What’s up down south?
Over the past year, we’ve witnessed the re-emergence of a presidential candidate who in August 2007, with a campaign in tatters, was counted out. We’ve heard about pigs and lipstick. We’ve met Joe the Plumber. We’ve been witness to unprecedented natural and financial disasters. We’ve seen what for many Canadians have become some of the greatest opportunities to purchase their ultimate winter dream home, again become a dream with our loonie’s recent dive. American taxpayers now own an interest in one of the world’s largest insurers. Large investment houses are now banks. What’s next?
These are unique and difficult times to plan for clients, and more so for those who are U.S. citizens, have U.S. connections, or own or would like to purchase U.S. assets.
One thing should hopefully be clear. The next U.S. administration will certainly place economic stimulus at the top of the priorities list. From a Canada/U.S. planning perspective, the Fifth Protocol to the Canada/ U.S. Tax Treaty was finally ratified on September 23rd. Further, significant tax changes for U.S. citizens who renounce their citizenships were passed in the U.S. earlier this year. Finally, the U.S. housing market will likely be a mess for many more years to come. So, how will some of these issues affect you and your clients?
U.S. Income Tax Proposals
Both candidates’ tax proposals are quite different. According to the nonpartisan Urban-Brookings Tax Policy Center, the rich would pay more under Barack Obama’s tax plan, while the poor and middle class would pay less. John McCain’s plan, on the contrary, would significantly reduce taxes for the rich, slightly reduce taxes for the poor and middle class, and increase the deficit substantially.
Obama would increase several taxes on people making more than $250,000 yearly, including Social Security taxes and the amount they pay on capital gains, which is currently at a top rate of 15% for most taxpayers. The top tax rate in the U.S. is currently 35% for taxable incomes greater than $357,700 for individuals and married couples. Obama is also proposing to increase the capital gains tax from 15% to between 20% and 28% for married couples making more than $200,000, and for singles making more than $165,000.
Payroll taxes in the U.S. far exceed those in Canada. Social Security (or FICA) tax is presently 6.2% on incomes up to $102,000, with Medicare tax—the tax levied at the payroll level for qualifying individuals over 65—at 1.45% with no income limitation. Obama would also keep the top corporate tax rate at 35%. In light of recent events in the U.S. financial and housing markets, Obama has suggested that if the economy was in a recession, he would not fully implement his tax proposals once elected.
John McCain, however, would make permanent most of the tax cuts that Bush enacted back in 2001, and which are scheduled to “sunset” in 2011. This would keep the top marginal tax rate at 35% and the lowest rate at 10%. For most U.S. taxpayers, dividends would be taxed at a maximum 15% rate, irrespective of what marginal rate they pay on ordinary income, including interest and employment income. Capital gains rates would stay at 15%. McCain would reduce the top corporate tax rate to 25%.
U.S. Estate Tax
The present estate tax exemption of $2 million is scheduled to increase to $3.5 million in 2009, with a maximum tax rate of 45%. Unless the Bush tax cuts are made permanent, the exemption amount could come back down to $1 million with a top rate of 55% in 2011. The two candidates differ on the estate tax. Obama would make the estate tax provisions that are currently in place permanent. McCain would set the tax rate at 15% for estates above $5 million. In light of the calamity within the financial markets, the cost of the war in Iraq, and the continued threat of global terrorism, the likelihood of any sort of relief on the estate tax side seems remote.
Giving Up U.S. Citizenship
We often hear Canadian advisors suggesting that U.S.-citizen clients give up their citizenship as a means of escaping the wrath of the IRS, both during their lifetimes and at their deaths. However, given the recent passing of the Heroes Earning Assistance and Relief Act (HEART) in June of this year, the prospects of renouncing one’s U.S. citizenship or abandonment of a green card have become more costly.
New rules impose a U.S. “exit tax” against U.S. citizens or long-term residents (generally a green card holder who was a lawful permanent resident of the U.S. for eight out of 15 taxable years) who give up their citizenship or green card. Effectively, this tax applies to the net unrealized gain of worldwide assets as if the property were sold for its fair market value on the day before the expatriation date to the extent the gain exceeds $600,000. A full and ordinary income tax on certain U.S. tax-deferred accounts, including IRAs, would be imposed as if the expatriate received the deemed distribution on the date of expatriation.
To make matters worse, any gifts or bequests received by a U.S. citizen or resident who previously expatriated, would be taxed in the hands of the recipient, not the donor. The tax would be at the maximum gift tax rate (currently 45%) to the extent the gift exceeds the annual limit of $12,000 in a calendar year ($13,000 after 2009).
The U.S. Housing Crisis
With private sector write-downs of almost $400 billion over the last year or so, the U.S. Treasury and Federal Reserve clearly felt the remaining subprime and related messy debt exposure were still too much for the banks to handle alone. Rather than establish a new agency, like the Resolution Trust Corporation during the Savings and Loan debacle some 20 years ago, the U.S. government is going to hold the mortgage debt itself.
We believe the U.S. real estate market will continue to soften and the opportunities to buy that U.S. dream home may still exist. The big unknown is the exchange rate. If you believe the loonie is going to rally at or near parity with the U.S. dollar again, you might want to advise your clients to wait for further declines in home prices in the U.S. However, if commodity prices normalize—as we have seen lately—currency declines could continue. To avoid currency speculation, you might want to advise clients to hedge now and allocate dollars earmarked for a future U.S. home purchase in a U.S. dollar account. This will reduce the risk in your client’s buying decision.
It’s important to stay abreast of the proposed legislation and ever-changing developments in the U.S. Ignoring what occurs down south could yield landmines that must be dealt with carefully. Involving competent Canada-U.S. experts is critical.