securities without the execution of a will. Further, as provided above, a registration of a security in beneficiary form may be canceled or chanaed at anv time by the sole owner or all of the surviving owners without the consent of the beneficiary. Thus, the Act may provide a practical and efficient way to control the disposition of securities held by a resident alien domiciliary or nonresident alien domiciliary.

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A World Of Numbers!

Our governments are continually increasing their ability to monitor our financial and tax activities. They accomplish this monitoring mainly by assigning taxpayer identification numbers to us (e.g. social insurance numbers) and then tracking these numbers by computer. This tracking can even be done across national borders (please see "IRS AND REVENUE CANADA TIGHTEN JOINT NOOSE!").

Following is a summary of the U.S. tax identification numbers with which many Canadians will be confronted:

  1. Social security numbers (SSN's)- these are issued by the U.S. Social Security Administration, generally only to U.S. citizens, individuals who have green cards, or other individuals legally admitted under other U.S. imn-iigration categories which authorize U.S. employment. (As a practical matter, many nonresident aliens not meeting the above criteria have been issued social security numbers with the stipulation "Not Valid For Employment").
  2. Employer identification numbers (EIN's) these are issued by the IRS to: a) Entities other than individuals that require a number (for example corporations, partnerships, trusts, and estates), and b) Any individual (U.S. or non-U.S.) who is an employer, or who is engaged in a U.S. trade or business as a sole proprietor.
  3. Individual taxpayer identification numbers (ITIN's) - these are issued by the IRS to Canadians and other nonresident aliens who require a U.S. taxpayer identification number, but do not have, or are not eligible for, a U.S. social security number. ITIN's are new, having just been implemented in the past few months.

Having a U.S. number does not, of itself, give you any right to live or work in the United States. This right is conveyed separately under the immigration laws.

The IRS previously issued taxpayer numbers (IRSN's) to many Canadians but they will no longer be valid. To determine if you require a new ITIN (or if you must obtain one for your spouse or children) please refer to the article "NEW U.S. TAX NUMBERING SYSTEM FOR CANADIANS".

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How The Exit Tax Effects Your U.S. Income Tax

The U.S. has recently expanded and tightened its laws affecting "long-term residents" who cease being taxed as U.S. residents, and U.S. citizens who renounce U.S. citizenship. These rules are referred to as the "expatriation tax" or "exit tax". For a definition of "long-term resident" please see "IMPORTANT NEW TAX TERMINOLOGY - "LONG-TERM RESIDENT" OF THE U.S."

If you are a "long-term resident" and you cease being taxed as a U.S. resident, (for example you relinquish your green card and no longer file IRS Form 1040 tax return as a U.S. resident), you will generally be subject to special U.S. income tax rules for the next 10 years. The same set of rules apply if you are a U.S. citizen and you renounce your U.S. citizenship. Certain exceptions to the rules apply, related to your ability (and qualification) to prove tax avoidance was not a principal purpose of your action. The tax treaty may also help you in certain circumstances, although tax treaties are to be reviewed and perhaps amended to reflect the new laws.

If the exit tax applies to you, then you will be subject to U.S. income tax on a large number of transactions for which you generally would have been exempt in the past.

A few examples are:

  1. Your profit on the sale of stock or debt obligations issued by U.S. entities or individuals will be subject to U.S. income tax. For example, if you sell the stock of a U.S. corporation for a profit you may have U.S. tax to pay even if the securities are located in Canada, and you are a nonresident alien of the U.S. at the time.
  2. Your profit on the sale of certain other tangible personal property may also be subject to U.S. tax if the property is located in the United States. For example, if you have a profit on the sale of art works, a boat, or jewelry located in the U.S., the profit may be subject to U.S. income tax even if you are a nonresident alien of the United States at the time. (Non-U.S. stocks or bonds located in the U.S. are not included in this rule).
  3. If you remove tangible personal property fromtheU.S., you may be subjectto U.S. tax atthat time, as if you had sold it for its fair market value. For example, if you own art or jewelry that has increased in value, you may be subject to U.S. income tax on the increase in value if you take the art or jewelry to Canada!

Many other examples apply. If you are a "longterm resident" a special rule allows you to use the fair market value of your property at the date you commenced U.S. residency as the cost of your property, unless you elect otherwise. In addition to the income tax rules described in this section, the new U.S. law imposes special U.S. gift and estate tax rules on long-term residents and U.S. citizens. (Please see "HOW THE EXIT TAX IMPACTS YOUR U.S. GIFT AND ESTATE TAX").

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Are You (Unknowingly) A U.S. Citizen?

Readers are aware that U.S. citizens are taxed differently than citizens of all other countries except the Philippines and Eritrea. U.S. citizens must file U.S. income tax returns, regardless of where they live in the world, unless their income is below the minimum filing amount. Also, they are subject to U.S. gift and estate tax on their worldwide property regardless of where they live.

Many Canadians are U.S. citizens without knowing it - either because they do not realize they have a birthright claim to citizenship, or because they inaccurately believe they have lost U.S. citizenship which they previously held.

Previous articles in the Taxletter described the birthright claims to U.S. citizenship. This article discusses individuals who were U.S. citizens and think they have lost U.S. citizenship. To lose U.S. citizenship you must:

  1. Perform an "expatriating acT' (for example, obtain Canadian citizenship) and, as a result,
  2. Obtain a Certificate of Loss of Nationality (CLN) from the U.S. Department of State.

Therefore, even if you think you lost U.S. citizenship (perhaps by becoming a Canadian citizen) you have not lost your U.S. citizenship unless you actually obtained a CLN.

If you are a "former" U.S. citizen who obtained Canadian citizenship and do not wish to be a U.S. citizen you should ensure you have obtained a CLN - otherwise you may be subject to unexpected U.S. income, gift or estate tax. You can apply now for your CLN and it will be retroactive to the day you performed an "expatriating act" with the requisite intent - i.e. possibly to the day you became a Canadian citizen.

On the other hand, if you were issued a CLN, but now regret losing your U.S. citizenship, it may be possible for you to reclaim your U.S. citizenship. As indicated above, to lose U.S. citizenship you must perform an "expatriating act". Prior to November 14,1986 the law did not expressly state the requirement that an expatriating act be performed with the intent of relinquishing U.S. citizenship. Hence, for example, a CLN may have been issued to you simply because you obtained Canadian citizenship, even though you had no desire to give up U.S. citizenship.

But the law was changed in 1986. Now, such people do not lose U.S. citizenship unless the expatriating act was intentional (i.e. you intended to give up U.S. citizenship). Thus dual citizenship is now allowed. Further, if you previously lost your U.S. citizenship you can apply to have your U.S. citizenship restored on the basis you did not intend to give up U.S, citizenship when you performed the expatriating act. If your application is allowed, your citizenship is restored retroactively, and you are considered to have been a U.S. citizen from your date of birth or original naturalization as a U.S. citizen.

However, what are the U.S. tax implications if you have your citizenship restored - do you have to file U.S. tax returns for all prior years? Please see the article - "U.S. TAX IMPLICATIONS FOR RESTORED U.S. CITIZENSHIP".

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Review Of Estate Tax Credits

Readers will recall that new tax treaty rules provide both a "proportionate" tax credit and a marital" tax credit that are intended to alleviate your U.S. estate tax liability. You are allowed to combine these two tax credits and deduct the total credit from the gross estate tax that would otherwise be payable. This determines the net estate tax payable. (Please see the Winter, 1996 Taxletter).

Proportionate Tax Credit

Under the proportionate tax credit rules your estate generally receives a tax credit equal to a proportion of $192,800. The proportion you receive is the same as the ratio of your U.S. taxable property to your worldwide property at the date of death.

Example :
William passed away January 1, 1996 at which time his U.S. property was valued US $150,000 and his total worldwide property was valued at US $1,500,000. The gross U.S. federal estate tax on US $150,000, assuming no other factors are involved, is US $38,800.

Since 10% of William's property was I ocated in the U.S. the proportionate tax credit is $19,280, (10% of $192,800). Therefore only $19,520 net federal tax is payable before considering other tax credits ($38,800-$19,280=$19,520).

Marital Tax Credit

If William's U.S. property "passes" to his surviving spouse, an additional tax credit may apply. This tax credit is based on the amount of the U.S. property that passes to his spouse. If all William's U.S. property passes to his spouse the credit can potentially be doubled to as much as $38,560 (2 x $19,280 above), which leaves only $240 net federal tax payable. ($38,800-$38,560=$240).

Hence this marital tax credit can be vital to you. But your estate will only receive this tax credit if it qualifies for the tax credit, It will only qualify if:

  1. The U.S. property "passes" to your surviving spouse,
  2. The transfer to your spouse would qualify for the marital exemption under U.S. tax law if your surviving spouse were a U.S. citizen, and
  3. All applicable elections and deadlines are properly addressed. For a description of these requirements please see the article "REQUIREMENTS FOR ESTATE MARITAL TAX CREDIT".

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U.S. Tax Implications For Restored U.S. Citizenship.

In these parate article "ARE YOU (UNKNOWINGLY) A U.S. CITIZEN?" we describe the citizenship status and alternatives under the imniigration laws for "former" U.S. citizens. This section describes the related U.S. income tax aspects. T'he IRS has issued tax guidelines for such individuals, as follows:

  1. If you obtained a CLN (Certificate of Loss of U.S. Nationality) and you bad your U.S. citizenship restored before January 1, 1993 you will not be held liable for U.S. income taxes as a U.S. citizen between the date you lost U.S. citizenship and the beginning of the taxable year it was restored.
  2. If you obtained a CLN and had (have) it restored after December 31, 1992 you will not be held liable for U.S. income taxes as a U.S. citizen between the date you lost U.S. citizenship and the beginning of the first taxable year beginning after December 31, 1992.

Suppose you thought you lost your citizenship but you did not obtain a CLN and now you are concerned about your U.S. income tax for all the intervening years?

Some of your options are:
a) Apply now for a CLN retroactive to the date of your expatriating act (provided you can prove your intent to expatriate at the time), or
b) You may apply to the IRS for relief similar to paragraph 2) above (i.e. exemption from being taxed as a U.S. citizen for the period up to January 1, 1993) provided you can demonstrate you performed an expatriating act and that you had a reasonable, good faith belief that you had lost U.S. citizenship.

If you did not perform an expatriating act with an intent to give up citizenship and you did not obtain a CLN, it is possible you remain subject to U.S. income, gift and estate tax as a U.S. citizen. In any event you should clarify your status so there will be no U.S. tax surprises for you and/or your heirs.

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Requirements For Estate Marital Tax Credit

In the article "REVIEW OF ESTATE TAX CREDITS" we stated the marital tax credit is only available if certain requirements are met. First, the property must "pass" to the surviving spouse. Generally, with some exceptions, this means the property must be inherited from the deceased spouse, or must be owned jointly by the two spouses in the form of joint ownership with right of survivorship. (Most joint ownerships between husband and wife conform to this type of ownership). In certain cases, another heir to the property can disclaim his/her right to the property in favor of the surviving spouse, in order to qualify for the tax credit.

Second, the terms of the transfer must meet the same conditions that would be required for the marital exemption if the surviving spouse were a U.S. citizen. Essentially this means the surviving spouse must have outright title to the property (or the right to reduce the property to possession). In other words it cannot be a "terminal interest", such as a "life interest" except that special rules apply to 94 qualified terminable interest property", (IIQTIPII property).

Third, the estate tax return must be filed, and certain elections made, by a deadline as described in the Winter, 1996 Taxletter.

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Procedure For Obtaining Naturalization

By Joseph Grasmick, Esq., Attorney
Tel: 716-842-3100

In the last Taxletter I described the eligibility requirements to obtain naturalization as a U.S. citizen. This article describes the actual procedure. The U.S. Immigration and Naturalization Service (INS) provides a kit called "Package N-400" to assist people in filing for naturalization. To obtain this package, contact the INS office with jurisdiction over the are in which you reside.This package contains the necessary forms and accompanying instructions.

The application for a naturalization petition consists of:

  1. One copy of the INS Form N-400, Application for Naturalization,
  2. Three identical photographs of the applicant,
  3. INS Form FD-258, Fingerprint Chart,
  4. INS Form G-325, Biographic Information, and
  5. The required fee: US $95 in the form of a cheque or money order.

Final Steps of Filing for Naturalization

Once the package has been assembled, it is submitted to the relevant INS district office. The INS will review the application components and conduct any necessary preliminary inquiry. Verification of admissibility as a naturalized citizen will take at least thirty days. The INS then notifies the applicant of a date to meet for a personal interview with an INS official, who will verify that the applicant meets all requirements.

The final step is the taking of the oath of allegiance to the U.S. Constitution. The applicant may elect to have his or her oath of allegiance administered by the INS in a public ceremony. These ceremonies are conducted at regular intervals, usually once a month. In the alternative, the applicant may take his or her oath of allegiance to the U.S. Constitution in a U.S. district court which usually takes place anywhere from a few weeks to ninety days after the INS personal interview, depending on the court schedule.

Note that once you obtain U.S. citizenship, you are required to use a valid U.S. passport whenever entering or departing the U.S. No such requirement exists for most travel between the U.S. and countries in the Western Hemisphere. For example, U.S. citizens are not required to present a passport when entering from or leaving for Canada. Contact an immigration expert for further information.

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New U.S. Tax Numbering System For Canadians

Life continues to get more complicated. As we mentioned in the last Taxletter, the IRS recently introduced a new U.S. tax numbering system to 44 assist" in tax administration. The new system is generally effective beginning January 1, 1997 (earlier for estates).

Assuming the individual involved is a nonresident alien without a U.S. social security number, (and not eligible for one - please see the article "A WORLD OF NUMBERS!"), the following section describes some circumstances in which a Canadian must obtain a U.S. Individual Taxpayer Identification number, (an ITIN).

When Do You Require an ITIN?

  1. If you are filing a U.S. tax return for yourself (for example you sell U.S. real estate, you want to claim a tax refund, or you have U.S. real estate rental income or U.S. business income), you must obtain an ITIN for yourself,
  2. If you are claiming your spouse as a dependent (deduction) on your U.S. tax return, an ITIN must be obtained for your spouse, even if your spouse has Do COnDection with the U.S.,
  3. If you are claiming children (or others) as dependents on your U.S. tax return, an ITIN must be obtained for each dependent. (For example, if you are a nonresident alien filing a U.S. tax return for U.S. real estate rental income and you wish to claim a deduction for your children you must obtain an ITIN for each child, even if they are all minors living in Canada. Similarly, if you are a U.S. citizen or green card holder living in Canada the same requirement exists when you file your U.S. tax return).
  4. If you are the spouse of a U.S. person and you elect to file ajoint U.S. tax return with that person, you must obtain an ITIN.

How To Obtain an ITIN

You apply for an IT'IN on IRS Form W-7 which you can obtain from the IRS by calling 1-800-829-3676 (in the U.S.), by calling a U.S. Consular Office in Canada, or by writing to:
EADC P.O. Box 25866,
Richmond VA 232868107.

The Form is then submitted to the IRS, ITIN Unit, P.O. Box 447, Bensalem PA 19020.

Beware there is surprising information about yourself that you must provide on the application Form (IRS Form W-7). Please see the article "IRS AND REVENUE CANADA TIGHTEN JOINT NOOSE"

Some Canadian individuals were previously issued a U.S. taxpayer identification number (IRSN) by the IRS because they filed a U.S. tax return or claimed a refund. These numbers will no longer be valid. You must obtain a new ITIN if you meet the requirements for an ITIN described above.

If you do not comply with the requirement for an ITIN the IRS may levy a $50 penalty and/or (in the case of failure to supply a number for a spouse or dependent), may deny the claim for the deduction (exemption).

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How The Exit Tax Impacts Your U.S. Gift & Estate TaxX

If you are a "long-term resident 'ceasing to be taxed as a U.S. resident (or a U.S. citizen renouncing citizenship), you will be subject to special U.S. gift & estate tax rules for the next 10 years (the ggexit tax"). Certain exceptions apply, having to do with your ability (and qualification) to prove tax avoidance was not a principal purpose of your action. The tax treaty may also help you in certain circumstances, although tax treaties are to be reviewed and perhaps amended to reflect the new laws.

U.S. Gift Tax -Tangible vs. Intangible

Nonresident aliens are generally subject to U.S. gift tax only on gifts of tangible U.S. property such as real estate, and boats and cars remaining in the U.S. Nonresident aliens are normally not subject to U.S. gift tax on gifts of intangible U.S. property, such as U.S. stocks or bonds.

Unfortunately a special new U.S. gift tax rule will apply to you if you are subject to the "exit tax" rules. For ten years you will be subject to U.S. gift tax on intangible U.S. property. For example, if you are a nonresident alien living in Canada you may be subject to U.S. gift tax on U.S. stocks or bonds you give to other family members, even if the stock or bond is located in Canada.

Estate Tax

Like other nonresident aliens you will be subject to U.S. estate tax on your U.S. property. But you may also be subject to U.S. estate tax on certain U.S. assets in Canadian and other non-U.S. corporations if you "own" 10% or more of the company. The rules are complex - please consult your tax advisor.

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IRS And Revenue Canada Tighten Joint Noose!

The ability of the IRS and Revenue Canada to exchange data on Canadian and U.S. taxpayers by computer will now increase dramatically as a result of the new requirements for certain Canadians to have a U.S. taxpayer identification number (ITIN). Please see "NEW U.S. TAX NUMBERING SYSTEM FOR CANADIANS".

You apply for your ITIN on IRS Form W-7, at which time you must provide some brief but very personal information to the IRS. Of course you must provide your name (and your name at birth, if different). In addition, Form W-7 requires you to provide your address in Canada (post office boxes and "care of' addresses are not allowed). Your date and place of birth are asked for, along with your sex, your father's complete name, and your mother's maiden name! In addition, you are asked for your passport number and U.S. visa number, if any.

Perhaps most interesting however, you are also asked for your Canadian social insurance number! You can image the potential cooperation between the IRS and Revenue Canada this will facilitate. Now, the IRS will have a fast, computefized cross-referencing capability between your U.S. and Canadian taxpayer numbers. Information on certain U.S. tax-related activities in which you are involved (such as the sale or rental of U.S. real estate, or your claim for a U.S. tax refund on U.S. investment or pension income) can be transmitted to Revenue Canada by computer, giving Revenue Canada your name, your Canadian address and your Canadian social insurance number.

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Do You Have To Pay U.S. Tax?

Do you have to pay U.S. tax if you sell U.S. securities or U.S. real estate for a profit?

If you are a nonresident alien of the U.S., resident in Canada, you generally do not have to pay U.S. federal incometax on yourprofitfromthe sale of U.S. securities (stocks or bonds) even if they are located in the United States. Similar rules exist if you sell other personal property in the U.S. for a profit such as art works, jewelry or a boat. However exceptions may exist, for example if you are subject to the exit tax rules (See the article "HOW THE EXIT TAX EFFECTS YOUR U.S. INCOME TAX"), or if the property is connected with your U.S. business. Also, certain real estate-related securities, including golf and other sporting memberships are taxable in many circumstances.

On the other hand, you generally do have to pay U.S. tax on your profit from the sale of U.S. real estate. (Special rules exist for certain property acquired before September 27, 1980). As an individual you are subject to U.S. federal income tax (capital gains tax) at tax rates from 26% to 28% on your U.S. real estate profits, provided your profit is a capital gain. Certain limited deductions are allowed. You can generally deduct your interest and property taxes incurred in the year of sale. In some States you may also be subject to additional State income tax. Florida, for example, has a corporate income tax but not a personal income tax.

If you sell U.S. real estate you must file a U.S. tax return even if there is a loss. If there is U.S. tax payable you still must report your profit on your Canadian tax return. However if your profit is subject to tax in Canada it is likely all or part of the Canadian tax will be offset by the U.S. tax you pay. Please consult your Canadian tax advisor. (Please see also "REVIEW OF WITHHOLDING TAX RULES ON U.S. REAL ESTATE SALES").

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Choosing A Foreign Company To Hold Investment

By Peter Cohen, Esq.,
Tel: 404-233-5275

When the first joint stock companies - the precursors of the modern corporation - were being established in England in the 17th century, their organizers had little reason to believe that the ground they were breaking would give rise to the most widely used medium for the conduct of most forms of business and investment activity.

Unlike other entities, such as trusts and partnerships, companies are recognized by both the Anglo American and civil law legal systems and in coun- tries influenced by such systems. Their versatility is reflected in their ability to service a myriad of business purposes from the largest of undertakings to the most elementary.

Despite the differences that may exist in complexity and size, all companies share a number of common characteristics which over the years have ensured their continued use and attraction. These include: the liability of shareholders is limited to their capital contributions, the separate legal personality of the company with its own rights and obligations is distinct from those of its owners, a separation exists between record and beneficial ownership of assets, and the delegation by the shareholders of a company of its corporate governance to directors who have a fiduciary duty to exercise their powers in the best interest of the company.

Companies and International Asset Protection

Generally speaking, the foreign customer of an onshore financial institution who has established a foreign company to maintain deposits or other investments does so to achieve one of more of the following objectives:

  1. secure protection against foreign government and private claims,
  2. ensure succession of ownership to the assets,
  3. provide flexibility in the use of the assets,
  4. preserve anonymity of ownership, and
  5. minimize exposure to taxation.

As the achievement of many of these objectives can depend on the location in which a foreign company is based, the choice of the foreign jurisdiction in which to establish a foreign holding company needs to be addressed as an initial inquiry.

Choice of Jurisdiction

Given the plethora of tax favored jurisdictions, the challenge confronting every adviser is to be able to give guidance as to the selection of a suitable jurisdiction as the base for a foreign holding company.

To attract business to their shores, many jurisdictions both offshore and onshore have used their sovereignty in fiscal matters to develop a legal framework which guarantees partial or absolute tax exempt status in that jurisdiction for companies and other entities established under their laws. Despite the similarity in the benefits of such legislation, advisors have tended, at various times, to favor certain jurisdictions in preference to others. There is no simple answer for the basis for such preferences which, in practice, frequently are a combination of subjective and objective criteria both on the part of the advisor and the client.

Factors influencing the choice of offshore jurisdiction customarily fall into the following three categories:

  1. General considerations,
  2. The legislative environment for companies, and
  3. The quality of available offshore administrators and costs.

Some elements to each of the general considerations are summarized below.

  1. Political stability. Does the jurisdiction have political stability?
  2. International Reputation. Does the jurisdiction have a good reputation for controlling abusive financial practices e.g. money laundering? Does the local Government prescribe Standards, e.g. licensing, capital or insurance requirements for offshore administrators?
  3. Treaties. What tax and information exchange agreements have been entered into between the jurisdiction and third countries?
  4. Financial Services. What is the level of sophistication of financial services available in the jurisdiction and is such sophistication required? For example: what is the experience of local banks in effecting wire transfers, letters of credit, offering multiple currency accounts?
  5. Location. Does the jurisdiction have to be located in a similar time zone to that of the advisor and the shareholders?
  6. Guarantees. What guarantees, if any, does thejurisdiction provide companies or trusts against a change in their tax status?
  7. Political Security. Does any local statute, law or judicial precedent clearly establish that the acts of a foreign state, which constitute a taking without reasonable compensation of assets, will not be enforced by the courts of the offshore jurisdiction?
  8. Legal System. Is the jurisdiction a common or civil law jurisdiction?
  9. Language. Are the laws, local advisors and administrators fluent in the language used by the onshore client and are such language skills required?
  10. Hague Convention. Is the jurisdiction a party to the Hague Convention on the authentication of documents?

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Review Of Withholding Tax Rules On U.S. Real Estate Sales

The U.S. generally levies a "capital gains" tax if you sell your U.S. real estate for a profit. (Please see"DO YOU HAVE TO PAY U.S. TAX?"). To enforce collection of the "capital gains" tax the IRS imposes a withholding tax at the time you sell your property. The withholding tax, which is usually 10% of the selling price, is only a prepayment of whatever capital gains tax you owe. You are supposed to "settle up') with the IRS after the tax year is over, by filing a U.S. tax return. When you file your U.S. tax return you pay more tax, or get a refund, depending on whether your actual capital gains tax is more, or less, than the withholding tax. If you do pay U.S. capital gains tax it is possible all or part of this tax will be a credit against your Canadian tax.

However there are exceptions to the 10% withholding tax. First, if the selling price of your property does not exceed $300,000 and the buyer and their family "plan to use the property as a residence", there is a total exemption from with holding tax if the buyer will sign an affidavit confirming the residency use. What is the meaning of "plan to use the property as a residence"? The property does not have to be the buyer's principal residence, and the buyer does not have to be a U.S. resident. Apart from that, the rules are strict. The buyer (and family) must have plans to reside at the property at least 50% of the time the property is used by any person during each of the first two twelve month periods following the date of sale. Vacant time is ignored.

Harry and Sally (U.S. citizens from Michigan) are buying your U.S. condo for $150,000. They plan to use the condo 3 months during each of the next two years and rent it out for 2 months each year. The condo will be vacant the remainder of the year.

The sale qualifies for exemption from withholding tax (provided Harry and Sally will sign the affidavit) because they will use the property at least 50% of the time it will be used by all persons during each year. (They will use it 3 months of the total 5 months' annual usage, which is 60%).

Therefore, if you are selling your property for $300,000 or less, you or your Realtor should immediately determine the plans of the buyer. You can obtain a sample affidavit from your closing agent and confirm, in advance, with the buyer that he/she will sign it. In this way you can hope to avoid surprises at closing time.

If your transaction does not qualify for the above exemption you have another alternative, but it is not as simple. You can apply to the IRS to have the withholding tax reduced from 10% of the selling price to 28% of your profit (35%forcorporations) assuming this effort is worthwhile. You make your application to the IRS on IRS Form 8288-B. It takes about three months to receive approval from the IRS. In the meantime, the sale can proceed, but the 10% tax must be held in escrow by the closing agent until the IRS response is received.

If your sale has already closed and the 10% tax has been remitted to the IRS, you can still apply for an early refund with Form 8288-B if the withheld tax exceeds 28% of your profit (35% for corporations).

Regardless of whether you take any of the action described above, you must still file a U.S. tax return after the end of your tax year.

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Reminder! - November 8 Deadline For Claiming U.S. Estate Tax Refunds

Readers are aware that the estates of many individuals dying between November 10, 1988 and November 9, 1995 are eligible to apply for U.S. estate tax refunds based on recent tax treaty changes between Canada and the United States.

The IRS has already made many of these tax refunds, along with refunds of penalties, where appropriate. In addition, the IRS is paying interest on the refunds! However beware - many estates must make the refund claim before November 9, 1996, otherwise it is likely the refund and interest will be forfeited.

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Trust Game Changed

The U.S. tax rules applicable to trusts have been drastically revised. Please consult your tax advisor. We will summarize the changes in the next Taxletter.

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Certain Gifts And Inheritances From Canadians Must Be Reported To IRS

Suppose you are a U.S. citizen or green card holder and you receive a gift >

Transfer interrupted!