The Tax Cuts and Jobs Act was signed into law on December 22, 2017. Several significant changes arose out of this tax legislation. Some changes contain sunrise provisions (i.e. delayed effective dates) while most of the individual changes contain sunset provisions (i.e. expiry dates), making planning rather difficult. All but two of the personal tax changes sunset in the year 2026. Furthermore, the law contains multiple instances where Treasury is directed to issue regulations to clarify the law. That process will take some time and result in ambiguity on some items until completed.
In this alert, we outline the more significant items impacting US citizens living in Canada and Canadians investing in the US.
Key provisions for Canadians investing or working in the US
The provisions impacting Canadians investing or working in the US may not have a net tax impact given that, as Canadians, you are still taxed on your worldwide income in Canada. Increasing or decreasing US taxes impacts the amount of credit available on your Canadian tax return. If your Canadian tax rate has typically been greater than your effective US tax rate, you will likely only see a shift in which country gets their share of the tax. Managing that shift with your 2018 instalment or estimate payments becomes important.
Starting in 2018, the personal exemption has been eliminated. In 2017, the personal exemption amount was $4,050 for most non-resident filers. That meant that if you owned a rental property, you could shelter $4,050 of net rental income from federal US taxes. As part of the simplification of personal taxes, the standard deduction was increased to compensate for the elimination of the personal exemption, but the standard deduction is not available to non-resident filers. This will also impact non-resident wage earners who will not have access to an exemption amount either.
State tax deduction
Prior to 2018, state income, sales and property taxes were deducted separately, without much limitation. The bill combines these deductions and implements an annual limit of $10,000.
Sale of partnership interest
Whether the sale of a partnership interest by a non-resident is subject to US tax was left with some room for interpretation due to conflicting results between a Revenue Ruling and a Tax Court case. The inconsistency has been removed by codifying the Revenue Ruling which subjects the sale to US tax to the extent it relates to US effectively connected income. This is effective for sales occurring on or after November 27, 2017. Starting in 2018, a sale of a partnership interest by a non-resident is subject to 10% withholding tax on the amount realized on the sale.
For those Canadians that are invested in US businesses or real estate investments through partnerships or LLCs, a new deduction from income is included in the Bill. The deduction is equal to 20% of qualified business income which includes rental income, but does not include investment income such as capital gains, interest and dividends. Qualified business income is subject to a W-2 wage limitation or 2.5% of the original cost basis for depreciable assets with lives of 10 years or greater. The depreciable asset provision permits the deduction for real estate investment pass-throughs that would not otherwise have W-2 wages.
Personal property (e.g. furniture and appliances) used in furnishing lodging (i.e. real estate rentals) is now eligible for s.179 current year expensing. Bonus depreciation is set to 100% until 2023 when it starts a five-year phase down. Used property is now eligible for bonus depreciation.
Estate and gift taxes
The lifetime gift, estate and generation-skipping transfer tax exemption is doubled from 2018-2025 and continues to be indexed by inflation. For 2018, this limit is $11.2 million. Non-residents may be subject to US estate tax on US situs assets on death to the extent that worldwide net worth exceeds the limit. That worldwide net worth limit doubles on first death if assets pass to a surviving spouse.
Access to the worldwide limit occurs as a result of a provision in the Canada-US Income Tax Treaty. US estate returns are still required to claim the increased exemption for decedents passing away with more than $60,000 in US assets. There was no change to gift taxes applicable to non-residents of the United States.
Key provisions for US citizens living in Canada
The provisions impacting US citizens living in Canada will have a varying impact depending on each individual’s personal situation. US citizens who control Canadian companies will see the biggest and most immediate impact. The changes outlined above, with the exception of the sale of partnership interest apply equally to US citizens and should be referenced in context with the provisions that follow.