Tag Archives: IRS

Knowing your status is key to breaking up with the IRS through expatriation

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By Elena Hanson

Special to the Financial Independence Hub

Giving up U.S. citizenship isn’t an easy decision to make, especially since there are benefits to having it. For example, if you are career-minded and interested in the larger, more diversified U.S. economy, or you want to find employment with a Canadian affiliate of an American company, holding the status of U.S. citizenship can be an advantage.

But when it comes to taxation, there are plenty of reasons to consider cutting ties with the Internal Revenue Service (IRS).

For starters, being a U.S. citizen can be, well, taxing. The tax obligations and restrictions of U.S. citizens, even those who are non-resident, can be onerous, to say the least, and include such things as:

  • Filing U.S. tax returns and paying U.S. income taxes.
  • Paying gift tax on gifts to any recipients, including a spouse if he/she is not an American, if the gift exceeds a certain threshold.
  • Restrictions on types of financial assets in order to avoid additional reporting or double taxation.
  • Restrictions on how to run a non-U.S. based business or on how to be part of non-U.S. family wealth.
  • Additional complexities with non-U.S. inheritance.
  • Full disclosure of a financial accounts and assets, even those received through employment, if the American has a signature authority.

These obligations apply to any U.S. citizen, no matter where they reside or where their assets are held. This includes those who are considered ‘Accidental Americans’ – people who discover for the first time that they are considered U.S. citizens.

Yes, that might be the case even if you’ve spent your entire life as a citizen and resident of Canada, so it is important to explore how to become tax compliant south of the border. Feigning ignorance will not likely save you from the long arm of the IRS, and the only thing costlier than paying and/or reporting U.S. taxes is not doing so. In fact, the fines and penalties associated with willfully ignoring obligations can be financially devastating.

So, knowing your status is the first step in changing your status.

The only way to relieve yourself of these obligations is to renounce U.S. citizenship. The legal process involves an appointment with the U.S. consulate, remitting a USD $2,345 administrative fee to receive a Certificate of Loss of Nationality, and the physical surrender of your U.S. passport.

From a tax perspective, renouncing may also require paying U.S. taxes and filing additional forms disclosing all financial aspects of your life, but it is probably the lesser of two evils over the long term; by retaining U.S. citizenship you must file lengthy tax returns with potentially hefty penalties, and possibly pay taxes annually).

Obviously, this process is more straightforward for those who are aware of their U.S. citizenship and already have a social security number. For those to whom U.S. citizenship has come as a surprise, you may have to acquire a social security number in order to file your first … and maybe shortly after that, your last U.S. tax return. Continue Reading…

A new take on death and cross-border taxes

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By Elena Hanson

Special to the Financial Independence Hub

Many Canadians work in the United States. But what if you worked there, owned an IRA (Individual Retirement Account), came back, and died here? What happens to the beneficiaries?

It depends on your age, marital status, and who the beneficiaries are. Add to that maturity of the account itself and what type of IRA it is. Furthermore, on December 20, 2019, President Donald Trump signed into law the ‘Setting Every Community Up for Retirement Enhancement Act’ (SECURE Act), which changed some key IRA rules. This kind of scenario can easily wind up as a dog’s breakfast, especially in the hands of a lawyer, accountant or financial advisor who isn’t up to snuff on the ins and outs of an IRA.

In a traditional IRA contributions are tax-deferred, as they are with a Canadian RRSP, and income is taxed in the U.S. when the money is paid out. U.S. law is such that account owners must begin to make required minimum withdrawals when they turn 72. This is like a RRIF in Canada. But if you pass away before that withdrawal period begins, there are three options for reporting the interest, as per one’s Canadian tax responsibilities:

1.) Include the fair market value of the IRA which becomes taxable on the Canadian income tax return of the deceased for the year of death.

2.) Include the fair market value of the IRA on a separate ‘Rights or Things’ income tax return which is due one year after the date of death.

3.) Legally transfer the rights to the account to a beneficiary, but this must be done within a certain period. Such an option is available only to beneficiaries designated in the IRA. If that beneficiary is Canadian, they must include the interest on their Canadian tax return. If the beneficiary is not Canadian, the amount is not taxed here.

What if you die after withdrawal begins?

Now, what if you pass away after the withdrawal period begins? This is a whole new kettle of fish because you, or your beneficiary, are dealing directly with the Internal Revenue Service (IRS).

Let’s say the deceased person passed away in 2020 but began making withdrawals in 2015. In that situation their interest in the IRA is not regarded as ‘Rights or Things.’ The amount of any annuity payment is included in the income of the deceased for the year of death: in this case, 2018. The balance would then be reported by the beneficiaries on their income tax return when they receive the payments after inheriting the account, and this would continue for as long as they are designated as direct beneficiaries.

This is where it’s important to have a tax professional – your lawyer, accountant or financial advisor – knowledgeable about IRAs. In fact, the U.S. levies income taxes only when amounts are paid out from an IRA.

So, assume a Canadian person who owns an IRA suddenly dies before their withdrawal period commences, and their designated beneficiary is also Canadian.

In this scenario the third option may be best; legally transfer the rights to the account to a beneficiary, and when that person receives payments, they must pay a 15% U.S. tax withholding. In addition, they must report the payment on their Canadian tax return but can claim the 15% U.S. tax withholding as a foreign tax credit.

However, if your advisor isn’t familiar with how an IRA works or IRS rules, the result may be the dog’s breakfast referred to earlier. For example, with Option #1 or #2, Canada ends up double-dipping on the IRA. Canada taxes the full value of the IRA in the year of death.

IRAs aren’t taxed until distributed in the U.S.

However, in the U.S., the IRA does not get taxed until it has been distributed. So, what ends up happening is that in the year of death, Canada gets its first dip by taxing the IRA on the decedent’s tax return. Later on, when the IRA gets distributed, the U.S. will tax the same income once it is distributed to the Canadian beneficiary, and Canada dips again by taxing the same income on the beneficiary’s tax return this time around.

Therefore, option #3 is best because it prevents the IRA from being taxed in full twice. Paying tax on your interest once is enough. Who wants to pay it twice? But this can, and does, happen. Continue Reading…

Bitcoin Blues: How new cryptocurrencies are disrupting Tax Reporting obligations (to IRS and CRA)

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By Elena Hanson

Special to the Financial Independence Hub

The latest buzzword is “disruption” and nothing has caused more disruption in the investment world than virtual currency, most commonly referred to as cryptocurrency. If you’re considering cryptocurrency as an investment option, there are a few things to know.

In a nutshell, cryptocurrency is a digital asset that can work as a medium of exchange. It uses cryptography to secure financial transactions, control the creation of additional units, and verify the transfer of assets.

The main difference between virtual currencies and traditional currencies is the decentralized control system. Cryptocurrencies like Bitcoin, which has been around since 2009, and Ether use distributed ledger technology such as block chain as a public database for transactions. Distributed ledgers are virtual ledgers that are decentralized across multiple locations, resulting in multiple copies of a transaction. While there is no central authority governing these transactions, the public nature of the ledger serves as a check and balance. However, having a currency that isn’t tied to any country or banking system can make regulation a challenge.

Just ask the 10,000 U.S. taxpayers who recently received letters from the Internal Revenue Service informing them that they may have improperly reported transactions involving virtual currencies and may owe back taxes on unreported cryptocurrency earnings.

The letters were accompanied by a stern warning from IRS Commissioner Chuck Rettig, who issued a press release on the matter. He said: “Taxpayers should take these letters very seriously by reviewing their tax filings and, when appropriate, amend past returns and pay back taxes, interest and penalties. The IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”

The IRS treats cryptocurrency like physical property and taxes it the same way. For example, if you receive a virtual currency as compensation from an employer, it is considered income subject to withholding and payroll taxes. And if you sell it, you could face capital gains tax. According to the IRS: “If you sold, exchanged, or disposed of virtual currency, or used it to pay for goods or services, you have engaged in a reportable transaction.”

CRA treats virtual currency much like the IRS

So, how does the Canada Revenue Agency treat virtual currency? Unfortunately, much like the IRS.

As far as the CRA is concerned, when cryptocurrency is used to pay for goods or services, it is subject to the rules for “barter transactions” or transactions that don’t involve legal tender. When accepted as payment for goods or services by a GST/HST registrant, the GST/HST portion must be calculated based on the fair market value at the time of the transaction. Continue Reading…

5 ways Real Estate boosts Financial Independence

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By Sia Hasan

Special to the Financial Independence Hub

Gaining financial independence is one of the most difficult propositions. Life is expensive, particularly if you live in a metro area, which is where most of the higher paying jobs are located. As a result, most people save only small amounts of their paychecks or none at all. Clearly, this is not the path to financial independence (aka “Findependence.”).

Thankfully, you don’t have to make a massive salary to become financially independent. There are several methods for building wealth, including starting a business, investing in securities, and investing in real estate. Even if you do the first two already, you need to consider these five ways of increasing your financial independence through real estate.

Real estate investment offers the highest returns for the lowest risk when compared to starting a business or investing in stocks. The reason is that real estate offers five surefire ways to grow your money, known by the acronym IDEAL. By setting a long-term plan to benefit from these five methods of making money in real estate, you are on your way to financial independence.

The IDEAL investment

IDEAL stands for income, depreciation, equity growth, appreciation, and leverage. To succeed in making real estate work as an investment, you need to look beyond your principal residence. Though owning your own home provides appreciation and tax benefits, most people can’t produce income from their principal residence, owners of duplexes and people who rent out spare rooms aside.

1.) Income

When you purchase a rental property, you generate income, provided that you collect enough rent to exceed expenses. With a cash purchase, this is easy. If you finance the purchase, you need to analyze the numbers carefully. Provided you finance the right rental property, you earn a much higher rate of return on the financed property than if you purchased it with cash.

2.) Depreciation

To increase your rental income profits, you need to bone up on the IRS depreciation rules. Because the property is a business investment, you get to deduct all depreciation off of your profits. This saves thousands of dollars in income taxes every year. Continue Reading…

How the CRA and IRS cooperate in taxing dual citizens

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By Peter Muto

Special to the Financial Independence Hub

Canada and the United States have very different tax regimes, and if you live and work in Canada but happen to be an American citizen, you better pay attention. It is estimated that up to two million Americans currently reside in Canada either as full-time or part-time residents. Full-timers who hold jobs in this country, effectively U.S. citizens and green card holders, sometimes start thinking of themselves as being Canadian. But as far as the IRS is concerned, that is a big mistake.

Unbeknownst to many, the IRS in the U.S. and the Canada Revenue Agency (CRA) in Canada can assist each other in collecting taxes from their respective citizens, and this also goes for those with dual citizenship. The fact is tax debts can be enforceable in a foreign jurisdiction. Canada currently has collection-assistance provisions in treaties with such countries as Germany, the Netherlands, Norway, New Zealand, the United Kingdom and Spain. And the United States.

A recent case concerning an American who was ordered to pay a big penalty in U.S. district court demonstrates this all too well.

How one Canadian resident fell afoul of the IRS

The man, Donald Dewees, teaches at the University of Toronto. He lives and works in Canada, and dutifully pays his Canadian income tax. But, as mentioned at the outset, Canada and the U.S. have very different tax regimes. The biggest difference is that in this country the federal government taxes people based on residency, but the U.S. imposes tax obligations on all its citizens regardless where they live, even if they have no U.S. income.

According to the rules, Dewees is supposed to file with the IRS a document called an FBAR: the Report of Foreign Bank and Financial Accounts, which is known as Form FinCEN 114. He has to do that annually. What is this for? One situation it applies in is when an American citizen or green card holder has financial interest in, or signature authority over, one or more foreign accounts as long as the aggregate value is more than US$10,000 at any time during the reporting period. So, even though the person may not hold an American bank account and may not even earn American source income, they still have to file this report with the IRS every year.

Voluntary Disclosure Programs

In this case, back in 2009 Dewees entered what is known as the Offshore Voluntary Disclosure Program (OVDP). He did that so he would be compliant with his U.S. tax obligations. So far, so good. This program is similar to Canada’s Voluntary Disclosure Program, which allows a taxpayer to pay fixed penalties. In this way you know right away how much you owe. Also, when you are in the U.S. OVDP, criminal charges will never be laid against you.

However, here is where DeWees veered off course. After entering the OVDP program, he wanted to know how much he owed in penalties and the amount was about US$185,000. So he withdrew from the OVDP program.

After that the IRS got involved. The IRS assessed a penalty for failing to file form 5471, which is required when you own a controlling interest in a foreign company; in this case a non-U.S. company. The minimum penalty is US$10,000 and that is for every year of non-compliance. For Dewees, that meant 12 years and 12 X $10,000 is US$120,000. That is the total for which he was assessed.

Continue Reading…