This article was originally published on October 4 2019 by Globe and Mail Inc. 

At your company, are you a jack of all trades or master of one? Shakespeare might put it like this: ‘To specialize or not to specialize, that is the question.’ Indeed, it’s a question often asked by business owners, managers and leaders.

Adam Smith, who is often regarded as the father of capitalism, wrote The Wealth of Nations where he described a pin factory with 10 employees who divide the work of making a pin into multiple steps, each person an expert at one step. Think of it as a precursor to the automaker’s assembly line. Using this model, Smith reasoned that pin production is greater than if each employee had performed all the steps in making the pin.

While that might work great for pins, what about something like professional services?

Large professional services firms tout themselves as “one-stop-shops.” At first glance, they appear to be generalists in such areas as audit, tax and advisory services. However, their services are broken down further into highly specialized practices led by experts in their respective functional areas.

For the customer, this can be the best of both worlds – all the expertise they need in one place and a collaborative “team” of people to deliver the goods.

The reality of this model is that experts are rarely the ones doing detailed work. They may serve as client contact or provide sign-off on the file, but the work is done by more junior staff who may be off-site or even offshore.

Such an approach would tend to follow the Adam Smith approach to greater productivity.

I’m familiar with the accounting industry. The Big Four firms employ a model encompassing many service lines for clients to choose from. Oftentimes, individual employees become specialized in one area, which can happen early in that person’s career, limiting exposure to other service lines.

This is great for achieving firm-wide efficiencies and developing experts in many areas, but where does it leave the employee in terms of skill development? Adam Smith identified this as well. He observed that individuals who do only one thing may be very good at it but lose the ability to grow and typically end up stagnating in their career.

In fact, most professional services practitioners want a broad scope. They don’t want to be stuck in the same silo their entire career.

Today professional service firms have specialization within the organization which means professionals are not exposed to multiple disciplines. In the world of tax, which is what I know, very rarely does a transaction or tax event happen in a vacuum. Thus, only by exposure to everything does the accounting professional get to test the waters and see what disciplines they enjoy.

Specializing too early in one’s career can be a liability. Imagine a doctor who skips right to neurosurgery and doesn’t get a foundational knowledge of the human body. The same logic can be applied to specializing in a certain area of taxation.

When the neurosurgeon graduates from medical school and starts a practice, do they incorporate or operate as a sole proprietor? A tax professional who focuses only on corporations would tend to advise to incorporate because that’s what they know. But it may not be the best advice.

If the neurosurgeon is a Canadian who went to medical school in the United States and decides to practice there, they need an accountant familiar with tax complexities south of the border. In my business, I often come across accounting professionals, as well as lawyers and financial advisers, who lack basic foundational skills because they never got this cross-section of experience. In other words, they worked in a silo.

My firm hires cross-border taxation experts, many of them from a Big Four environment who were frustrated with career-stifling silos.

Every business wants to reduce costs and gain market share over competitors. But how do you contribute to those factors and avoid becoming too specialized?

  1. Focus on the “big picture” for your career. First, do the foundational work in order to increase the efficiency, accuracy and overall value of specialized work.
  2. Think twice about being called ‘expert.’ It looks good on paper but being pigeonholed can be career-limiting. Explore areas that are unfamiliar but related, and work for people who prioritize career growth. Given the chance, you could be more valuable to your company in a different role.
  3. Bring your ideas and perspectives to the table and have a say in what you do. Being fully engaged in your job will always produce optimal results.

In today’s marketplace, the value of specialization doesn’t come from being laser-focused on one area. It comes from knowing many things that impact that area.

 

This article was originally published on August 26 2019 by Private Wealth Canada 

We all like receiving and giving gifts. But how does tax law view the act of giving? Did you know that giving a gift could have tax implications?

In fact, depending on the value of the gift, there could be serious tax implications. And when it comes to transfers of money or property between spouses, the income tax laws in Canada and the United States are very different, which means if you’re gifting to an American or even to a Canadian who lives in the U.S., it’s best to be prepared.

By way of background, the Canada Revenue Agency employs what is known as anti-income splitting rules. The idea is to deter the practice of gifting for the purpose of income splitting between spouses. So, cash and acquired assets are traced to the spouse who earned or contributed money (in order to acquire the asset). And any future income generated by such a transaction, even including appreciation of a property, is on the record for that spouse at tax time. Even if the spouse who owns the asset wants to give their partner partial or full ownership, the one doing the gifting still gets dinged for taxes.
Is there a way around it? Yes.

To avoid this situation, the principal spouse (the one doing the gifting) can sell the asset to their spouse at fair market value and pay tax on any resulting capital gain, or the asset can be loaned to the other spouse under an ‘intra-family loan agreement’ with specific terms and rates, and that document must be signed by both parties.

When it comes to property gifting between spouses, the U.S. Internal Revenue Service (IRS) is more generous as it allows unlimited, tax-free transfers for as long as both spouses are American citizens, or green card holders, or they are treated as a U.S. domiciliary under certain provisions of the Internal Revenue Code. Most of the time, transfers between U.S. spouses have no tax implications at all since the parties tend to file their returns jointly and are taxed on the household basis and not an individual earner basis.

parties tend to file their returns jointly and are taxed on the household basis and not an individual earner basis.

Less Generous

Unfortunately, if you are U.S. citizen and your spouse is Canadian, the IRS is less generous. For example, let’s say a Canadian resident who is a U.S. citizen wants to gift money or property to their Canadian spouse who is not a U.S. citizen. If the annual market value of the gift exceeds US$155,000 (2019 rates), gift tax may result. Gift tax rates range between 18 per cent and 40 per cent of the market value of the gift. Furthermore, the same gift may end up being double-taxed – first as a deemed disposition in Canada at the rate of up to 26.76 per cent (for an Ontario resident in 2019), and then again under the U.S. gift-tax provision.

On the flip side, when a Canadian citizen gifts to a spouse who is a U.S. citizen, the IRS requires a timely disclosure if the gift exceeds a certain amount. Failure to do so could result in a penalty – US$10,000 or 25 per cent of the value of the gift, whichever is greater.

What about asset transfers resulting from divorce or separation? In Canada, the property would be transferred at the original cost unless ‘an election is made to do so at fair market value.’ In the U.S., the transfer at cost is only available if both spouses are American. If an asset goes from a separated or divorced spouse who is a U.S. citizen to a Canadian citizen, it is measured at market value and the principal spouse is subject to capital gains tax.

Overall, when dealing with multinational households, it is always best to plan in advance so you can match the value of property being gifted under the provisions of both U.S. and Canadian regimes. Also, be aware that the location of the asset may create additional tax considerations.

A wise man once said, “It is more blessed to give than to receive.” Evidently, that man wasn’t dealing with the potential tax implications of cross-border gifting! All the more reason you should consult with a tax professional who is familiar with the tax regimes and laws of any country you may be dealing with.

How new cryptocurrencies are disrupting Tax Reporting obligations (to IRS and CRA)
This article was originally published on September 17 2019 by 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.

Also, just as in the U.S. tax system, capital gains or losses could be considered taxable income because a commodity is bought or sold. Finally, cryptocurrency must be reported as income when it is received as compensation from an employer.

More information is available on the CRA website, which has a link to what you need to know about the Voluntary Disclosure Program. The CRA hasn’t issued any dire warnings yet, but its website says that failing to report cryptocurrency transactions is considered illegal and that the agency is “actively pursuing cases of non-compliance in order to make sure that the tax system is fair for everyone.”

If you’re considering cryptocurrency transactions for business or investment purposes – or you’ve already ventured down that path and this is all news to you – you are wise to seek out the services of a tax expert to make sure you are compliant.

Employer or PEO — who is the daddy?
This article was originally published on August 19 2019 by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc

If you’re a Canadian resident working for a U.S. company in Canada, there are a multitude of crossborder implications regarding employment law, payroll reporting, income taxes and Social security taxes. The evolution of the professional employer organization (PEO) since the 1980s has become a popular solution for U.S. and Canadian employers when employing remote workers.

PEOs make up a billion-dollar industry. What began as a provider of payroll services evolved to a provider of virtually all HR management functions and it could affect tax responsibilities. Many people, lawyers included, are not familiar with PEOs.

PEOs involve leased employment agreements with a company in which the PEO acts as the legal employer through a co-employment relationship and the PEO is responsible for hiring, firing, payroll, benefits administration, etc. In the U.S., there are more than 900 PEOs employing about 3.7 million people and the number is growing. In Canada, the concept is relatively new, with only 177 PEOs operating as of 2017.

While there are benefits in choosing the PEO route, the arrangement can lead to confusion about tax liabilities and determination of joint employment regarding who is liable for certain taxes, such as for unemployment and workers’ compensation. There may also be confusion about whether income paid to employees is exempt under a tax treaty.

The U.S. Department of Labor recently proposed a new standard to test the relationship between a PEO and its “client” in terms of joint-employer status. It is deemed to be joint employment if the
PEO meets any of these conditions:

  • Hires or fires the employee.
  • Supervises and controls the employee’s work schedules or conditions of employment.
  • Determines the employee’s rate and method of payment.
  • Maintains the employee’s employment records.

Here is how the Canadian PEO works for a U.S. company. The company enters into an agreement with the PEO to “lease” an employee. The PEO is the legal employer, responsible for payroll,
benefits, employment standards and other HR management functions, while the U.S. company retains daily oversight of the employee (i.e., common law employer). This allows the company to
hire the talent it needs and to manage the employer’s regulatory requirements at a reasonable cost with little disruption to the business.

Let’s say a U.S.-based company — we’ll call it ABC Inc. — employs a Canadian resident remotely in Canada; we’ll call him John. How does ABC Inc. manage John’s payroll and HR matters? Should
ABC Inc. hire a Canadian payroll expert or an employment lawyer to keep it out of trouble? It might because Canada has a different framework than the U.S. for employment law.

So ABC Inc. enters into an agreement with the Canadian PEO to effectively lease John. But what happens, in terms of taxation, if he travels to the U.S. to meet clients or attend meetings? Who is
the employer when it comes to determining if his remuneration is eligible for a treaty exemption under Article XV of the United States – Canada Income Tax Convention (1980)?

In this case John lives and works in Canada, but his “functional employer” is ABC Inc. even though a Canadian-based PEO administers his payroll and benefits. So when he travels south of the
border on business he is advised that he is covered under the treaty because his “legal employer” is in Canada. Therefore, John doesn’t have to pay income tax in the U.S.

John assumes he is exempt from U.S. taxation because his compensation earned while working on U.S. soil is paid by the Canadian PEO. Here’s what the treaty says according to subparagraph
XV(2)(b): If the compensation is not paid/borne by a U.S. resident and the employee doesn’t spend more than 182 days in the U.S. during any 12-month period beginning or ending in the
year, the compensation earned while on U.S. soil will be exclusively taxed in Canada, the employer’s country of residence.

That sounds straightforward. John gets paid in Canada. He pays tax in Canada. He does not meet any of the U.S. residency tests and continues to be a tax resident of Canada. Also, the PEO is
based in Canada and is not a U.S. resident.

Unfortunately for John, the relationship between ABC Inc. and the Canadian PEO constitutes a joint-employer relationship and ABC Inc. is a U.S. resident. That means the “borne by” test of the
treaty is met. So, despite being a Canadian resident who lives and works in Canada, John is still working for a U.S. company and any compensation allocated to time spent working on U.S. soil is
subject to taxation by Uncle Sam, assuming his compensation during the year exceeds the treaty threshold of US$10,000.

What is the upshot of all this? If you are a company in a cross-border PEO arrangement or an employee under this arrangement, understand what joint-employer status means and the possible
cross-border implications for income taxes and Social Security taxes. Will the PEO administer the U.S. payroll obligations in addition to the Canadian? What if a U.S. state does not follow the
treaty?

This is where the advice of a cross-border tax expert is highly recommended.

The Internal Revenue Service has begun sending letters to more than 10,000 cryptocurrency holders, warning they may have broken federal tax laws.

The agency wasn’t specific about the possible violations it was reviewing, but those who hold digital currencies could be subject to a variety of taxes, especially on capital gains.

“Taxpayers should take these letters very seriously. The IRS is expanding efforts involving virtual currency,” IRS Commissioner Chuck Rettig said.

The agency expects its mailing to be completed by the end of August. Three variations of the letter are being sent, depending on the information the IRS has about the recipient.

The IRS letters come as bitcoin, the world’s most popular cryptocurrency, has ridden a new wave of optimism in recent months. In mid-July, bitcoin topped $12,000, more than three times its value at the end of 2018. Investors, speculators and Facebook Inc. have extolled the potential of digital currencies.

At the same time, use by drug dealers and other nefarious actors has marred its reputation. The IRS has expressed worries about the ability of digital currencies to promote tax evasion.

An IRS spokesman declined to say how it learned about the targeted cryptocurrency holders and their transactions.

Do you think government should tax profits bitcoin trades? Join the conversation below.

One possible source is information provided to the agency by cryptocurrency exchange Coinbase. In mid-March of 2018, Coinbase provided data—under a federal-court order—on about 13,000 accounts as requested by the IRS.

Coinbase turned over data on customers who bought, sold, sent or received digital currency worth $20,000 or more between 2013 and 2015.
The data included the customer’s name, taxpayer identification number, birth date and address, plus account statements and the names of counterparties.

A representative for Coinbase declined to comment.

“In terms of the actual people who have crypto capital gains, most of them are not prepared because they have not been filing crypto taxes based on conversations with thousands of our users” said Chandan Lodha, chief executive and co-founder of CoinTracker, a digital-currency tax software company.

Mr. Lodha said that many cryptocurrency exchanges weren’t built to provide users with transaction histories. Without such histories, investors would have had to keep track of their transactions by hand.

“This is a problem that people should have been paying attention to for a long time,” he said.

The sternest version of the letter, released Friday, asks recipients who believe they have followed the law to sign a statement declaring, under penalty of perjury, that they are in compliance with tax laws.

It also says the recipient should understand the IRS may be in touch with them.

The two other versions of the letter are less threatening. The mildest warns that the recipient “may not know the requirements for reporting transactions involving virtual currency” and then details them.

Tax professionals warned that the letters shouldn’t be ignored.

They say it is usually far better, and less expensive in the end, to go to the IRS and attempt to rectify past mistakes. By sending the letters, the agency put people on notice that they are already in its sights.

Jimmy Song, a cryptocurrency investor who teaches a course on bitcoin at the University of Texas at Austin, said he heard rumblings about a potential crackdown on Twitter this week.

The new enforcement “doesn’t feel good,” Mr. Song said. “It seems like an intrusive way to get people to pay and I personally don’t like it because I’m a libertarian and many people who own this are.”

According to an IRS spokesman, there is no explicit requirement that many cryptocurrency sales be reported to the agency by third parties. Sales of stock shares must generally be reported on Form 1099-B to the IRS by the brokerage firm.

Among the possible taxes: If an investor sells a cryptocurrency after holding it longer than a year, the profits are typically long-term capital gains.

The tax rate is 0%, 15%, or 20%, plus a 3.8% surtax in some cases, depending on the owner’s total income.

an original WSJ documentary, markets reporter Steven Russolillo ventures Japan and Hong Kong explore universe His mission: create WSJCoin, virtual token for newspaper industry. Image: Crystal Tai. Video: Clément Bürge

In general, the IRS has until three years after a return’s due date to assess a deficiency, but that limit expands to six years if income is understated by more than 25%.

There are many exceptions, however. For example, the statute of limitations doesn’t start to run until a tax return is filed, and there is no time limit to bring civil fraud charges.

When it comes to preparing tax returns involving cryptocurrencies, Darren Neuschwander, a certified public accountant, said many tax preparers are frustrated because the IRS has long promised new guidance on cryptocurrencies that it hasn’t yet released.

“It’s ironic that the IRS is issuing these letters because we’re still waiting to know more rules,” he said.

Write to Laura Saunders at laura.saunders@wsj.com
Copyright ©2019 Dow Jones & Company, Inc. All Rights Reserved. 87990cbe856818d5eddac44c7b1cdeb8
Appeared in the July 27, 2019, print edition as ‘IRS Warns Holders of Digital Currencies.’

 

The Canada Revenue Agency (CRA) sent more than 700,000 records to the U.S. Internal Revenue Service (IRS) in 2017 as part of a tax-information sharing deal between the two countries, said a CRA official during a roundtable discussion at the annual national conference of the Canadian arm of the Society of Trust and Estate Practitioners (STEP Canada) in Toronto on Friday. The figure is current as of April 2019.

In 2014, the Canadian government signed an intergovernmental agreement (IGA) with the U.S. to exchange tax information on each other’s tax residents on an annual basis.

Under the IGA, which took effect in 2015, Canadian banks and other financial institutions report information on their American accountholders who have an aggregate balance of US$50,000 or more, excluding balances in some tax-sheltered accounts, to the CRA, which shares the data with the U.S. government.

In effect, the IGA implements the U.S. Foreign Account Tax Compliance Act (FATCA), a law passed in the U.S. in 2010 that compels global banks to report on their U.S. clients to the U.S. government. FATCA was designed to prevent offshore tax evasion by U.S. taxpayers.

So far, the U.S. government has not requested any further information in respect of the data sent by the CRA, said panellist Marina Panaourgias, an industry sector specialist in the trust section of the income tax ruling directorate of the CRA.

Terry Ritchie, director of cross border wealth services at Cardinal Point Capital Management in Toronto, suggests he isn’t surprised that the IRS has made no further inquiries about the exchanged data.

“Now that they have that information, what is the IRS likely to do with it? Probably nothing,” Ritchie says. “They have more problems in their own backyard that they should be more attentive to than to be chasing non-compliant U.S.-resident taxpayers in Canada.”

In recent years, global governments have made it an increasing priority to clamp down on offshore tax evasion.

For example, in 2017, Canadian financial institutions began identifying accounts belonging to individuals who are tax residents of foreign countries and reporting that information to the CRA under the Common Reporting Standard (CRS) regime, which was developed by the Organization for Economic Co-operation and Development. Canada began exchanging that information with foreign countries under the CRS the following year.

This article was originally published on June 7 2019 by The Advisor’s Edge (www.advisor.ca)
This article was originally published on June 7 2019 by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc.

Identity theft was an issue long before the Social Insurance Number (SIN) existed, but it keeps evolving. It is common today because high-tech hackers work around  the  clock  to find new ways to access our personally identifiable information. This makes taxpayer data some of the most sought-after information for cybercriminals.

So what are the Internal Revenue Service (IRS) and the Canada  Revenue Agency (CRA) doing to protect our sensitive information from being used to file a fraudulent tax return? A comparison between the  two agencies shows a big gap when it comes to planning and strategizing ways to protect taxpayers from tax-related identity theft.

With a population as large as that of the United States, there are hundreds of millions of opportunities to steal a person’s identity. In   fact, this has been a major concern of the IRS for some time. In 2015,   in response to the surge in identity theft that came along with taxpayers’ increased use of online technologies, the IRS formed the Security Summit.

The IRS Security Summit is a public-private partnership made up of representatives from the IRS, state tax agencies, the larger tax community (i.e., tax-preparation firms, software developers, payroll and tax financial product processors, and tax professional organizations) and financial institutions. They work together to protect U.S. taxpayers from identity theft refund fraud. In 2017, the summit also established the Identity Theft Tax Refund Fraud Information Sharing and Analysis Center (IDTTRF-ISAC) to facilitate information exchange, provide a real-time forum for discussion and promote the use of data analysis, all with a view to detecting and preventing tax- related fraud.

This ambitious initiative has proven to be very successful. IRS statistics for 2015 to 2018 show that during this time frame:

  • taxpayer reporting of identity theft fell by 71 per cent;
  • confirmed identity theft returns intercepted by the IRS declined by 54 per cent;
  • US$24 billion in fraudulent refunds were protected by the IRS stopping confirmed identity theft returns;
  • an additional US$1.4 billion in fraudulent refunds was recovered by financial industry partners.

In contrast to the formal programs and awareness campaigns of the IRS, the CRA  seems to be in    the dark. Its so-called “strategy” to prevent tax-related identity theft puts the onus on Canadian taxpayers to be vigilant around such things as telephone scams and phishing expeditions. And its “awareness campaign” appears to be limited to four posters reminding  taxpayers  that  we  can protect ourselves; tax agencies and tax preparers are  encouraged  to  put  these  posters  on  their office walls! There is no Canadian equivalent to the Security Summit and nothing like IDTTRF- ISAC. The Office of the Canadian Privacy Commissioner (OPC) is working to address data breaches that lead to identity theft by provisioning a mandatory requirement that organizations give proper notice to affected individuals and to the OPC when a data breach occurs. And that’s pretty well it.

But it seems the IRS has always outpaced the CRA in matters of data security. In 2014, some 900 SINs were stolen from the CRA due to the Heartbleed Internet bug, which was a serious  vulnerability in an encryption software intended to secure web communications. The IRS was not impacted at all. Meanwhile, the CRA had shut down online services to prevent incidents such as    the theft of SINs from happening. Yet the theft still occurred, while IRS online services continued unscathed for the duration of the notorious cyberthreat.

It’s high time that the CRA get in step with its American cousin.

According to an IRS press release issued on April 8, IRS commissioner Charles Rettig was happy to celebrate the wins of the summit, but was also quick to caution about sophisticated criminals. “Identity thieves are often members of sophisticated criminal syndicates, based here and abroad,” he said. “They have the resources, the technology and the skills to carry on this fight. The IRS and the Summit partners must continue to work together to protect taxpayers as cyberthieves continue to evolve and adjust their tactics.”

Tax lawyers and tax accountants should be aware that part of this ongoing cybercriminal evolution involves targeting tax professionals and their clients’ personal data. This remains a major issue for the IRS, as the agency has no control over third-party data security. If you are a tax professional and believe you have experienced a theft of your U.S. taxpayer client data, contact the IRS stakeholder liaison for assistance.

And what if you are a tax professional in Canada with concerns about data breaches on this side   of the border? Well, I know I’m suddenly longing for the days when data security came in the  form of a paper shredder.

 

This article was originally published on May 31 2019 by The Lawyer’s Daily (www.thelawyersdaily.ca), part of LexisNexis Canada Inc.

The Internal Revenue Service (IRS) in the U.S. is bringing its IT systems into the 21st century, which is good news for American taxpayers and Canadians who must file U.S. returns. It is also good news for tax lawyers and tax accountants.

The IRS Integrated Modernization Business Plan is a 45-page, six-year plan laid out in detail with initiatives categorized under four pillars:

  • Taxpayer Experience
  • Core Taxpayer Services & Enforcement
  • Modernized IRS Operations
  • Cybersecurity & Data Protection

The first pillar focuses on modernizing the taxpayer experience. The goal is to make interacting with the IRS and with personal tax information as easy as online banking. Some of the perks highlighted in the report include simplified online interfaces, better access to information and self-service options, and improved customer service through callback technology, online notices and live online customer support, all while protecting taxpayer information and data.

The second pillar, Core Taxpayer Services & Enforcement, involves programs and initiatives that aim to retire outdated systems and consolidate  disparate  systems  and  data  into  updated solutions. For example, 60 different case management systems will be decommissioned and replaced with a single, consolidated, enterprise-wide platform. The IRS says the new system will  be an “end-to-end view of taxpayer cases and interactions.”

Phase two also introduces real-time tax processing, which is described as “near real-time data processing” that will allow taxpayers to easily adjust their return online after they file. As Canadian taxpayers, we are painfully aware that the CRA’s online system is currently not close to “near real-time” and plans to make improvements are high-level at this time.

The third pillar, Modernized IRS Operations, aims to simplify infrastructure and implement new technologies such as data analytics and automation in order to create efficiencies. The IRS modernization plan anticipates that the initial investment in emerging high-tech solutions  will result in significant long-term savings for the agency through improved processes and optimized systems.

The last pillar, Cybersecurity & Data Protection, has three main initiatives: 1) Identity & Access Management, 2) Security Operations & Management, and 3) Vulnerability & Threat Management. With this one the IRS will try to better protect taxpayer data from the persistent risk of cyber threats. Incredibly, the report says the agency faces 1.4 billion attacks every year.

Why did the IRS need this integrated modernization business plan? The agency recognized that it has been experiencing its own financial struggles for decades with trillions of dollars lost to tax evasion and a tax gap of over US$450 billion (which  represents  the  difference between  taxes owed and taxes paid on time). Intensifying these shortfalls is the fact that 45 per cent to 55 percent of the IRS workforce is on the verge of retiring.

On April 10, IRS commissioner Charles Rettig announced to the Senate Committee on Finance that the agency requires US$2.3 billion to US$2.7 billion over a six-year period to implement an IT modernization plan that would include revamping its IT systems. Why? U.S. Senate Finance Committee chair Charles Grassley called the agency’s IT systems and infrastructure “woefully outdated,” and expressed concern that past efforts and investments to update its technology may not have been money well spent.

In 2018, the IRS processed almost 141 million tax returns and any agency with a volume like that needs the latest IT technology. The IRS has already been under the strain of updating disparate systems for the 2017 Tax Reform Act, not to mention the five-week government shutdown earlier this year.

Modernization is key for several reasons: to 1) improve the agency’s ability to recoup monies owed; 2) prevent further losses due to tax evasion and fraud; 3) create much-needed efficiencies and 4) ensure ongoing compliance with tax laws for taxpayers.

Since almost 90 per cent of U.S. taxpayers file their returns online these days, nobody at the IRS wants more outages on deadline day, which they refer to as Tax Day.

On April 17, 2018, the IRS announced that its systems were experiencing technical difficulties   (i.e., they crashed) due to transmissions from software providers to the agency’s tax-processing systems. Those systems were more than 60 years old. And guess what? The IRS system crashed again this year on the last Tax Day. A similar outage occurred in March on the CRA website when online services were down for a day.

I wouldn’t say that exciting times are ahead for taxpayers and their representatives, but these real and sustainable improvements to services, operations and security for the IRS are most welcome. From the perspective of a tax practitioner, the planned consolidation of various data sources for greater risk management, tax compliance, tax enforcement and information sharing have me (almost) looking forward to next year’s tax season. Or maybe the tax season six years from now.

 

What is Subpart F Income?

Generally, the taxation of earnings and profits in the U.S. of a controlled foreign corporation (“CFC”) are deferred until repatriation through the distribution of dividends. A CFC is a foreign corporation that is owned more than 50 per cent of vote or value by a U.S. person or persons (i.e. U.S. citizens, resident individuals, U.S. partnerships and corporations, non-foreign estates and U.S. trusts) who each own at least 10 per cent of vote or value. However, there are exceptions to the deferral with respect to passive and certain types of active business and personal services income. These types of income, under specific circumstances, are taxable in the hands of the U.S. person whether or not distributed to the shareholder. The deemed income inclusion is what is referred to as “Subpart F” income. The Subpart F rules are anti-deferral provisions to prevent U.S. persons from delaying the recognition of taxable income through the use of foreign entities.

What are the changes?

Beginning in 2018, a US citizen resident in Canada, who is required to accrue passive income (or other subpart F income) on his US personal tax return under the subpart F provisions of the CFC rules, will exclude the income from his US tax return if a Canadian corporate tax of over 18.9 per cent is paid on the income. This is what is commonly referred to as the “high-tax exception”. In Ontario, investment income is taxed at 50.17 per cent to the CFC (including capital gains taxed at 25.09 per cent), therefore, the high-tax exception would apply to exclude the investment income from being taxed currently as subpart F income. The current provisions ignore any subsequent reduction to the corporate tax as a refundable dividend tax on hand (“RDTOH”) once the income is distributed to the shareholder as a dividend for purposes of the high-tax exception.

Why were the changes enacted?

Treasury is aware that certain jurisdictions use a tax integration system where the corporate income tax paid by the CFC is refunded when the income is distributed, even if the shareholder is subject to little or no tax on receipt. This has raised concerns where CFCs are formed specifically to exempt passive income (or other subpart F income) from US taxation under the high-tax exception. To address this perceived abuse, proposed regulations were released on November 28, 2018 that modify the high-tax exception. Now, if foreign taxes paid or accrued are reasonably certain to be refunded to the shareholder on a subsequent distribution, such foreign taxes are not treated as paid or accrued for purposes of the high-tax exception.

What about capital gains?

As previously noted, Ontario’s tax rate on investment income is 50.17 per cent. After the RDTOH, the tax is reduced to 19.5 per cent on a subsequent distribution and the high-tax exception should apply. However, the high-tax exception with respect to capital gains will not be available due to a reduced tax rate of 9.75 per cent after the credit for the RDTOH. There may be situations where accumulated RDTOH can reduce the effective tax rate to below 18.9per cent. In this case, the high tax exception will not apply.

The regulations are still in proposed form and may change after the IRS receives comments from the public. If enacted in its original or revised form, it will be effective for tax years ending after December 4, 2018.

Three things to know about updates to the EIN application form

In an effort to improve security and transparency around the Employer Identification Number (EIN) application process, the Internal Revenue Service has published updated instructions to Form SS-4, Application for Employer Identification Numbers.

An EIN is an identification number assigned to sole proprietors, corporations, partnerships, estates, trusts, employee retirement plans and other entities. It is the equivalent to a Canadian Business number and all businesses operating in the U.S. must have an EIN in order to file tax returns or entity classification elections with the IRS. In some cases, it is also required to open a U.S. bank account.

If you are a Canadian doing business in the U.S., there are three key takeaways from these updates:

1) Requirement for an SSN or ITIN. EFFECTIVE MAY 13, 2019, taxpayers cannot apply for an EIN unless the responsible party named on the application has either a social security number (SSN) or Individual Taxpayer Identification Number (ITIN). While it is not expressly described in the new instructions to the application, it is understood that an EIN can be assigned to an international applicant (i.e. an entity that has no legal residence, principal office, or agency in the United States or a U.S. possession) if an SSN, ITIN, or EIN for the responsible party is not available. In this case, the applicant can enter “foreign domicile” on line 7b of Form SS-4.

2) Change to the definition of “responsible party”. As of December 2017, the IRS requires that an EIN applicant’s “responsible party” must be an individual who owns or controls the entity or exercises ultimate effective control over the applicant. The responsible party can be a U.S. or non-U.S. person, but it can no longer be an entity. (Government entities and military are exempt.)

3) Elimination of the “check-the-box” exception. The “check-the-box” exception no longer applies. Prior to this change, a SSN or ITIN was not required to apply for an EIN if the reason for obtaining an EIN was to file IRS Form 8832, Entity Classification Election (i.e. a “check-the-box” election to change the entity’s classification for federal tax purposes). In the most recent version of the application, the IRS has eliminated this exception.

The check-the-box election as a planning tool

The “check-the-box” election has been a popular post-mortem planning tool used by Canadians to avoid the U.S. estate tax on U.S. situs assets held by a non-U.S. taxpayer at death. A Canadian partnership is initially created to own the U.S. situs assets and, following the death of the non-U.S. taxpayer, a check-the-box election is made to treat the Canadian partnership as a corporation for U.S. tax purposes. A non-U.S. decedent who, at death, holds shares of a foreign corporation (which serves as a “blocker”) that owns U.S. situs assets is not subject to the U.S. estate tax. The “check-the-box” election can be effective up to 75 days prior to the date the election is filed, which effectively permits the ownership by the non-U.S. decedent of the “foreign corporation” to occur prior to the date of death.

The U.S. estate tax is assessed at up to 40% of the fair market value (and not the gain) of the U.S. situs assets, however, the lifetime estate tax exclusions that are permitted under the Canada-U.S. Treaty may provide relief from the U.S. estate tax. Because the lifetime estate tax exclusions have doubled for 2018 through 2025 under the Trump Administration’s new tax Act, this planning tool may prove to be less effective until the end of 2025.

Advance Planning is Highly Recommended

Limited Liability Companies (“LLC”) that are wholly-owned by non-US persons must now comply with the reporting requirements of Form 5472, Information returns of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.  The Form must be attached to a proforma U.S. tax return (i.e. Form 1120, U.S. Corporation Income Tax Return) and is due by the 15th day of the fourth month following the end of the foreign owner’s tax year or calendar year. For a calendar year foreign owner, the tax return is due April 15.

Because the ITIN application process is quite onerous and may take months to complete, advance planning is critical to ensure that elections are made in a timely manner and the U.S. filing requirements are met by the due date.

There is no change to the application process for tax professionals who act as a designated third-party in completing the process for an entity.