Canada/US Cross-Border Planning Revisited with Terry Ritchie | E089
An update on cross-border planning.
On today’s episode we have Terry Ritchie. He is Jason’s go-to guru on all things for American Canadian cross border, and also a friend. Terry is a vice president and partner at Cardinal Point Capital and Cardinal Point Wealth Management, a cross-border or ICPM firm specializing in the cross-border space. As the US federal tax base and Canadian integrated rates are higher, most clients with decent income will have more foreign tax rates in the US than they can use up.
Episode Highlights:
1.17: Terry is a partner in Cardinal Point Capital, the Canadian entity, and Cardinal Point Wealth, which is on the US side. They are the largest cross-border wealth management firm in Canada and the US.
1.41: Terry’s responsibility as one of the private wealth managers is to work with typically private clients and individuals with cross-border issues.
4.29: In Canada, if you die and do not leave things to your spouse, you must pay all reliable due taxes. Whereas in the US, it's not the same.
5.08: In the US, most of the folks who in prior years would have been exposed to the significant estate tax are now off the rules because the tax exemptions have crept up over the years.
6.33: Terry have had situations where you look at clients and say, are you better off from an income tax perspective dying in Canada or the US, or what can you do?
10.47: If the worldwide estate of the decedent is less than $12.06 million US, there will be no estate tax. But getting to that result is difficult because the transfer agent or the compliance officers will say we are not going to distribute the shares until we get a clearance letter from the IRS, which takes a long time.
12.44: If the market goes up and down, the assets go up and down. We value the estate based on the fair market value of the assets as of the date of death, but the investments can go up and down until things are resolved, says Terry.
13.51: Whenever you are over the $60,000 threshold, that's your barometer in the US to determine whether you are filing a requirement. There may not be a state tax at the end of the day, but there may be a requirement to file, says Terry.
15.37: The closest counterpart to the tax-free savings account in Canada from the US perspective would be a Roth IRA.
16.13: If you do anything like an American in Canada, like setting up a bank account or tax-free saving account, additional compliance requirements must be dealt with on the US side, says Terry.
17.46: Some relief was provided in March 2020 through the revenue procedure that said RESP and RDSP do not have to go through these 35-20 or 30-20 filing requirements but did not speak about TFSA.
21.03: Framing taxes as a cost-benefit is a way to get around where the breaking point is or where the client wants to make the call for assets, says Jason.
22.40: If you are a US taxpayer, US resident, and citizen in Canada, and you have a home, and you bought it for some dollar, and you sell it for million dollars, we have a great benefit in Canada because as a Canadian taxpayer you are paying no tax on that appreciation, but that doesn't work on the US side.
26.43: If you are an American Canadian and you have got some property, and if there may be some tactics closure on the US side or you remotely cell it, it's good to keep track of any improvements and receipts when you did it.
28.09: If you are a Canadian going down and buying property in the US and you are going to be using it for personal purposes, there is no income tax implication on that property until you ultimately become an Angel.
29.15: We often recommend that when you write a cheque for the purchase of joint property and work with the title company officer or agency, good two cheques in half from both the purchasers, says Terry.
31.11: In Canada, you have to reconcile everything in Canadian dollars, and in many cases, you may have a net loss for US purposes because of the mandatory depreciation deduction, and then you can have a net income.
32.09: We need to think from the IRS and CRA perspective that there is going to be withholding tax requirement that could come into play here when a Canadian ultimately sells their property, and that process can be very, very timely, says Terry.
35.45: People say that as an American living in Canada, you shouldn't have anything like a mutual fund or ETFs other than securities because it is a tax burden. Terry talks about the reasoning for that and how that is dealt with.
38.15: There are a bunch of rules in Canada taxes and a bunch of rules in the US and there are your tiny little document deals with cross-border issues like couple tax treaty. But there are a million and one different ways these two things don't line up, and it's open to debate, says Jason.
39.29: CRA makes life far more miserable for clients and taxpayers than the IRS, whatever could ever be.
40.21: Because of the sources of income you have, the deductions you are entitled to under the treaty, and the fact that you are taking foreign tax credits for taxes paid on the US side, the CRA is going to poke and prod you, says Terry.
3 Key Points:
If nothing changes on the gift and state rules and other tax rules that were put into play here, from the end of 2025 to the beginning of 2026, the estate and gift tax exemptions and income tax rates will go back to what they were ten years ago, says Terry.
Terry talks about the fact that Canadian citizens who never have been American could also find themselves on the subject of the US estate tax.
Some people decide to go to Florida, Arizona, or wherever and want to buy a place. Terry explains what should they be concerned about, and what are the best practices to do that?
Tweetable Quotes:
“Snowbirds or non-residents in the United States have a non-resident state tax imposed on them if they own certain kinds of defined as a US set of assets.” – Terry
“People don’t realize that assets are not just stock. It can also be Canadian-based mutual funds and ETFs that qualify as US assets.” – Jason
“We also manage a lot of money for those clients that choose to go ahead and talk about the pros and cons of TFSA in Canada for an American or US taxpayer, and we make sure that we're managing that tax.” – Terry
“We have an article on our blog site that talks about how one might choose to own property in the US as a non-resident and the pros and cons of those strategies.” – Terry
“Sometimes, it may make sense to hold assets on a joint base and then have transferred death deeds after that.” – Terry
“I have seen clients who have a nil result and have their tax returns done, and they have ten mutual funds, but the cost of preparing that return is crazy where the net taxable is not going to change.” - Terry
Resources Mentioned
Facebook – Jason Pereira’s Facebook
LinkedIn – Jason Pereira’s LinkedIn
Terry Ritchie - terry@cardinalpointwealth.com
Transcript;
Producer: Welcome to the Financial Planning For Canadian Business Owners podcast. You will hear about industry insights with award-winning financial planner and entrepreneur, Jason Pereira. Through the interviews with different experts, with their stories and advice, you will learn how you can navigate the challenges of being an entrepreneur plan for success and make the most of your business and life. And now your host, Jason Pereira.
Jason Pereira: Oh, welcome. Thank you for joining us. Today on the show I have Terry Ritchie, previous guests and my go-to guru on cross border, all things American Canadian cross border, and a personal friend. Terry is a vice president and partner at Cardinal Point Capital and Cardinal point Wealth Management, which is a cross border RIA slash ICPM firm that specializes specifically in this space. And I brought them on the show to talk about what's changed since the last time we had them on roughly two years ago, and just a recap of some of the major points of consideration for anyone who's an American citizen living in Canada when it comes to planning for their financial life. And with that, here's my interview with Terry. Terry, good sir, always a pleasure to speak with you.
Terry Ritchie: Great. Thanks for having me again, always a pleasure as well.
Jason Pereira: So Terry, tell us a little bit about what it is you do.
Terry Ritchie: So I'm a partner in Cardinal Point Capital, which is the Canadian entity and Cardinal Point Wealth, which is on the U.S side, the RIA side. So we are the largest cross border wealth management firm, I guess, in Canada and the U.S. So we manage about a billion six of assets for clients scattered in Canada and the U.S. We've grown quite a bit over the last number of years, which has been awesome. And we've got a lot of new colleagues, so there's a little bit over 30 of us now within the practice. And my responsibility as one of the private wealth managers is to work with typically private clients individuals that have cross border issues on other side of the border. And that may be investment related, it may be tax, estate planning, but all of us do comprehensive Canada, U.S financial planning, and many of us live this lifestyle in some manner or form.
Terry Ritchie: I live in Phoenix in Calgary and go back and forth, and have a number of colleagues that also have residences in both jurisdictions as well. So these issues apply to us, and so we can relate those experiences that we have to consider is part of the planning process for the clients that we work with. And so we've got an equal number of clients, probably Canadians that move back to Canada. I'm sorry that move back to Canada from the U.S or again, Americans that move up to Canada. Snowbirds, we have a lot of situations where we have U.S beneficiaries that inherit wealth from mom and dad in Canada that become angels or those kinds of things. So anything that's cross board related, we typically get involved with.
Jason Pereira: So you've been on the show before, you were gracious enough to give me your time back then and gracious enough to agree to do this again. So I wanted to talk about first and foremost, that was roughly about two years ago. I think it was pre-pandemic, it was sometime around there.
Terry Ritchie: It was around, it certainly was prior to President Biden coming in play, I guess.
Jason Pereira: Oh, that's for sure. So basically I wanted to talk about, what's changed for Americans living in Canada when it comes to their planning based off of, well, just what's happened in both countries? So what's new and exciting is what it comes down?
Terry Ritchie: New and exciting. Well, the stock market's pretty crazy. There's folks that have obviously have been impacted globally, but certainly in Canada and the U.S. related to that, we got inflation as a factor. So yeah, revisiting retirement modeling and that kind of stuff. What numbers and assumptions do you use given where inflation's at and things like that? I think the biggest changes, and my colleague, our chief invest officer Matt Prevalo and I did a webinar for our clients prior to the election where we were talking about some of the implications that were proposed by Trump at the time, and certainly more so by Biden related to gift income and estate tax considerations.
Terry Ritchie: And so there's some pretty onerous and yucky proposals that were thrown out there, and so there was certainly some concern around what kind of planning might affluent Americans, whether they be in Canada, the U.S considered to utilize prior to the estate tax exemptions or gifting limits changing or whatever. And of course the income tax rates were looking to go up and there was some concern about additional surtaxes for wealth over a million dollars, that kind of stuff. So all that stuff didn't happen and it ain't going to happen.
Jason Pereira: Well, the midterm's coming up, so how's it good?
Terry Ritchie: Yeah, that's right. It ain't going to happen.
Jason Pereira: Let's plant piece here. I want to get to one key difference between Canada and the U.S that I find staggeringly shocking, and an easier system than estate tax. So it has to do with basically the bump up in cost base that incurs on death. So unlike Canada where when you second, well, if you die and leave things and not a spouse, you basically have to pay. It's all real, all the taxes are due. Whereas in the U.S, it's not the same. So what happens there? When someone dies and there's a deferred capital gain, what happens?
Terry Ritchie: So I mean you're better off certainly dying from a income tax perspective in the U.S than in Canada today. I mean, there have been proposals that were made a number of years ago that related to sort of removing this estate tax based on value. So one of the things that we have in the U.S is when you become an angel, it's a true value tax. The thing that's kind of unique is that most of the folks who in prior years would've been exposed to this significant estate tax, lots of those folks are now off the rules because the estate tax exemptions have creeped up over the years and are now significant levels. So right now, the estate tax exemption is 12.06 million. So for a married couple, that's just little over $24 million. So to the extent that a married couple's estate is not worth more than 24 million bucks, and they become an angel, no value tax would come into play here.
Terry Ritchie: And then in terms of what the beneficiaries ultimately receive is there's a stepping up of that cost basis at the time of death. So an example I've often used with clients is let's say my father bought some stock in a company at zero and he dies and he's got an unrealized capital gain on that specific position of let's say, this is worth 10 million. He bought it for nothing and the unrealized gain is $10 million. And my dad decides to become an angel one day and I'm the sole beneficiary of that wealth. So what's the benefit that we derive here. Well, one, because the value of his estate let's assume that's the only thing he has is not worth more than 12.06 million bucks, again, no estate tax. So we have to worry about the government getting 40% of that dollar. And then Terry, me, goes ahead and inherits this wealth and gets what my basis is in that thing, 10 million, that whole 10 million unrealized gain, gone.
Terry Ritchie: And we know that's not going to be the case in Canada. So if my dad was a Canadian resident, a dual citizen, for example, different story here. So I've had situations where you sort of look at clients and say, are you better off from an income tax perspective dying in Canada or the U.S, or what can you do? I had one client years ago where we looked at because of the value of some of his retirement plans that were U.S based in Canada, going back and dying in the U.S so we wouldn't have this ordinary income tax that could be imposed in Canada as we do and RSPs and other kinds of things. So it is a unique situation. Now, that being said, we are in an uncertain environment. We talked earlier about the midterms, and again, I think that Joe's not going to get very far with any of his policies because of what's going to maybe happen in November.
Terry Ritchie: But one of the things that when this legislation was passed under the Trump administration, a number of years ago, many of these tax changes are going through a process that we call sunset. We had this back when Bush was present as well. So effectively the way it was passed means that in 10 years after it was passed, it sunsets back to the original sort of guidelines, the original laws that were existence or their inflation adjusted. So for example, right now, unless nothing has changed in the gift and estate rules and other tax rules that were put into play here, at the end of 2025, so the beginning of 2026, the estate and gift tax exemptions and income tax rates will go back to what they were 10 years ago. Estate tax exemptions would be in place adjusted. So there's going to be somewhere around the six or 7 million range as would've come back. It's certainly a lot better than what that Senator Warren and Bernie wanted, which is like $1, but three and a half to 5 million is what they've been proposing.
Jason Pereira: Yeah. I do find it amusing how bent out of shape people get over these costs of the estate tax given almost no one pays it.
Terry Ritchie: That's true. One of the things I've often, I've been doing this for 35 years and there's a lot of... Let's just pick on snowbirds for a bit of time here. So snowbirds or non-residents in the United States, have a non resident estate tax that's imposed on them if they own certain kinds of what are defined as U.S situs assets. Most common type of asset that snowbirds or non-residents have, Canadians in the U.S would have would be real property, their vacation home, their renter property that they own personally. And in the past because where the estate tax exemptions were at, there's a lot of thought around, how should we own it? Should we hold it jointly, personally, throw it in a trust, set up a corporation, those kinds of things. And there's pros and cons around each of those, and we've got an article on our blog site that sort of goes over that.
Terry Ritchie: And there's a number of other practitioners that have got some great papers and articles related to that as well. So we go through this exercise with trying to complicate client's lives because of this potential for estate tax exposure. But at the end of the day, I think in my 35 years of practice, maybe I've had three clients out of the hundreds and hundreds I've served that have become angels because what happens is typically, if a couple owns property in the U.S, and one of them dies, the likelihood of maybe the surviving spouse either selling a property and come back to Canada, whatever, is greater. That doesn't mean that you don't want to take that into consideration, but the likelihood of people dying and having exposure has been pretty, pretty small.
Jason Pereira: Pretty slim.
Terry Ritchie: But as a practitioner, we have to be aware of that because it's always been a moving target. Right now, it's not a big deal for the majority of the Canadians owned property in the U.S, or for majority of anybody who's doesn't have estate worth more than 24 million bucks. But we have to our job as planners in the U.S wealth is always be aware of these implications in both Canada and the U.S and plan accordingly.
Jason Pereira: Well, and let's talk about one important facet that a lot of people take for granted. And that's that basically a Canadian citizen who's never been American could potentially find themselves subject to U.S estate tax as well.
Terry Ritchie: Yes.
Jason Pereira: So speak to me about how that happens.
Terry Ritchie: So because again, the estate tax exemptions are so high, for the majority of clients that advisors will be speaking to, at the end of the day, it'll be a nail result or a no result. But here's the problem for the Canadian, the traditional Canadian. And it could be I used to make the joke that you have a Canadian that's been, we have Canadian here, I'm in Calgary today, so here is here. And they've never been to Las Vegas to see Donnie Marie, but yet they happen to own... It's now Donnie only apparently, but they happen to own greater than $60,000 of U.S shares. Let's say it's Microsoft, for example, okay? They've never been to the U.S, never have any intention to go to the U.S, but they become an angel that day.
Terry Ritchie: Because the shares are worth more than $60,000, there will be a requirement for the executor on behalf of the estate to file a nonresident estate tax return. So we know that because if the worldwide estate of the decedent is less than 12.06 million U.S, there'll be no estate tax. But to get to that result is a pain in the butt because the transfer agent or the compliance officers, the back office of the firm that the shares are at are going to say, listen, we're not going to distribute these shares until we get a clearance letter from the IRS, which takes a long time. The last one I did, which was three years ago, took two years to get for the estate. And so what you have to do is when you file the non-written estate tax return is you include, it's a 706-NA.
Terry Ritchie: But along with that goes the will, along with that, you have to go ahead and provide a statement of the decedent's worldwide estate. They need to know the value of the client's RSP or RIF, the value of the non-res status, the value of any real property they have here, any businesses. If they have instances of ownership or life insurance, that the face fact, all that has to get in there. And we know at the end of the day, it's going to be a new result. So when you get over that 60,000 threshold, you have the filing requirement for U.S purposes, and it can be a pain in the butt, and it's costly too
Jason Pereira: Well, yeah. And again, I will say very high net worth people can actually have to pay, can actually be selected to it, right? It's a proportion, that 24 million doesn't fully apply to them, right? It's a proportion of their overall global holding. So I'll let you speak to that.
Terry Ritchie: Yeah. It's true. I mean, actually the last one I did, which took again two years, because I don't have a lot of folks becoming angels on me. The COVID deaths the last couple years, this was a younger guy. He died tragically and he was a non-resident, he happened to have over 3 million dollars of assets that he'd left in the U.S, the advisor down there played some games and used the U.S address, things like that. So he became an angel, and so in his case, there was estate tax to be paid. So he quantified that we went ahead and submitted an extension, paid the estate tax.
Terry Ritchie: But in terms of the assets could not be released to the family members until we got the clinch certificate, and again, that took two years to get. And again, those assets were frozen. So if the market goes up and down, those assets go up and down as well. We value the estate based on the fair market value of the assets as of the date of death, but those assets can go up and down until things are resolved. So it can be an administrative burden that can be timely and constantly.
Jason Pereira: So it is, it is burdensome. Now there are ways around that, right? I mean, so what people don't realize is that it's not just stock, it can also be Canadian based mutual funds and ETFs that qualify as U.S assets, right?
Terry Ritchie: Well, generally so in Canada, lots of ways to get around that is as you would use Canadian based ETFs that invest in U.S shares. If you've got a Canadian mutual fund or a Canadian based ETF that invest in those U.S shares, they're not considered situs, they're not domicile, so therefore you're not going to have a U.S estate tax exposure. But when we look at planning, some of the things that advisors aren't aware of is that you might go ahead and structure their investment portfolio to invest in U.S shares through ETFs or Canadian based mutual funds. But then they might just have this couple shares of outside stock, or let's say they're company stock that happens to be U.S domicile, that can throw them out of whack here. So again, whenever you're over that $60,000 threshold, that's sort of your barometer here to determine whether there's going to be filing requirement or not.
Terry Ritchie: Again, there may not be estate tax at the end of the day, but there may be that requirement to file, to prove that you had no estate tax before those shares can be released. For a lot of clients, again, I use the expression. I don't want to complicate your life anymore than it already is, and sometimes practitioners, typically lawyers and accountants will go ahead and suggest setting up a whole new company is a means to own U.S shares. Again, because integration
Jason Pereira: Ownership of shares, I mean, literally, there's easier ways to do it.
Terry Ritchie: Yeah. But it's a greater administrative burden, you've got integration rules in Canada and the U.S that corporate and personal side that may not make that as compelling as it was in the past. So again, we use a comprehensive approach, looking at the big picture here and then making that decision from there. But it can be a surprise for people thinking I'm going to invest in some Tesla directly or some Disney, and then somebody becomes an angel and it happens to be more $60,000, then we've got some explaining to do to the IRS.
Jason Pereira: Absolutely. Basically, so not a lot has changed, but there is some, we're definitely going to see a sun setting at this point, unless there's a government turnover and they choose to extend these rules, so that we know that's not... Actually, I'm surprised it is that early. I forgot it was going to be as soon as 2025, so it's not far off. So there is going to be a need for some potential planning, if anyone's exposed to estate tax to do that now before it's too late. So that's the changes. Let's talk about some of the more table stake stuff or the common things. And this might be nothing new in these categories, but just a reminder of some of these issues or types of accounts or ownership issues that affect Americans living in Canada. So first and foremost, my favorite one that I'm planning an article on shortly because it keeps coming up is the use of TFSAs by Americans in Canada.
Terry Ritchie: So the TFSA, the tax free savings account in Canada, the closest counterpart to that from a U.S perspective would be a Roth IRA. So many, many years ago, the U.S created a similar type of vehicle that allows an individual to make a contribution where that contribution would grow on a tax free basis, and then future distributions from that plan would also come out on a tax free basis as well. There's no deduction going in as there would be in Canada. So in Canada we have the TFSA, so the question often becomes you are an American living in Canada, should you or can you go ahead and make a contribution to a TFSA? And the answer is, yes, you can. The next question is, should you? And we could argue and debate whether you should, or you shouldn't, and I've given up on arguing with people about this. Because if you do, if you do anything as an American in Canada, sending up a bank account, see if you say an RSP, there are additional compliance requirements that have to be dealt with on the U.S side.
Terry Ritchie: So we do know that in the past, up and through through March of 2020, just the period of time when Tom Hank got COVID, March, 2020, and the whole world changed, that we got a revenue procedure out of the IRS that was kind to us, specifically, those Americans in Canada that may have created an RESP or an RDSP for children or whatever. So in the past in RESP and an RDSP and a TFSA were generally deemed by the IRS as a foreign trust. And so they're fairly onerous filing requirements that the IRS imposed for foreign trust. We have similar rules in Canada as well. If you're a Canadian taxpayer, the beneficiary of a trust out of the U.S, similar kind of disclosure rules, to a certain extent.
Terry Ritchie: The penalties may not be as onerous as what the IRS imposed, but if you had either those three kinds of vehicles it'd file a form 35 20 in a form 35, 28 on an annual basis. It's a fairly intimidating form, at least 3520 is. A lot of it didn't apply to certain clients and lots of parts, lots of pages there. But effectively, if you didn't file that form on a timely basis for these vehicles, then the IRS could come back, it did come back and spank you with the penalty as high 35% based on the value of what's in the trust there. So there are a lot of practitioners that thought that this was onerous, it's stupid, and it didn't really apply, and so finally there was some relief that was provided in March, 2020 through the revenue procedure. I think it's 2021 17, I believe. That basically said RESPs and RDSPs do not have to go through this 3520 filing requirement. However, it didn't speak to TFSAs.
Jason Pereira: Exactly.
Terry Ritchie: So if I presented six cross border tax practitioners to you, I'd say half of them would say, TFSA is not a trust. Don't worry about filing the 3520s and 20As, and the other three would say, "yeah, you should." We've taken the position, we don't file the 3520 and 3520As, we file a statement with the tax return of the client, basically outlining why we believe that this should not be required to be filed as that. We do pick up the incomes because the differential is if we've got a client that has a TSA, we recognize that they're tax free and candidly on the growth side, but they're not tax free on the U.S side. So any income that accrues within that vehicle would be taxable on the U.S return.
Terry Ritchie: So, because we also manage a lot of money for clients, for those clients that choose to go ahead and we talked about the pros and cons of a TFSA in Canada for an American or a U.S taxpayer, we make sure that we're tax managing that. So let's say we're using VTI or exchange traded funds that doesn't bang out significant dividends or capital distributions.
Jason Pereira: But even if it does, at the end of the day, in most cases, because it's a U.S federal tax rates only, and Canadian integrated rates are higher, most clients who have decent income are going to basically have more foreign tax rates in the U.S than they can use up. So basically the odds of them actually even paying, if there are distributions, are pretty slim.
Terry Ritchie: That is absolutely correct. What we don't know is way down the road, as these things accumulate significantly, or keeping one of these guys who put it, who has a TFSA and you were trading significantly in there, [inaudible 00:19:33] CRA coming after. Yeah. Then it's a different issue. But I've always thought that perhaps, maybe somewhere down the road with when CRA and when finance and treasury get together and they re sort of rehash the treaty, that maybe this might be a provisional throw in their list, Hey, there's similar, let's go ahead and allow for relief on both sides of the border and life.
Jason Pereira: I would think so.
Terry Ritchie: But who knows? I mean, there's other things that are more important to treasury and finance than perhaps that right now. But for clients that come in, again, the question is if your intention is to be here for quite some time and never return to the U.S, maybe we should pursue that. If you're going to go back, you're here in a short term assignment, does it make sense to do TFSA before you go back? Maybe not. What we've done for clients who've returned to the U.S is we typically will wind up the TFSA. So we get rid of it, take the proceeds and off they go down to the U.S and pay the requisite tax if they're a U.S person.
Jason Pereira: There's no point at that point. So a hundred percent tax won't just fix you finally for no reason. And so the way I obvious frame this when people ask you about this is it comes down to two factors for me. One, what is the account going to charge for the filing in the first place? And two, what does that as it relates to the amount of money you would invest in it. So if you're new to Canada, you got $6,000 worth of room, it sure as heck ain't worth it, right? To pay like a hundred bucks for it. But now when we're getting limits that are in the 80 thousands, right? If you're here the entire time and you can max out the entire TFSA and your account's going to charge you 200 bucks to do the filing, now we're looking at an incremental cost that's pretty immaterial given the tax benefit that can be extracted from this. So again, framing it as a cost benefit is definitely a way to kind of get around where is the breaking point, or where does the client want to make that call?
Terry Ritchie: But like I said, we have an article on our blog site related to this, and you said that you're writing an article too, that I'll be happy to look at as well. But I think it's a matter of discussing the pros and cons with the client. I think every situation is different. There's no perfect answer. I think you'll hear a number of different comments from a number of different practitioners, but it's something that, again, we don't file the 3520, and again, you mentioned, I'm not going to try to suggest how an accounting firm or an accountant should structure their practice, but it goes back to the whole PFI issues and the 3520 issues, 8621, and things like that.
Terry Ritchie: Obviously, to the extent that you're filing 8621s, because you're going ahead and assuming that these mutual funds in Canada are all PFI and your TFSA has a 3520 filing requirement. The cost of that filing is going to be much greater than some of that takes a position that maybe a statement should be filed, which is some of the statements, some of the things that we've done within our practice. And a number of other well respected practitioners in Canada cross quarter tax lawyers have taken similar positions as well, so to each his own.
Jason Pereira: Absolutely. So, I mean, whether they want to take the more onerous, slightly more costly approach. I mean, I've seen this done for as little as a hundred bucks as much as well, I see someone trying to charge a thousand for it, but usually it comes in more reasonable. It's frankly for that immaterial cost. Let them decide what they're comfortable with clients willing to assume that, that's fine. So TFSA, that takes care of TFSAs. You mentioned PFI, we'll come back that in a second, but let's talk about the Canada's favorite pastime, home ownership. How does that vary in Canada versus the U.S?
Terry Ritchie: So the biggest differential I think is that if you're a U.S tax payer, a U.S resident, U.S citizen in Canada, and you have a home and you bought it for a dollar and you sell it for a million dollars, we have the great benefit in Canada as a Canadian, taxpayer paying no tax on that appreciation. That doesn't work on the U.S side because we are a U.S taxpayer, and therefore we have to look at U.S Rules. And so on the U.S side, there's no full tax free exemption related to the sale of your principal residents. However, there are, there are some exemptions, but you have to meet certain rules to be entitled to those exemptions. Effectively, what happens is you've got to have lived in the home. It has to have been your principal residence for at least two out of five years. And if it has been, and you're married, you're entitled to each a $250,000 capital gain exemption.
Terry Ritchie: So for a married couple, typically that's a half million dollar. So for example, this last tax season, I had a client who bought some property in Vancouver, sold it, moved to another place in Vancouver and there was a capital gain. And the capital gain exceeded the 500,000 exemption that this married couple was entitled to take. We know that on their Canadian return, we had zero tax result, obviously had to report it, but a zero tax result. But we did have to pick up about $300,000 of capital gain income on the U.S side. Now, can we take a foreign tax credit for that? Generally, no, because we didn't pay any tax in Canada on that. So there was no foreign tax credit relief and where we're basically able to take foreign tax credit relief is employment income and some of the investment income that was sourced.
Terry Ritchie: But for that, the answer is no. So we basically didn't pay the income tax per se on that, forgive me, he paid some income tax, but what was the big surprise there? The Medicare Sur tax, the 3.8%, the net investment income tax that was imposed on that. Because his income was in his case, was well over $450,000. So he has the net investment income tax that kicks in on the capital gains, dividends, interests, passive income, those kinds of things. So that's a big surprise. So from a planning perspective, what can be helpful there is this couple happened to be both Americans in Canada. But there are situations where you've got, I use the term, mixed marriage. You've got a U.S Citizen married to a non citizen spouse. So in that case, let's say that we had that for this couple.
Terry Ritchie: What could they have done there to avoid the U.S tax? Well, what could have happened here? The value of the property was $2 million. The U.S citizen, the property was held jointly, but the U.S citizen could have gifted his half interest to his non-citizen spouse. He would've had to file a gift tax return. The gift, the annual limit this year for a U.S Citizen gifting stuff to their non-citizen spouse is $164,000. So basically anything over that number 709 return, a gift tax return have to be filed by him. So to file a gift tax return, he would go ahead and report that taxable gift, but his lifetime gift tax exclusion is $12.06 million. So in that case, no income tax results on that gift, and there's no gift tax result there, but now his wife completely a hundred percent owns that property. Obviously, you have to pay for it properly with a lawyer in Canada and things like that, file the gift tax return, but now who sells it?
Terry Ritchie: The non-citizen sells it, so therefore, if that's done, then there's not going to be any income tax result on the U.S side. So we've done that for first clients over the years when it's made sense. But if you've got a married couple, that's not been the case. So it can be a surprise for clients, particularly for clients who live in your neck of the woods or in Vancouver or BC where property values have gone up substantially. So folks need to be aware of that.
Jason Pereira: Oh yeah. We had one client who bought their house in downtown Toronto prior to capital gains being a thing, that's how long ago they bought it. So the gain is just monumental. They were, "We're going to sell and downsize." And then we went over this issue, they were just like, well, we're not moving. They couldn't bring themselves to pay that tax bill. So that is what it is.
Terry Ritchie: And what's important there too, it's important for clients, American clients may not keep track of their improvements, things like that to adjust their basis up, right? So it's important that if you're an American in Canada, you've got some property because there may be some tax exposure on the U.S side when you ultimately sell it, it's good to keep track of any improvements, receipts, when you did it. Because you have to adjust for exchange rates so that we can get that basis up, so we can hopefully reduce that level of gain if you've got exposure beyond the half dollar exemptions, that would be bearable for a married couple.
Jason Pereira: Excellent. So bottom line is you got tax implications, especially if you're both American. One important thing to mention there is the gain is adjusted for exchange rates.
Terry Ritchie: Correct.
Jason Pereira: So yeah, so 500,000 in Canada is not 500,000 in the U.S as we all painfully know.
Terry Ritchie: But Jason, it's 5,000 U.S. So 250 U.S each, that's correct. Yeah.
Jason Pereira: Exactly. Yeah. Too often the numbers applied in Canadian dollars and we don't do the conversions, so it's not quite as bad, but it is a moving number that depends on the exchange rate at the time of sale. So that is also something else to keep in mind.
Terry Ritchie: Yeah. You've heard my Canadian dollar joke. The dollar fluctuates, it flucks down and flucks up, it's been fluffing up pretty good here recently, so.
Jason Pereira: There you go. So let's talk about this the other way. Let's talk about people who basically decide to go, they go to Florida, they go to Arizona, wherever it is. And they say, oh, it's lovely here, I'd like to buy a place. What are the best practices around that? What should they be concerned about and what are the best practices about how to do that? And we're talking about both. They're American citizens, I think it's less of a concern, but let's talk about Canadian citizens in particular who maybe don't have U.S exposure.
Terry Ritchie: It sort of goes back to what we were talking about earlier and related to estate taxes, income taxes, what's the use of the property. So if you're a Canadian going down and buying property in the U.S and you're going to be using it for personal purposes, there's no income tax implication on that property until you ultimately become an angel, if you both die or somebody dies or you ultimately sell the property. So it can be very easy to establish a property, the question becomes, how do you title it? Do you title it on a joint tenants for fellowship basis? You have it in sole ownership and use a beneficiary deed to deal with estate planning issues. If you've got large estate tax exposure because of the value of your worldwide estate, does it make sense to hold it through a Canadian company and look at the implications related to that through a partnership or through a trust?
Terry Ritchie: So it really depends on, again, a number of different factors. If you are the traditional Canadian snowbird and your joint worldwide estates, let's say 5 million, it might just be pretty straightforward to go down and acquire it on a merry joint basis, enjoy your property, and then deal with the tax consequences. If there are any when you ultimately sell the property, one of the things that's important to note that for state planning purposes, if you're going to go ahead and acquire property on a married joint tenant with a survivorship basis with your spouse, that I often recommend because we have this rule in the U.S called the tracing rule. So the presumption is if you own a property jointly with somebody that 50% should be attributed to your estate and the other 50% to the other owner's estate. It doesn't work that way into these tracing rules, particularly for estate planning purposes.
Terry Ritchie: You've got to prove that the decedent owned that property. So what I often recommend is when you write a check for the purchase, I work with the title company officer, the screw agency officer. That you write either two checks, one for half from dad, one from mom, or make sure it comes from a joint account that you can prove. And I just say, just make a copy of that check, put it in your sort of estate planning folder to prove that if there's a requirement to file on a non-resident tax return and you're reconciling the value that property and the ownership of it, you've got the proof of that. So again, and we have an article on our blog site that talks about the ways that one might choose to own property in the U.S as a non-resident, the pros and cons of each of those strategies.
Terry Ritchie: If you go ahead and are you going to go down there and rent the property, different story. Typically, what often happens is you're going to have, well, you look at the ownership of that, there's still going to be estate tax planning requirements related to that if somebody were to become an angel, but there's going to be an income tax filing requirement as well. And so will a lot of clients, particularly Canadian clients forget to find out is that, well, I'm not earning the... I've seen this all the time and you're just shaking your head, so you notice this as well.
Jason Pereira: Exactly.
Terry Ritchie: Well, I'm not earning the money in Canada, so I don't have to include it in my T1. Yes, you do. Yeah. So you've got to file a non-resident return if you're engaged in effectively a trader business, you're renting property down there. And there's two ways to deal with that, you can have withholding at source or to file a return, and generally it's most people's best interest to file a return. So you pick up the gross income, you deduct any ordinary user expenses for that property. There's a requirement to monitor, you have to mandatorily, is that a word? You have to depreciate the property for U.S purposes. So what happens is in many cases you might actually have a net, not a net income, but a net loss, but you still have to file return. So it's a 1040-NR with schedule E, which is the profit loss statement related to the rental property, and you have to file that return on an annual basis. And then in Canada, you have to reconcile everything in Canadian dollars and pick it up.
Terry Ritchie: So in many cases, you'll have a net loss for U.S purposes in many cases, because of the mandatory depreciation deduction, and in Canada, you might have a net income. And of course you can't take a foreign tax credit in Canada because you didn't pay any U.S tax on that, but you have to do that. Another area where a lot of Canadians forget is that this is a T1135 funding requirement. If the value that property is more than a hundred thousand dollars and it generates income, you've got to file the foreign income verification state with your CRA tax with your T1. So that's the T1135. So make sure you file that because if you don't file that, as you know Jason, CRA is not going to give you some relief. The ignorance is no excuse for the law, from their perspective, so you get spanked with a penalty for not filing that form. So there's some compliance requirements that have to coming into play there, and that's just something that we counsel clients on, and we've got an article on our blog, so this speaks to that stuff too, so.
Terry Ritchie: And then I think the other big issue related to this, which is a pain in the butt, and before we finish, I do want to talk about some pain in the butt stuff that we need to think about from an IRS and CRA perspective is there's going to be a withholding tax requirement that could come into play here when a Canadian ultimately sells their property. And that process can be very, very timely and a big pain in the butt, just as it is to get a clearance certificate when a non-resident sells real property in Canada files a T2062, is waiting for the 116s, it's a pain in the butt, but it's something that people need to be aware of when they sell properties, and non-resident of either kind.
Jason Pereira: It's also a trap. I mean, I think you know this as well as I do, that there's an entire, like sub-industry of lawyers in the U.S warning people to hold this stuff in trust to avoid the probate issues and rightly so, it's two years out, but where I've had several clients come back in a huff and a need to do this, and they're like, oh no, we got to move this into the trust, and it's like, well, you're Canadian also, that's going to be a deemed disposition, and there's a capital gain of X amount. And you get to pay that in Canada. Well, the lawyer didn't tell me that, how can that be true? Because the lawyer doesn't care about your Canadian tax issue, right?
Terry Ritchie: Yeah. Well, I think it's a true fiduciary. We have talked to our clients about the pros and cons of everything. And unfortunately again, a number of accounts attorneys make their living by selling stuff or suggesting that an entity makes more sense than just to hold it personally. I mean, there are a number of states in the U.S that have what are called beneficiary deeds or transfer on death deeds. I had a couple that unfortunately dad passed away in Hawaii, but when I did this estate plan, and they're Canadian citizens, but they owned some property in Hawaii. We went ahead and we developed these estate plan we chose because of the there's some benefits that were available in Hawaii to set up a transfer on death deed. So they owned this property Maui with a transfer on death deed.
Terry Ritchie: And then we had their Canadian will in Canada structured with a spousal trust there so that when, when one of them died, that the decedent interest was not going to form part of the surviving spouse estate, so we were able to reduce U.S estate tax exposure if she became an angel. But very easy, we avoided probate there because now what happens is that his interest, the decedent's interest did not have to go through probate, it ultimately went to her, and then we redid her estate plan as well. And now she's got transferred death deeds for her kids. Now, if you've got good kids who are smart, responsible, that may make some sense, but you got to rejig your state plan accordingly. But again, sometimes it may make sense to hold assets on a joint basis and then have transformed death deeds after that. But again, I'm not going to argue with somebody who a trust may make sense in certain cases, a partnership or a
Jason Pereira: It might. 100%, but it's the implications on both sides of the border, and that's the issue that too often, it's up here too. People say, this is what works in Canada. That's great. But you have two sets of rule books to play with, and that's the challenge.
Terry Ritchie: I spoke at a presentation on behalf of one of the larger banks here in Canada, in the U.S a number of years ago. And I was speaking all this stuff and a guy grabbed me at the end of the presentation, and a lawyer in Florida had charged him $5,000 to set up a trust to hold his property in Mesa and to avoid probate. Here's the deal. The guy's estate, his worldwide estate was a million and a half dollars worldwide, and the value of this property in Mesa was $250,000. No estate tax, probate in Arizona is not a big deal, but this guy charged him $5,000 to have this entity in place, it just doesn't make sense. The guy got shafted unfortunately.
Jason Pereira: Yeah. Like I said, there's a sub industry that basically does all this stuff, and they have their web, they have their seminars and no one wants to pay tax on death. And everybody wants an easy estate, and it's an easy sell, unfortunately. Unfortunately and unfortunately, because it's merit in many ways, but as we just pointed out, they're not there to consult on these issues. So one more topic to wrap up. I think it's just we're focusing on the big general ones that most people face, and this is the PFI issue. And I still encounter still to this day, basically people saying you shouldn't own anything other than secure. If you're an American living in Canada don't own any mutual funds or ETFs, you should just own nothing but securities because it is tax burdensome or just you can't without knowing, speak to me about what the reasoning for that is and how that is dealt with.
Terry Ritchie: So again, back to the whole TFSA issue, you're going to find two camps, one that are pro 8621 and others that are not. There's some pretty smart guys in Canada, some pretty smart cross quarter tax lawyers that we know very well that have taken the position that most Canadian, the Canadian mutual funds that our corporations of trust are not PFI. And therefore 8621s are required. We've taken that position for many years. Other practitioners have not, and again, to each own. So we effectively go ahead and file a statement in the return. We pick up all of the income, we do all the form reporting that's required. Most of the ETFs fund companies in Canada, I've got smarten about this and they have different, different viewpoints as well. And you'll find that there are QEF qualifying, electing fund statements that are provided for the taxpayer if they choose to go that route. But again, it's a debate, I've got papers I've sent off to folks. I've heard other practitioners positions and things like that, nature. I mean, when the PFI rules came in back in the seventies and in the seventies
Jason Pereira: Most people ignored them, continue.
Terry Ritchie: I was alive before you were born, the logic there was to try to go ahead and spank those folks who are investing in the Caymans or Barbados or whatever. So, Canada is a offshore jurisdiction, for example, the net was cashed rather wide here, and so a lot of practitioners believe that's the case. I have personally in all my years never seen either through streamlined disclosure or going back and filing returns where this has been been the case, but again, with our clients, we talk about the pros and cons of this, but I have seen clients who have a knee result and have their tax returns done. And they may have 10 mutual funds. The cost of preparing that return, it's crazy. With where the net tax flow's not really going to change. So we're not going to, we don't want to argue with people about this, but we do want to make them aware of their pros and cons.
Jason Pereira: And they're just are in ways to simplify the account, you need 10 different holdings, right? Can this not be accomplished through one or a handful as opposed to creating this make work task. So, yeah, and one of the things to keep on coming back to, and we're going to close on this thought is that there's debate on this and you had these arguments out there and different people's interpretations, and that kind of language may seem a little bit weird to people hearing that in that way. It's like tax is a bunch of rules. Yes, tax is a bunch of rules.
Jason Pereira: Tax is a bunch of rules in Canada, tax is a bunch of rules in the U.S. And there's this tiny little book or tiny little document that deals with cross border issues, they call the tax treaty, but there's a million and one different ways that these two things don't line up and it's open to debate and it's open to interpretation. And frankly, a lot of these things are just issues that neither government ever wanted to create or cares about, but they're looking at their tax law. They're not looking at everybody else's and the implications for that as we've seen with many of the U.S filing requirements. But at the end of the day, this is the issue is that this is open to interpretation as long as it's justifiable to some degree.
Terry Ritchie: You're absolutely right. I mean, it's planning. But again, it's a matter of discussing these issues with clients and kind of running the numbers and going through the pros and cons. And again, we're not doing anything that's evasive or illegal, it's an interpretation. We've never had a situation we're fully disclosing the position that we're taking on the returns that are filed. We're not excluding any return or any income, we're just reporting it a little bit differently. And again, some practitioners would disagree with the position that I'm taking, that we're taking, but again, the other thing too, I think is important to note is that for the American in Canada, again, I've been doing this for 35 years, I am an enrolled agent with the IRS. It's not the IRS, we have to worry so much about it's really CRA. CRA makes life far more miserable for clients taxpayers than the IRS would ever or could ever be.
Terry Ritchie: And one of the pet peeves I have is, the process. And I have a blog, an article I wrote on this recently related to the administrative requirements that we have for CRA and IRS as a taxpayer. So for the American that moves to Canada, I'm sorry. Yeah. The American that moves to Canada, get used to the fact that if you've got social security, they're going to ask you why you're taking 50% deduction. If you're getting a distribution from your IRA and you're paying RMD, and you're going to take a foreign tax credit, they're going to ask where that came from. If you've got making charitable nation in Canada, they're going to ask for receipts. If you've got medical expenses, they're going to ask for receipts. That does not happen on the U.S side. So it's just a far more onerous, a painful process in Canada to deal with CRA. It's just part of our assessment review process.
Terry Ritchie: And so we like to counsel clients like, just get used to the fact that because of these sources of income that you do have, and because of the deductions you're entitled to under the treaty and the fact that you're taking foreign tax credits for taxes paid on the U.S side, that they're going to poke and prod you, and yes, I understand that didn't happen on the U.S side when you live down there or when you're filing returns, but get used to the fact that it will happen in Canada, and that's something we have to just work through and understand. And that's a big issue that clients that move to Canada from the U.S have never seen while they've been in the U.S.
Jason Pereira: Yeah. I mean, it's interesting. As a business owner, you get used to these sort of things, right? More and more every year, CRA taps you on the shoulder and ask you, excuse me, where did this expense come from? It's pretty common now. And at the end of the day, we have to always to remember that part of the job when we file taxes anywhere is to justify and support what it is we're doing. And frankly, it is a pain, it is a massive pain, but we got to live with it. And unfortunately, if you are living across borders, it's a reality because those two authorities are not talking to each other the way that internal authority would to another department. And even then it's still shotty. So with that, thank you very much, Jerry, appreciate this update, and I appreciate going back to these fundamentals. I'm sure this is going to be helpful, and I specifically targeted some of the more common questions I get in this space from either advisors or clients. So glad you helped me clear this up.
Terry Ritchie: Well, they're controversial. I mean, some people that will listen to this will take offense that maybe is the position that you or I might take, but again, it's important that clients are aware of the pros and cons of each of these, these areas.
Jason Pereira: But absolutely, and in your fairness, you covered the areas of how it is traditionally done, whether it's whether your opinion is the same or not. So you've talked about filing the PFI forms and the QA and the QEs. Exactly. If the accountant wants to default to that and that's what the client's paying their account for, so be it, but there are other views of this, so totally get it. Terry, where can people find you and find your blog and all these wonderful posts?
Terry Ritchie: Well, so our website is a www.cardinalpointwealth.com. So cardinalpointwealth.com, and if you go to blogs, there's lots of stuff that's there. We've got some eBooks there related to moving from the Canada to the U.S, lots of stuff that's there. And then my email address is terry@cardinalpointwealth.com.
Jason Pereira: Terry, it's always good sir, always a pleasure, and thank you for your time.
Terry Ritchie: Very well. Thanks, Jason. See ya.
Jason Pereira: So that was today's episode. I hope you enjoyed that and hope that cleared up a number of misconceptions and help broaden your understanding of what it is to be an American living in Canada or a Canadian buying stuff in the States. So as always, if you enjoyed this podcast, please leave a review on Apple Podcast, SoundCloud, Spotify, Stitcher, whatever it is your podcast. And until next time, take care.
Producer: This podcast was brought to you by Woodgate Financial, an award-winning financial planning firm catering to high net worth individuals, business owners, and their families. To learn more, go to woodgate.com. You could subscribe to this podcast on Apple Podcast, Stitcher, Google Play, and Spotify, or find more episodes at jasonPereira.ca. You can even ask Siri, Alexa or Google Home to subscribe for you.