One unexpected – but significant – outcome of the recent tax reform legislation enacted in the United States is that thousands of US taxpayers living in Canada may be required to pay a one-time levy on the “adjusted retained earnings” of certain private corporations in which they have an ownership stake. Because this measure was intended to target corporations, many individuals may not be aware of their liabilities and reporting responsibilities under the new law, yet the clock is ticking with a June 15, 2018 deadline looming.
The Tax Cuts and Jobs Act (TCJA) represents the single largest overhaul of the US tax code in more than a generation, creating significant changes for businesses and individuals alike. Designed to stimulate investment in the US economy through considerably lower corporate tax rates, as well as through a raft of other amendments, the reform package will have a wide-reaching impact on US taxpayers – including some surprising outcomes for certain Americans residing in Canada.
Intended to target corporations, “repatriation tax” ensnares individual business owners
Because of the way in which the new law was drafted, a US citizen or Green Card holder living in Canada who owns at least 10% of the votes or value of certain privately owned Canadian corporations, or certain other non-US corporations (collectively referred to as “specified foreign corporations”), is liable to pay a transition tax (also referred to as the repatriation tax) on their share of “adjusted retained earnings” within those corporations as part of the shift to the new territorial system for taxing foreign company income under the TCJA.
This new tax obligation will come as a surprise to many, as will the rapidly approaching deadline of June 15, 2018 to report and begin making installment payments.
Making the best of an unexpected situation: Important to act quickly to minimize impact
Although an individual’s exact transition tax obligations will vary on a case-by-case basis, there are steps that can be taken to minimize the impact of the mandatory, one-time tax. Generally, a person can elect to pay the tax over an 8-year installment plan of 8% of the net tax liability in years 1-5, 15% in year 6, 20% in year 7 and 25% in year 8.
However, taxpayers who don’t pay their first installment by June 15, 2018 (or in some cases, as discussed in the next paragraph: June 15, 2019) – or who pay too little by the just noted deadline – lose the 8-year installment option and would then be required to pay the entire transition tax amount plus interest, increasing their currently due tax liability by over 10 times.
In the case of certain fiscal year corporations, individual taxpayers have the option of deferring their initial transition tax payment until filing their 2018 return (with payment being required on or before June 15, 2019). This decision must be made in the US shareholder’s first tax return following the year-end of the corporation. Therefore, eligibility will depend on when the fiscal year of the specified foreign corporation ends.
However, that extra year before commencing payment also comes at a cost. Specifically, the deduction applied against the transition tax will be greatly reduced, most likely resulting in significantly higher overall US taxes – despite the reduction in rates scheduled for 2018.
As a result, even for those taxpayers who are able to shift their first transition tax payment until 2019, advancing it into 2018 will most likely prove to be the less expensive option, as illustrated in the table below. Our tax advisors can assist with this decision, but it will be important to review the available options prior to June 15th.
Accelerate or Defer? Two scenarios:
|Accelerate to 2017 Tax Year (Payment due June 15, 2018)||Defer Until 2018 Tax Year (Payment due June 15, 2019)|
|Adjusted Retained Earnings - this Shareholder’s Portion (CAD)||$1,000,000||$1,000,000|
|US Dollar Conversion (USD)||$800,000||$800,000|
|Total Transition Tax Liability||$140, 000||$218,000|
|Payment Due 1st Year||$11,200||$17,440|
|Remainder Due Years 2-8||$128,800||$200,560|
|Total Savings (USD)||$78,000||--|
As noted above, American citizens living abroad, and impacted green card holders, have until June 15, 2018 (2019 in some cases) to pay their first installment (thereby electing to pay this new tax via installments). Given the multitude of significant changes taking effect this year as a result of the TCJA, this year’s US return preparations won’t be business as usual. Talking to your qualified tax advisor before the deadline will help to avoid any surprises while maximizing all eligible benefits.
 These are hypothetical cases and shown for demonstration only. All figures have been rounded, so that concepts could be illustrated, along with the magnitude of the amounts involved. Individual tax obligations and payment requirements will vary based on multiple variables, including but not limited to the nature and type of assets within the underlying specified foreign corporations.