Canadians Returning from US Employment

US citizens and permanent residents are exposed to the US gift and estate tax regime even if they live in Canada. Exposure to this regime, which is different than the Canadian system, often requires the execution of tax planning strategies that can be achieved through careful estate and gift tax planning.

One strategy involves planning for exposure to US gift tax. Gift tax applies at graduated rates of up to 40% on gifts of property with some exceptions for gifts made under a certain amount per year. There is also a lifetime gift tax exclusion amount that is adjusted for inflation each year. However, the unlimited gift tax exemption for gifts made between US citizen spouses does not apply to US permanent residents, which necessitates additional planning for such individuals.

When US citizens and residents pass away, federal estate tax is applied to their gross worldwide estate (including some life insurance proceeds) at the same rate as gift tax: up to 40%. (State-levied estate tax may also apply, depending on one’s state of residence.) The federal estate tax exemption is tied to the gift tax exemption such that depleting one’s gift tax exemption during life reduces the portion of a deceased’s gross estate that can be exempt from estate tax upon death.

If estate planning is done effectively, estate tax can be mitigated or even avoided by holding assets in certain vehicles. Rules surrounding the calculation of the value of a deceased’s worldwide estate can be complex, so establishing the correct structures in which to hold assets is important.

Moreover, the unlimited marital deduction that US citizen spouses enjoy, which effectively allows the tax-free transfer of assets from first-to-die to surviving spouse, is not available to non-US citizens. The need to counterbalance this lack of marital credit also necessitates sophisticated cross-border estate planning for non-citizen high net worth US persons.

When we analyze our clients’ current estate plans, we recommend strategies that they can implement prior to departure to Canada as well as once they live north of the border. Our primary intention is to help clients protect their assets from estate tax on both the federal and state-wide levels so their estates will be as robust as possible for future generations inheriting wealth.

Canada and the US each have government pension plans that Americans living in Canada may be able to benefit from in retirement. Cross-border tax issues should be considered when assessing how much government pension income Americans living in Canada will be able to collect.

Those who have spent their careers working in the US may be eligible for US Social Security payments. Generally, you are eligible to receive US Social Security if you have worked for approximately 10 years in the US.

Americans who move to Canada to continue their careers will also be eligible for Canada Pension Plan benefits (“CPP”) upon retirement as CPP contributions are mandatory in Canada. Old Age Security (“OAS”) benefits are also available to those Canadian residents who spend at least 20 years living in Canada as adults.

When Americans move to Canada, they worry about whether they will still be able to receive their US Social Security payments and how much tax the CRA will collect.

Fortunately, through the Canada-US Tax Treaty (the “Treaty”), US Social Security Credits are only 85% taxable by the CRA, and the IRS does not tax Social Security benefits of Canadian residents. (Note that the CRA taxes 100% of CPP and OAS benefits, while only 85% of CPP and OAS benefits are taxable by the IRS under the Treaty.)

One cross-border pension limitation that may affect Americans who move to Canada is the Windfall Elimination Provision, or “WEP”. The WEP is a US domestic law that allows the US government to claw back Social Security payments of a US person who earns CPP income.

Another potential limitation is the CRA’s OAS clawback rule. The rule is that if a Canadian resident’s earnings exceed a certain threshold amount in yearly income (from sources such as employment, investment, or even CPP income), the government can force the resident to pay back some of their OAS payments. Above a certain maximum threshold, the CRA can stop providing OAS payments entirely.

We work with our clients to balance the competing cross-border pension rules that may exist in Canada and the US and, moreover, to advise on planning opportunities.

American residents moving to Canada may have already contributed to one or more US retirement accounts, including a Traditional Individual Retirement Arrangement (“IRA”), a Roth IRA, a 401(k), a 403(b), and/or a 457(b).

Each of these retirement accounts comes with its own set of benefits for US residents. But do these accounts have the same benefits for Canadian residents? Often, Americans moving to Canada want to know whether they should retain these accounts after their move. The answer varies with each unique situation.

IRAs and 401(k), 403(b), and 457(b) accounts all receive tax-deferral treatment in the US; fortunately, Americans who move to Canada continue to enjoy tax-deferral on their IRA, 401(k), 403(b), and 457(b) accounts – as long as they file the proper election with the CRA.

Keeping your retirement accounts open post-move is generally the simplest method of handling them. However, when withdrawals are made down the line, they will be subject to higher Canadian tax rates as both the CRA and IRS will tax this income. Foreign tax credits are available from the CRA, but they may not fully offset the cost of US tax.

To avoid paying Canadian tax rates on IRA, 401(k), 403(b) and 457(b) withdrawals as a retiree in Canada, it may be advantageous to convert these accounts to Roth IRAs prior to moving north of the border.

Another tax-planning option for non-US persons is to convert retirement accounts to a Registered Retirement Savings Plan (“RRSP”) after arriving in Canada. RRSPs are pre-tax, tax-deferred savings accounts for Canadians. Converting US retirement accounts to an RRSP does not work well for US citizens or Green Card holders who retain their US residency status post-move, however; also, this strategy can be complex to execute.

Note that RRSP withdrawals are taxed more favourably for US residents than Canadian ones. Therefore, American residents who own RRSPs from previously living in Canada may want to withdraw their RRSPs as American residents, prior to returning to Canada.

Ultimately, determining how to handle your US retirement accounts when moving to Canada is a complex process that involves analyzing one’s total financial picture.

One of the most wonderful benefits of moving from the US to Canada is access to the Canadian health care system, which is government-funded and free for all Canadian residents.

Health insurance in Canada is governed by each province. While health insurance is available to all residents of a province, new residents typically have to wait for a certain period of time before qualifying for coverage.

Each province has its own rules regarding the wait time for health insurance coverage, but the wait is generally three months, which is the case in Ontario, for example.

The wait time for health insurance coverage often prompts new Canadian residents to purchase private Canadian health insurance coverage to bridge their gap in coverage. Such policies are typically affordable, and there are a variety of plans available through private insurance providers.

Since most American residents have life insurance policies in place before they move to Canada, it is important for us to review such policies prior to departure to confirm that they reflect our clients’ desired beneficiaries and to ensure that they will not create any cross-border tax traps.

One of the most common cross-border tax traps associated with life insurance policies is that certain American whole life and universal life policies may not be tax-exempt in Canada as they are in the US. This discrepancy can trigger a tax liability in Canada, but not in the US.

A similar issue arises when Americans living in Canada purchase Canadian whole life or universal life insurance policies that are not considered tax-exempt by the IRS though they are tax-exempt in the eyes of the CRA. Moreover, Canadian whole life and universal life insurance policies may trigger the egregious Passive Foreign Investment Company (“PFIC”) rules.

We advise our clients on the potential tax liability of their life insurance policies, and we suggest tax-advantageous ways of surrendering policies prior to moving north, if necessary.

We also advise US persons on the tax filing requirements associated with owning Canadian policies, particularly the requirements of the Foreign Account Tax Compliance Act (“FATCA”), which is the legislation that governs US persons’ reporting requirements for foreign accounts and other financial assets located outside the US.

Life insurance policies also pose potential US estate tax liabilities. There are estate planning solutions that can mitigate tax exposure, however, such as the irrevocable life insurance trust (ILIT).