Financial planning is a knotty exercise at the best of times. Imagine then the complexity of it when it must be done around assets, owners and interests that straddle borders.
Now more than ever, individuals and their families are moving back and forth between Canada and the U.S. for personal and professional reasons. This creates complex cross-border investment management, wealth and financial planning challenges that require specialized expertise to manage.
Those in a dual citizenship marriage or those with professional and personal assets both in Canada and the United States need financial advice, investment planning and wealth and estate planning in accordance with securities regulations on both sides of the border, said James Sheldon, CEO and co-founder of Cardinal Point Wealth Management, a cross-border firm with offices in Toronto and San José, Calif.
“Tomorrow’s financial advisors understand that the world is getting smaller, that the individual and families are moving,” said Sheldon, himself a Canadian with an American wife, as he detailed the U.S.-Canada cross-border financial planning issues and solutions at the Independent Financial Broker Toronto Fall Summit.
“A client who finds himself in multiple tax jurisdictions needs sophisticated advice,” he said.
According to Statistics Canada census figures for 2006, there are more than a quarter million Americans residing in Canada permanently and another 27,600 on a non-permanent basis. On the other hand, there are more than a million Canadians living permanently in the U.S. These figures don’t include Canadian snowbirds.
“Even a temporary relocation requires a calculation by the advisor to determine whether or not they have overstayed their welcome long enough that the IRS can tax them,” said Sheldon.
One of the biggest challenges cross-border financial planning poses is having to deal with the big three: the U.S. Internal Revenue Service (IRS), the Canada Revenue Agency (CRA) and the Canada/U.S. Tax Treaty. “You’d think [the three] would have some continuity in how they deal with one another’s assets; they do not,” he said. “A deferred tax position like an RRSP in Canada is considered to be a foreign trust in the U.S.”
There is potential for double taxation in some situations. The IRS tends to tax capital gains made on RRSPs if the holder is residing in the U.S. Worse, if the holder returns to Canada and discharges the RRSP, the holder gets no tax credit for tax already paid in the U.S.
However, in a situation like this, it is possible to defer taxes by invoking the Canada/U.S. Tax Treaty prior to, or filing with, the Treaty and stop the double taxation. This is an area that is going to get increasingly important to advisors’ practice, he added.
The Canada/U.S. Tax Treaty, revised four times since originally signed in 1980, overrides certain areas of the tax code in both Canada and the U.S. to provide protection from, among other things, double taxation in both countries.
Another critical measure requires taking stock of what you own well before the planned cross-border move. “First thing you should do is take an absolute inventory of everything you own—your assets, liabilities, dates of birth, net worth, cash flow statements.”
If one of the spouses moves and the other doesn’t, then there are separate planning issues around that. It may be a good idea to place assets into the hands of the spouse who is not moving, said Sheldon.
Canadian departure tax
When a Canadian immigrates to the U.S. there is a Canadian departure tax on most types of assets held by the taxpayer. These assets typically include stocks, bonds, exchange-traded funds, partnerships, securities, etc.
“Each of the assets you catalogue has a tax identity with it,” said Sheldon. “[The CRA] is going to look at getting its pound of flesh before you leave, [and] you have to know what that is.”
It helps tremendously to know what may or may not attract departure tax and if it is, or isn’t, a good idea to sell some of the assets before emigrating. The CRA has an exit checklist that helps determine if one intends to have a closer relationship to one tax jurisdiction than the other.
“You may or may not have to sell your personal property,” said Sheldon, adding that the Canadian capital business property doesn’t need to be sold. Some of the other assets that don’t attract departure tax include pension and registered accounts, Canadian stock options, life insurance policies, annuities, etc.
There are ways to reduce the exit tax. One of the ways is to “offset the gains and losses in your investment portfolio.” The same goes for personal property. “What you should also consider for your clients is selling everything in the RRSP for 31 days and then repurchasing back, redoing your asset allocation model in the RRSP.”
He strongly recommended invoking the Canada/U.S. Tax Treaty protocol to eliminate tax for the use of foreign tax credits. “When you live in one jurisdiction and you move to another and sell something in the first jurisdiction and buy in the other, what you have created is a foreign tax credit.”
The Treaty also provides tax relief with regard to the Canada Pension Plan and old age security. Invoking the Treaty means “Canada can only withhold 15%” while the rest of the money flows to the holder in the U.S., where the tax rate is considerably less.
“One of the things you don’t want is the CRA to question your residency status,” said Sheldon. Closing all investment and brokerage accounts, making plans to become a non-resident public and updating estate planning documents to reflect U.S. residency go a long way in clearly establishing one’s U.S. residency status.
Will and TFSA
“In many states, a provincial will is not valid, so if you end up going to the U.S. you need to engage a local lawyer who will go over your current will and see if the wording is consistent with the rules of the state you’re living in.”
Sheldon also advises dual citizens against holding a tax-free savings account (TFSA). The TFSA, he said, under the tax protocol, is not considered to be anything other than a foreign trust and, therefore, taxable in the year that it makes money. “It’s something new in Canada and it’s not covered yet, [so] you really ought to reconsider the benefits of TFSA for dual citizens.”