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TIGTA has something to say about NRAs

Pensions Rentals

It appears almost 13% of all foreign property owners in various counties of California, Florida, Nevada and Texas aren’t reporting rental income on their US properties.  Chances are they aren’t paying the associated taxes on that money either.  That is what a recently released yearlong investigation by the Treasury Inspector General for Tax Administration (TIGTA) determined.

The report stated that nonresident aliens (NRAs) living in 5 counties of those 4 states failed to report and pay any taxes on rental income in 2013. If that statistic is assumed for the estimated 5,600 NRA rental properties in those regions, the unpaid taxes could exceed $60mil. The TIGTA feels this is unreasonable.  “The IRS should explore the feasibility of obtaining property tax lists through its information sharing partnerships with the states.” The report goes on to add “The IRS recognizes the potential for noncompliance in this area but has not been proactive in addressing the issue.”.

The TIGTA’s audit of the IRS ended in October of 2016 and the subsequent report outlined recommendations for the IRS to develop a compliance initiative which focuses on this underreported revenue.  The IRS agreed and set a deadline of Oct. 15, 2018 for implementation.

TIGTA’s review discovered 68% of NRAs had not been complying with proper elections, which means approximately 12,000 individuals violated the rules. The report pointed out that the IRS could assist NRAs, making them aware of proper elections that will benefit them by reducing their tax liability.  Since withholding tax on gross rental income for US properties owned by NRAs is 30%, electing to treat this revenue as linked to US trade or business may be wise. Applying associated expenses against the proceeds could also help with the balances due.

The review goes on to suggest the IRS revise the form 1040NR (the Nonresident Alien Income Tax return) to guide NRAs to the proper elections under Section 871(d). “While Schedule E is required to be used by nonresident aliens to report their rental income and expenses, the form instructions do not include any mention of the election requirements… The significant percentage of nonresident alien individuals not attaching election statements to their Form 1040NR may be due to the limitation of the Schedule E instructions.”

The third recommendation laid out by TIGTA suggested the IRS verify withholding credits claimed on Form 1040NR to information in the database created for Foreign Investment in Real Property Tax Act.  Researching the NRA’s master file account to verify rental and depreciation calculations was also brought forth.  The IRS, however, declined to act on this stating “Absent enhancements to the IRS’s systems that will capture data and automatically verify cost basis, it is not feasible at this time to include a manual verification of cost basis for a potential audit when validating FIRPTA withholding”.

Recent information shows that from April 2015 to March 2016, NRAs accumulated an additional $43.5 billion of US property.  This reflects an $8.7 billion growth over the 2013 levels.  Seems to me like the IRS should get busy on this issue and capture some of that cash.

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Election 2016: Who will Make a Better Neighbor with their Tax Reforms

Trump or Hilary - Scotties Ad

Walking through the TTC subway at Broadview or on many bus stops throughout the city, you will see a bright pink (brand name) tissue ad that will likely bring you to tears – pun intended.

The ad shows a woman crying, casting a frown, looking mortified with the words “Hillary Wins” to her left and “Donald Wins” to her right. Rather than showing the expected dichotomy of one side of her face showing happiness while the other side dissatisfaction, she is clearly equally displeased with the prospect of either candidate winning.

This ad provides some accurate and much needed comedic relief, capturing just how truly emotive this presidential race has been.

We all know the craziness surrounding both Hillary Clinton and Donald Trump. They have both been vilified in the media for lies, videos, scandals, and more. But what is more important and much less talked about are each of their tax plan proposals and broader business agenda for the next four years.

Tax is not the sexiest topic to discuss but it is one of the most important issues on the campaign docket (or at least should have been there). The most recent polls show that “The Trump” and “Pantsuit” (among their long list of monikers) are locked in a dead heat. As the race between them has intensified significantly over the last few weeks, polls showing the leading margins have narrowed. So rather than becoming embroiled with things or actions which are entertaining but slightly distasteful, let us focus on some of the key campaign tax proposals.

The Trump campaign                        

Is one’s business success a winning qualification for being president of the United States of America? Donald Trump seems to think so, which has lead some to have unwavering faith that his tax proposals will be nothing short of propitious for Americans, and even Canadians alike.

Tax cuts: Trump’s plan calls for substantial cuts in tax rates, although more of the “savings” will be realized by the wealthier taxpaying households.  He has said he plans to implement a “cross-the-board income tax reduction especially for middle-income Americans.”

Corporate Tax: His plan also calls for a lowering of the corporate tax rate to traditional corporate structures (in contrast to previously promised all business entities, including pass-throughs) to an even 15% from 35%, which would be extremely beneficial for business owners and future entrepreneurs. He also promises a 10% rate on a one-time repatriation of business profits held offshore – “All this money will come roaring back”.

 Estate Tax: Trump plans to eliminate the estate tax entirely. “The Donald” would love a good ol’ tax-free inheritance.

Income Tax: Trump’s plan would simplify the current income tax structure to include just three tax brackets from the existing seven. The highest rate would decrease from the current 39.6% to 33% for taxpayers earning over $225,000.  The plan also provides for repeal of the alternative minimum tax and the 3.8% “Obama” Net Investment Income Tax. The standard deduction would increase to $30,000 for joint filers and the wealthy would face a cap on itemized deductions at $200,000 for joint filers.

The Clinton campaign

Hillary often speaks about everyone contributing their “fair share” to society and her tax proposals reflect this narrative.

Tax cuts: Here is one of the biggest differences between the candidates. A Clinton election would be really expensive for the high net worth circle. For wealthier families, Clinton’s election means a significant tax increase. Her plan for raising taxes on the wealthy is supposed to generate more revenue for the government to be used on social services like subsidized higher education.

Corporate Tax: Hillary does not plan on changing the corporate tax rate in its current form. Nor does she plan on upsetting the status quo. All those businesses in industries that enjoy favorable taxation will retain those tax benefits. This includes real estate holding companies, mining companies, farmers/agricultural producers, research and development companies, and oil and gas developers.

Estate Tax: Clinton says she will increase the estate tax rate from 40% to 45% and lower the threshold that triggers the tax from $5.45 million to $3.5 million – most people don’t ever have to worry about this anyway. (Only about 4 in 1,000 of US residents and citizens are ever subject to the estate tax according to a 2016 National Public Radio report).

Income Tax: Clinton would not change the tax rates for anyone making less than $250,000 a year.

She does call for an increase of the minimum effective tax rate to 30% for anyone earning $1 million a year or more. She will also add an additional 4% surtax on incomes over $5 million, making a new tax bracket of 43.6% for ordinary income and 24% for qualified dividends and long-term capital gains. Such new bracket in reality  would cost taxpayers 47.4% and 27.8% once adding the Net Investment Income Tax which she plans to retain.  Hillary is also a staunch supporter of seriously limiting income tax deductions for the wealthy. This is her campaign hallmark.

According to the Tax Policy Center, this plan will result in 75% of the additional taxes levied would be paid by those in the top 1% of the income scale. (“The Donald” is much less vigilant in taxing those in the 1% club.)

Will the tax plans of either candidate actually benefit Canada’s economy?

Going back to the (brand name) tissue ad, while it is funny, it really opens up the discussion of US-Canada economic relations. The main focus is trade. The second focus is on Canadian investors.

Suppose Mr. Trump is elected, his American-centered rhetoric could be of some concern to Canadian markets since he claims he would overhaul international trade agreements such as NAFTA and the Trans-Pacific Partnership. Trump, taking a highly protectionist stance, will likely want to bring jobs and goods back into America and keep them there. Considering most of Canada’s exports go straight to America, a curtailment of such trade agreements could be quite unfavorable for Canada.

Madam Clinton also does not support the Trans-Pacific Partnership and has voiced very clear criticisms at current NAFTA agreements, even though the U.S. has benefited just as much as Canada with the increase in trade and cross-border investments from Canadians.

As far as Canadians investing in U.S. markets, Clinton is more widely perceived as the better choice for their portfolios because Trump causes too much divide and controversy throughout the world- this could make every economy more volatile as whole. Clinton is not likely to cause any disruption to current, profitable status quos, and herein lies her appeal to Canadian investors.

So when it comes to the question of who will make a better neighbour, it seems to be a draw. Only time will tell.

*Advertisment image shown above  is by Scotties Tissue

 

 

 

 

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Canadians that relocate to the US for career purposes – Post 6

american citizens in canada

Post #6 – How Can HCBT Help

In the previous posts, we outlined:

  • tax compliance and reporting issues that S1 & S2 had not dealt with;
  • how HCBT could help correct prior year problems / reduce penalty exposure through a VDP submission;
  • assist with CofC submissions and the reporting of the property sale;

What we cannot do is eliminate the incremental stress and professional costs of dealing with tax authorities in a time crunch before a pending sale.

What can be learned from this?

There are important triggering life events when every taxpayer should seek appropriate and timely professional advice.  In the cross border context, all moves between countries requires professional advice.  The tax and financial consequences in both the departure and arrival country must be identified in advance.  It is imprudent to assume there are no changes from your current domestic situation or that issues can be reviewed after the move.  Often, compliance or planning issues can only be dealt with properly, before the move.  Although rare, it is conceivable that a tax / financial issue created by a transfer between countries could be sufficiently important, to rethink the move decision.

In a Canadian domestic context, any change in use of any real estate from personal to rental / business use, creates tax consequences, whether or not properties are sold.  Failure to consider these issues in advance could be costly.

HCBT has realized that sharing peoples past tax situations can be a very valuable learning tool to our clients and community. We will continue to publish sanitized client situations in future posts.  In the meantime, if you need or know someone who needs our assistance on cross border or other Canadian / US tax issues please contact us.

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Canadians that relocate to the US for career purposes – Post 5

Pensions Rentals

Post # 5 / Damage Control

In the last post HCBT had recommended S1 & S2 access the Voluntary Disclosure Program [VDP] to possibly reduce the penalty component of their $20,000 tax problem.  However, timing was an issue.

CRA public information states that most Certificate of Compliance [CofC] requests will be processed in 30 days.  The 30-day target presumes no unresolved prior year issues.  After receiving the offer, consulting with the lawyer / HCBT less than 30 days remained before closing date.  The CofCs must be presented to the purchaser’s lawyer on closing to avoid withholding from the sale proceeds.

The VDP submission to correct the 2013 to 2015 deficiencies must be completed and submitted before the CofC request.  S1 & S2 had to scramble at the last minute to assemble old financial information from 2013 to 2016 so the proper reporting on departure and rental reporting can be completed/submitted.  Even with professional help and utilization of the VDP there was a real risk the CofC review would not be completed on time to prevent withholding of sale proceeds.  If so, the process could be extended for several months, delaying the tax refund.

S1 & S2 also needed to understand why the sale of their family home was not tax free, which is what most of the Canadian tax paying public thinks.  The theory is that 1 family unit [2 spouses plus children under 18] can own 1 family home / principal residence without paying tax on any gains realized on that home.  The tax mechanics to accomplish this are based on a formula

Exempt Gain =   Total Gain Realized   x     Principal Residence Years / Total years of ownership

Principal residence years are the years the taxpayer used the property as a family home plus 1 bonus year to allow for mid-year transactions.  In most cases the years of usage and the years of ownership are the same, so 100% of the gain is exempt.  However, in Expat or rental conversion situations a problem results.  Any year after ceasing to be a resident of Canada does not count in the top half of the fraction.  S1 & S2 had a change of use to a rental property just after departure.  Rental years do not count in the top half of the fraction.  The mechanics of the formula are such that the sheltered gain percentage gets smaller with each passing year after departure from Canada.

US Implications:  The use of the family home as a rental property and subsequent sale will also have US tax consequences, which are not discussed as part of this series of posts.

 If you want to know how HCBT can help, see post # 6.

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Canadians that relocate to the US for career purposes – Post 4

remote-canadian-employees-with-u-s-employers

Post # 4 / Financial Damage Control

In the last post we outlined the tax compliance and reporting issues that S1 & S2 had not dealt with in tax years 2013-2015 inclusive.  This created over $20,000 in tax, penalties and interest.  Here are the main points of our discussions.

S1 & S2 were primarily concerned with getting the Certificate of Compliance [CofC] so that no funds are withheld from the sale proceeds – they want to submit the CofC request and hope the issues in 2013 to 2015 are not questioned.  They were unsure why this process was so onerous when the sale of their family home should be tax free.

HCBT Response: The documentation required to obtain a CofC is quite extensive.  The submission form specifically asks the following:

  • how the property was used while the owner was non-resident [ e.g., personal use, business use, rental, etc];
  • about Canadian tax reports filed for business and rental activities of the property;
  • a proforma calculation of the capital gain and/or income earned and the tax owing on the disposition of the property;

CRA essentially conducts a desk audit of S1 & S2 Canadian tax compliance to ensure all required returns / reports have been filed, any tax has been collected, before funds leave Canada.  CRA will use S1 & S2’s social insurance number to check all activities that might have a Canadian tax balance owing.  With this information it will be obvious to CRA that there are compliance problems in the year of departure and subsequent.  If no CofCs are obtained substantial funds will be withheld from the sale and placed on deposit with CRA.  S1 & S2 will have to file Canadian personal tax returns to recover the excess withholding.  After receiving the returns CRA will do essentially the same desk audit before processing the refund.

HCBT Alternative Approach:  CRA has a voluntary disclosure program [VDP] that allows taxpayers to correct prior year tax deficiencies.  If certain conditions are met, only the tax and interest must be paid but not penalties.  Given that penalties are a significant portion of the $20,000 financial exposure using this program could be of serious  benefit to S1 & S2.  To be accepted the taxpayer has to voluntarily initiate the corrections before CRA is investigating the taxpayer.  Secondly, complete disclosure of all issues is required.  The taxpayer cannot selectively disclose tax problems.

If S1 and S2 are going to access the benefits of the VDP they must submit most if not all of the corrective information on the 2013 to 2015 issues before the is CofC submission request is made.

If you want to know how this story ended, see post # 5.

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Canadians that relocate to the US for career purposes – Post 3

Firpta

Post # 3 / What Went Wrong – Specifics / Financial Risk Created

In the last post S1 & S2 were dealing with the shock of over $20,000 in tax, penalties and interest plus the possible delay of the sale of the family home.  These following compliance deficiencies were identified.

Tax Year of Departure 2013

  • S1 did not file prescribed “List of Properties by Emigrant of Canada” to disclose 50% interest in family home plus $75,000 RV personal use property. Penalty for failure to file $2,500;
  • S2 did not file prescribed “List of Properties by Emigrant of Canada” to disclose 50% interest in family home plus 1,000 shares of previous employer. Penalty for failure to file $2,500;
  • S2 did not file prescribed “Deemed Disposition of Property by Emigrant of Canada” or a tax return to report $55,000 accrued gain on 1,000 shares of previous employer. S2 will owe CRA approximately $4,500 for unpaid tax, late filing penalty, and interest because no return was filed in 2013;
  • S1’s return will be adjusted to disallow the spouse credit because S2 revised income exceeds allowable limit. S1 will owe CRA approximately $2,300 for unpaid tax and interest.

Tax Year 2014

Because they were renting their family home on a breakeven basis S1 & S2 did not think they had to report this activity to the US or Canadian tax authorities.  For Canadian purposes the gross rental income is subject to non-resident withholding tax of 25%.  This should have been remitted to CRA in the month following the rent receipt, unless elective procedures followed and a special rent return is submitted by June 30, 2015.  The elective return reports rental income net of expenses and tax is charged at normal Canadian marginal tax rates on the net profit only. Often the tax owing at marginal rates on a net basis, is relatively nominal compared to the 25 % withholding

  • No elective procedures or special rental return has been filed. CRA can charge $5,400 [$1,800 per month for 12 months @ 25%] plus interest for late payment;
  • S1 & S2 held the property jointly. Both should have elected and filed special rental return on their respective share;

Tax Year 2015

  •  No elective procedures or special rental return has been filed by June 30, 2016. CRA can charge $5,400 plus interest for late payment;

 This looks really bad, if you want to know how Hanson Cross Border Tax helped S1 & S2 minimize the financial damage, see post # 4 next week.

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Canadians that relocate to the US for career purposes – Post 2

expanding into the US

Compliance Lapse / What Went Wrong / Financial Risk Created

In the last post we described sanitized facts based on a real client situation.  This scenario is typical of what Canadian Expats face on a foreign work transfer.  There are unique Canadian and US tax and disclosure requirements upon relocation from Canada to the USA.  It is unlikely that even the most financially knowledgeable individuals would properly discharge these responsibilities without seeking professional help in advance.   Failure to satisfy disclosure requirements can and do result in substantial penalties, even if no tax is owing.  This post uses a Canada / USA relocation to illustrate but the same principles apply when departing Canada for any country.

In August 2016, S1 & S2 consulted a lawyer about the upcoming sale of the family home.  The lawyer advised that because they were non-residents, each would need a Certificate of Compliance [CofC] obtained from Canada Revenue Agency [CRA].  Otherwise the purchaser would have to deduct $225,000 [$900,000 x 25%] from the sale proceeds of the family home and remit these funds to CRA.  The lawyer advised that this is a standard process for real estate purchases from a non-resident.  S1 & S2 cannot avoid the CofC requirements by selling the property to another purchaser.

S1 & S2 consulted Hanson Cross Border Tax.   Based on a preliminary review of their fact situation, the potential tax, penalties and interest on reporting deficiencies exceeded $20,000.  S1 & S2 were shocked because they had always been told the sale of the family home is tax free.  They thought the sale would be straightforward.

 This discovery was only the beginning, if you want to know where S1 & S2 further went wrong, come back next week to see post # 3.

 

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Canadians that relocate to the US for career purposes – Post 1

american citizens in canada

Our website and letterhead uses “HCBT” as an abbreviation for Hanson Crossborder Tax Inc.  After the next few posts HCBT could also mean Hanson Cross Border Tragedies.  These are real life sanitized client stories to illustrate the financial and emotional burden created if cross border tax situations receive inadequate care and attention. The first in the series involves a typical Canadian family in which the main breadwinner gets the chance of a lifetime to relocate to the USA at a substantially higher salary.   Canadian Expat Post #1 will summarize the facts, common to many Canadians that relocate to the US for career purposes.

Post #1 Background 

  • Family of two Canadian spouses plus 2 young children lives Ontario [S1; S2; C1; C2];
  • Family home is owned jointly by S1 & S2. Purchased in 2008 for $450,000; Estimated value in December 2013 $600,000;  Expected value increases $50,000 in each subsequent year;
  • S2 employed in previous years. Primary responsibility now is care of C1 & C2;
  • S2 owns 1,000 shares from a previous employer stock option program. Shares cost basis is $5,000.  Estimated value in December 2013 is $60,000;
  • S1 employed by Canadian employer for $150,000 CDN per year;
  • S1 has self-directed RRSP with $100,000 in mutual funds / ETF’s. Maximum contribution has already been made earlier in 2013;
  • S1 purchased a recreational vehicle for $75,000 in August 2013;
  • In early December 2013, S1 is offered a position with Texas company with an annual base compensation of $225,000 USD;
  • Family relocates to Texas in December 2013; rents apartment so S1 can start a new job on January 2nd, 2014;
  • S1 & S2 decide to rent the Ontario family home rather than sell it. S2-B, brother of S2, lives near the family home.  S2-B will obtain tenants, repair and maintain property, collect / deposit rents for fee of $200 per month.  S2-B has no previous experience in rental property management.
  • Tenants move in on January 2, 2014 and pay rent $1,800 per month. S1 & S2 expect that they will breakeven costs versus rent.  Tenant rent is deposited into joint bank account of S1 and S2 at an existing Canadian bank account.
  • S1 & S2 did not seek legal or financial advice about selling or renting the family home;
  • S1 prepared and filed a 2013 T1 return reporting employment income, RRSP deduction, spousal credit;
  • S2 had no income and therefore did not file a 2013 T1 return;
  • S1 & S2 prepared and filed joint US returns for each 2014 & 2015, reporting only US income, i.e. Texas employment earnings;
  • On August 30, 2016, S1 and S2 receive an offer to sell the Family home for $900,000 with closing date on September 30, 2016.

Unfortunately, tax planning was not considered by the family described above. Next week please come back to read post #2 of this series and let’s see what happened.

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New IRS Compliance Deadlines May Impact Your Filings

IRS Compliance Deadlines

On 31 July 2015 President Obama signed the bill into law (The Surface Transportation and Veterans Health Care Choice Improvement Act of 2015, H.R. 3236, also known as Highway or Stop-gap Bill) which amongst other measures sets new due dates for commonly filed US income tax returns and other disclosures. These changes to the filing deadlines are applicable to returns for tax years beginning after 31 December 2015 which means for calendar-year filers the new deadlines will first appear in 2017.

FinCen Form 114

The standalone June 30th due date for electronically filed form FinCen 114, Report of Foreign Bank and Financial Accounts, (also known as FBAR) is now almost history. Starting in 2017, FBARs will have to be submitted at the same time as income tax returns, whether on APRIL 15 or with a six-month extension. A provision for an automatic 2-months extension to June 15 similar to Treasury Regulations Section 1.6081-5 for Americans abroad shall also apply. This is a very welcome change which makes a lot of sense for taxpayers and tax practitioners.

FBAR is required if a taxpayer, whether an individual or an entity, has a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account, exceeding certain thresholds. For additional criteria on filing FBAR please see the following IRS link: https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Report-of-Foreign-Bank-and-Financial-Accounts-FBAR

Form 1065

U.S. Return of Partnership Income reported on Form 1065 and partner’s Schedule K-1, Partner’s Share of Income, will soon change its current deadline of APRIL 15 or on the 15th DAY of the FOURTH MONTH following the taxable year. Starting with 2017, the filing deadline will be MARCH 15 or on the 15th DAY of the THIRD MONTH following the taxable year. This change effectively aligns the due date of the partnership return with the deadline of another flow-through entity’s tax reporting – S corporation (Form 1120-S). The likely hope behind this switch is that Schedule K-1 reporting each partner’s share of the partnership tax items will be available in time for their inclusion into the partner’s individual or corporation tax return.

We are not so optimistic and think that the change will likely lead to a greater number of extensions of partnership returns in addition to the returns of their partners.

For instructions of filing Form 1065 see the following IRS link: https://www.irs.gov/uac/Form-1065,-U.S.-Return-of-Partnership-Income

Form 1120

The deadline for a U.S. Corporation Income Tax Return has been flipped to what used to be the partnership return’s deadline, or APRIL 15 for a calendar year taxpayers or on the 15th DAY of the FOURTH MONTH for fiscal year-end filers. This means that we now will be clogged even more with the matching personal and corporate deadlines! If it is not confusing enough, here is another twist. C corporations with tax year-ends of June 30 will continue filing their returns on September 15 until 2025 and on October 15 thereafter. https://www.irs.gov/uac/Form-1120,-U.S.-Corporation-Income-Tax-Return

It is yet known whether the filing deadline will change for treaty-protective Form 1120-F, U.S. Income Tax Return of a Foreign Corporation.

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ARE YOU STILL WAITING FOR YOUR U.S. REFUND? IT MAY STILL BE AWHILE

IRS

If you filed a Form 1040NR, U.S. Nonresident Alien Income Tax Return, in 2015 claiming a refund from an overwithholding of tax on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, and have not received the refund yet, you are not alone. The delay is due to a current policy adopted by the Service while it conducts an examination of withholding agents and intermediaries on payments to nonresident alien individuals, foreign entities and foreign governments. No refunds are released within the first 6 months from the later of either the original due date of Form 1040NR or the date when the return was actually filed. To put it into perspective, if you filed your 2014 1040NR by its statutory due date of June 15, 2015 with all the appropriate withholding attachments, you will only be able to collect a refund after December 15, 2015.

It is currently unknown whether the same compliance focus will be adopted by the Service in 2016. To avoid a potential and unnecessary delay in collection of an overwithheld tax we advise our clients and prospects to submit in advance accurately completed Forms W-8BEN, Certificate of Foreign Status of Beneficial Owner for U.S. Tax Withholding, W-8BEN-E or any similar W-8 category forms to enable a withholding agent or intermediary to hold back only the required rate of tax on U.S. source income.

For a reference to IRS W-8 forms please see here

1042-2-s

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