Canadians' immigration to the U.S.: taxes coming and going if not planned properly.

AuthorVenables, Robert L., III

Canadians looking to immigrate to the United States must consider a number of tax issues. Despite similarities in the countries' taxing systems, some significant differences must be properly planned for to avoid paying significantly higher cumulative taxes. This item focuses on a couple of the major differences that need to be considered before emigrating from Canada.

Income Tax Residency

One of the major differences from an income tax standpoint between the United States and Canadian tax systems is which taxpayers are subject to taxation on their worldwide income and which taxpayers are subject to taxation on only their income sourced to that country. U.S. persons, which includes citizens and resident aliens under Sec. 7701(a)(30)(A), are subject to tax in the United States on their worldwide income. A resident alien is a person who (1) is lawfully admitted for permanent residence; (2) meets the substantial presence test; or (3) satisfies the requirements and makes an election to be treated as a resident (Sec. 7701(b)(1)(A)). If the person is a noncitizen and nonresident, he or she is subject to U.S. taxation on his or her U.S.-source income and not on worldwide income.

Canada, similarly to the United States, taxes its residents on their worldwide income, while nonresidents are taxed on their Canada-source income (Canada Revenue Agency Income Tax Folio 55-F1-C1). Unlike the United States, however, citizenship is not a determining factor. Therefore, a Canadian citizen who is not a Canadian income tax resident is taxed in Canada on his or her Canada-source income only. Another distinction is that the United States has codified the definition of "resident," while the meaning of the term "resident" in Canada has been left to judicial interpretation (id.).

Transfer Taxes: How Estates and Gifts Are Taxed

Another major difference between the Canadian and U.S. taxing systems is how the countries levy taxes on estates and gifts. In the United States, estates and gifts are subject to a transfer tax under Subtitle B of the tax code. The value of the property transferred, less allowable deductions, exclusions, and credits, is subject to tax. The current maximum tax rate for estates and gifts is 40% (Secs. 2001(c) and 2502(a)). The estate or gift is reported, if required, on Form 706, United States Estate (and Gen eration-Skipping Transfer) Tax Return, or Form 709, United States Gifi4 (and Generation-Skipping Traner) Tax Return, respectively.

In general, in the case of gifts of appreciated property, the donee takes a carryover basis in the property and has a tacked holding period (Secs. 1015(a) and 1223(2)). In the case of inheritance, "a person acquiring the property from the decedent or to whom the property passed from a decedent" gets a step up (or down) in basis to the property's fair market value (FMV) at either the date of death or, if elected, the alternative valuation date provided in Secs. 2032 and 1014(a). Whether property is acquired or passed from a decedent is determined under Sec. 1014(b) and is important not only for determining the basis of the property under Sec. 1014(a) but also in determining the holding period of the property under Sec. 1223(9).

In Canada, estates and gifts are subject to a deemed-disposition tax on the transfer. The deemed-disposition tax operates as though the donor/decedent sold the property for the property's FMV. The donor/decedent determines his or her gain or loss by comparing the deemed proceeds of disposition against his or her adjusted cost basis. The gain or loss is then reported on the donor/decedent's income tax return. Thus, under Canadian law, a transfer of property at death or by gift during the donor's lifetime is treated as a "sale" of the property and taxed under Canadian income tax principles and not under a transfer-tax regime such as the one the United States uses.

The deemed-disposition concept is also important to understand for Canadians thinking of emigrating. When Canadians who are Canadian residents for income tax purposes emigrate from Canada, they will be subject to the deemed-disposition tax on their property. Certain types of property, however, are excluded from the deemed disposition. Form T1243, Deemed Disposition of Property by an Emigrant of Canada, provides the list of excluded properties, including:

  1. Canadian real or immovable property, Canadian resource property, and timber resource property;

  2. Canadian business property (including inventory) if the business is carried on through a permanent establishment in Canada;

    3 Pensions and similar rights, including registered retirement savings plans, pooled registered pension plans, registered retirement income funds, registered education savings plans, registered disability savings plans, tax-free savings accounts, and deferred profit sharing plans;

  3. Rights to certain benefits under employee profit sharing plans, employee benefit plans, employee trusts, employee life and health trusts, and salary deferral arrangements;

  4. Certain rights or interests in a trust;

  5. Property the person...

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