Snowbird Desiring More Time in the US

Most snowbirds fly from the cold Canadian snow and into the warm American sunbelt, migrating to states like Florida, Arizona and California for anywhere from two weeks to six months a year. It is common for snowbirds to start heading south for only a short period of time each winter. Over time they find themselves trying to maximize the number of days they spend in the US as they come to value their sunbelt lifestyle more and more over time.

Eventually, many snowbirds would like to spend eight months a year in the US, or even 11 months a year – time that could be used to continue building the community of friends they’ve made down south, improving their golf game, or simply enjoying the weather.

Due to immigration and tax rules, however, spending more time in the US as a Canadian resident can become challenging. Canadians must carefully calculate the number of days they spend in the US each year to avoid going over the limit. Such calculations are quite complicated (although our Substantial Presence Test calculator can help), and snowbirds often end up feeling restricted that they can’t live their lives exactly as they desire.

This frustration prompts our snowbird clients to wonder whether it would just be easier to move to the US on a more permanent basis, avoiding immigration and tax penalties that go along with overstaying one’s welcome in the US as a Canadian resident.

Making the decision to move to the US necessitates careful pre-departure tax, estate, retirement, investment, and immigration planning. Snowbirds who will spend most of the year in the US must obtain adequate health insurance coverage in addition to other insurance products, as well as familiarize themselves with potential cross-border tax filing requirements.

Keep reading for more information about these cross-border financial planning topics as they apply to our snowbird clients. Please note that the topics covered below require detailed, comprehensive analysis before specific recommendations can be made to an individual client, which is the purpose of creating a cross-border financial plan prior to departure.

Residency

Canada and the US each have strict domestic rules regarding tax residency. Under each country’s domestic tax laws, snowbirds who spend most of their time in the US but continue to live in Canada for part of the year might find themselves being tax residents of both countries simultaneously. This is not an ideal situation as it increases the chance that a snowbird will be exposed to double taxation. It is therefore preferable to establish a singular tax residency in the US (which, due to its lower tax rates, may provide a tax savings for snowbirds moving south). Establishing a singular tax residency also simplifies a snowbird’s tax filing obligations.

Fortunately, the Canada-US Income Tax Treaty (the “Treaty”) has tiebreaker rules that evaluate an individual’s facts and circumstances to determine which country has a stronger claim to a person’s residence. The Treaty overrides domestic tax rules; as long as snowbirds can prove tax residency in the US by demonstrating various facts under the Treaty, they are automatically deemed non-residents of Canada.

Snowbirds who spend the majority of their time in the US often like to retain a residence in Canada that they can use during the months spent north of the border. With the right pre-departure planning and consideration of Treaty rules, it is possible for a snowbird to keep a home in Canada without being deemed a Canadian tax resident, thereby maintaining a snowbird lifestyle even after moving to the US – and without jeopardizing one’s status as a US tax resident.

Departure Tax

Canadians moving to the US may have to pay departure tax upon exiting Canada. Departure tax is not a penalty for leaving Canada and moving to the US. Rather, upon departure, a snowbird is deemed to have disposed of their assets at fair market value even though an actual sale does not occur; this deemed disposition may lead to capital gains tax (commonly known as “departure tax”).

Some assets are exempt from departure tax (such as RRSPs and Canadian real estate), but others (such as non-registered investment portfolios and shares of private corporations) are not. However, departure tax can be deferred, mitigated or even eliminated.

As such, a comprehensive plan for handling departure tax should be established prior to moving to ensure that snowbirds are aware of what to do with each asset before exiting Canada and to ensure that they benefit from available tax planning opportunities.

Canadian Holding Company

A common tax deferral strategy for high net-worth Canadians usually involves having various investments owned through a holding company. While this structure works well for Canadian tax residents, retaining funds in a Canadian holding company once a snowbird moves stateside may not be the best course of action.

The IRS treats US residents who are shareholders of foreign companies which earn passive income in a punitive manner. The IRS may view a Canadian holding company as either a “Controlled Foreign Corporation” (“CFC”) or a “Passive Foreign Investment Company” (“PFIC”); snowbirds with PFICs or CFCs must comply with IRS tax filing obligations, and they may be taxed at an egregious rate on income earned in their PFICs and CFCs. As a result, snowbirds who move to the US and continue to earn income from their Canadian holding companies often find themselves caught in a cross-border tax trap.

The impact of the CFC and PFIC rules can be minimized or eliminated. For example, prior to moving, a snowbird may consider creating a structure that is more tax-efficient than a Canadian holding company in which they can continue to hold funds as a US tax resident.

Situs Wills, Trusts, and Power of Attorney Documents

Ideally, estate plans should be made in the jurisdiction where one’s assets are located. Some Canadians moving to the US plan to retain certain Canadian assets, such as a cottage. Such clients should therefore have a Canadian estate plan that covers Canadian assets retained post-move and a US estate plan for all assets that will be held in the US. It is also prudent to create power of attorney documents for all jurisdictions in which one plans to retain assets and spend time.

It is likely that Canadian moving to the US have already drawn up Canadian wills and incapacity documents, such as powers of attorney for property and health care. US estate planning documents such as a will and/or trust, as well as incapacity documents such as powers of attorney for property and health care, must also be drafted.

We assist our clients by reviewing their estate planning needs and determining the optimal course of action based on their assets; for example, it may be clear that it is more prudent to prepare a US revocable trust in addition to or instead of a US-situs will to avoid or minimize state-levied probate fees and the time-consuming probate process. Establishing pre-entry dynasty trusts and/or charitable trusts may also be helpful for Canadians moving to the US.

Preparing comprehensive cross-border estate plans provides peace of mind. Establishing power of attorney documents on both sides of the border guarantees that the substitute decision-maker of one’s choice will be able to act in both the US and Canada with respect to not only property, but health care decisions as well. It is also important that one’s estate plan considers domestic laws on both sides of the border to ensure the proper distribution of assets to heirs.

Not only can a cross-border estate plan provide peace of mind in this manner, but it can save money in terms of probate fees (as mentioned) and by considering the US estate and gift tax regime.

US Gift and Estate Tax

US residents who are domiciled in the US, and citizens are all exposed to the US gift and estate tax regime in the same manner. Exposure to this regime, which is different than the Canadian system, requires the execution of tax planning strategies that can be achieved through careful estate 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 domiciles and permanent residents, which necessitates planning prior to departure.

When US domiciliaries and US citizens 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 high net worth Canadians moving to the US.

When we analyze our clients’ current estate plans, we recommend strategies that they can implement prior to departure. 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.

Registered Retirement Savings Plan (“RRSP”)

Many Canadians contribute to RRSPs throughout their lifetime because of the myriad tax savings they receive; tax deductions on gross income coupled with tax deferrals on income earned inside RRSPs make these plans wonderful retirement saving vehicles for Canadians living in Canada. But what about Canadians who move to the US?

While the answer varies from client to client, generally, it is important to keep in mind that RRSPs can provide tax-saving opportunities for Canadians moving to the US. While a Canadian resident withdrawing their RRSP upon retirement in Canada may have to pay tax at the top marginal rate of over 53% to the CRA, US residents can withdraw their RRSPs in a lump sum at a Canadian federal tax rate of 25%. With pre-departure cross-border financial planning in place, our snowbird clients who become US tax residents may be able to reduce this tax to only 15%, providing a significant tax savings.

Another advantage of a US resident paying tax to the CRA on an RRSP withdrawal is that tax paid to Canada generates foreign tax credits in the US. These credits create additional cross-border tax planning opportunities.

Canada Pension Plan (“CPP”)

Unlike RRSP contributions, CPP contributions are mandatory payments made throughout one’s career in Canada. Our clients are sometimes concerned that they will not be eligible to collect CPP if they are living in the US at the time when they would like to begin receiving payments. Clients have similar concerns about their eligibility to receive Old Age Security (“OAS”) payments from the Canadian government after they become US residents.

Fortunately, non-residents of Canada typically remain eligible for CPP and OAS payments. (It should be noted, though, that in order to receive OAS payments, a snowbird who has become a US resident must have lived in Canada for at least 20 years after turning 18.)

There are, however, potential cross-border pension payment limitations that may affect Canadians who move to the US and continue to work south of the border. Such individuals may work for enough years in the US to earn US Social Security income in addition to CPP payments. One limitation results from the Windfall Elimination Provision, a US domestic law that allows the US government to claw back Social Security payments of a US resident who earns CPP income.

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.

OAS Clawback

The IRS treats OAS income in the same manner as CPP income: snowbird residents of the US will be taxed on only 85% of that income at US federal tax rates, which are typically lower than Canadian rates.

In addition, Canadians who retire in the US and collect OAS payments stateside benefit from being able to avoid 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.

Since US residents’ OAS payments are not subject to the clawback, snowbird clients who move to the US can save money, particularly when they keep other cross-border financial planning opportunities at the front of their minds.

Canadians looking to permanently move to the US should be aware of the following investment planning and portfolio management issues.

Passive Foreign Investment Companies
Within a taxable or non-registered account, Canadian mutual funds, exchange-traded funds (“ETFs”), and real estate investment trusts (“REITs”) are classified as passive foreign investment companies (“PFICs”) by the IRS, with extremely punitive tax treatment. Any taxable or non-registered accounts holding these securities should be “cleansed” or “purified” prior to becoming classified as a US person for IRS purposes.

Within tax-deferred or registered accounts (such as “RSPs” and “RIFs”), Canadian mutual funds, ETFs, and REIT holdings are not subject to the PFIC classification.

We can help build, maintain, and oversee a holistic and optimized cross-border investment portfolio that remains aligned with your strategic investment objectives, risk tolerance, and time horizon, and complements other aspects of your cross-border financial plan while remaining compliant with Canadian and US tax authorities.

Regulatory Compliance
For investment professionals, the relevant regulatory bodies in Canada are the Investment Industry Regulatory Organization of Canada (“IIROC”) and the provincial securities commissions. The relevant regulatory body in the US is the Securities and Exchange Commission (“SEC”).

While there are recognition and reciprocity of investment credentials on both sides of the border, investment professionals who are licensed only in one country need to formally apply for registration with the relevant regulatory entity in the other country so that their education, training, and work experience is recognized.

Owing to the additional legal complexity, heightened business risk, and regulatory reporting workload associated with operating in another country, most firms are unwilling to embark on the registration process because of their focus on domestic or regional clients.
Once you officially exit Canada and become a tax resident of the US, it is very likely that your current investment professionals will no longer be able to continue to work with you due to regulatory and compliance restrictions.

In such cases, we can help build, transition, and oversee an optimized and compliant cross-border investment portfolio that remains aligned with your strategic investment objectives, risk tolerance, and time horizon, and complements other aspects of your cross-border financial plan. We work with each client to independently determine the most suitable investment portfolio for your particular situation.

Foreign Source Income (“FSI”)
As a US resident, you will receive Foreign Tax Credits (“FTCs”) for any tax paid to Canada. However, you will only be able to use these credits on your US tax return to offset other foreign passive income. Where it makes investment sense, it can be beneficial to re-structure your portfolio and investments to take advantage of these FTCs by ensuring that your investments generate an adequate percentage of FSI, thereby potentially reducing your US federal tax liability.

The most effective source of FSI is generated from foreign (outside of US) bonds and other interest-bearing securities. Investment in such vehicles should be considered to the extent that the fixed income allocation remains consistent with your overall investment objectives, risk tolerance, and time horizon.

Manager Selection and Oversight
Portfolio management is a daunting process for many individuals in general and is compounded by the additional complexities within a cross-border context. Your advisory team should be knowledgeable about investing on both sides of the border; ideally, they will have a comprehensive understanding of the cross-border tax, financial planning, and regulatory issues that can arise.

Having an investment manager who understands your situation and needs and who works seamlessly with tax experts, lawyers, and financial planners is crucial to your financial well-being.

We favour a multi-manager approach to portfolio management – identifying and selecting managers for a particular asset class or investment mandate. Our independent oversight helps you determine which managers fit best with your investment objectives and risk tolerance. Moreover, we will coordinate total portfolio reporting, manager monitoring, optimized tax management, and comprehensive cross-border advice to help you avoid tax traps, penalties, and other issues. Where possible, we negotiate preferential pricing on investment management fees for our clients.

As an independent firm and investment fiduciaries, we can help build, transition, and oversee an optimized and compliant cross-border investment portfolio that remains aligned with your strategic investment objectives, risk tolerance, and time horizon, and complements other aspects of your cross-border financial plan.

The US Health Care System: An Introduction

The US health care system is different than the Canadian one. US residents generally have three options for obtaining US health insurance: i) via an employer; ii) via private purchase; or iii) via federal government programs such as Medicare, for retirees.

Eligibility for Medicare begins at age 65 for US citizens and permanent residents who have been legally living in the US for at least five years. If Medicare-eligible US residents have also earned enough credits to be eligible for US Social Security payments (typically achieved by working in the US for 10 years or by being married to a spouse who has earned enough credits), then they will not have to pay premiums for Part A Medicare benefits, which cover inpatient care at hospitals.

There are also Part B and Part D Medicare premiums. Part B premiums cover outpatient care, such as doctor visits and lab tests, and Part D premiums cover prescription costs. Medigap coverage is also available to supplement Part A coverage. Medigap can be used to cover Medicare deductibles and co-payments and to purchase coverage in addition to Medicare, such as travel insurance.

Private Health Insurance

We assist our snowbird clients in determining both their health insurance needs and the potential costs of insurance over time, including the cost of both Medicare and private insurance.

Private insurance can provide coverage for a wide range of needs, from outpatient care to prescription drugs, emergency room visits to surgery and everything in between. While private insurance can be expensive, there are ways to reduce or offset this cost.

Under The Patient Protection and Affordable Care Act (Obamacare), not only can health insurance applicants not be refused for having pre-existing medical conditions, which is good news for Canadians moving to the US, but certain subsidies (such as premium tax credits) are also available to reduce the cost of private health insurance premiums and out-of-pocket costs. Another benefit to obtaining private health insurance as a US resident is the ability to open a Health Savings Account, or HSA. This account comes with a variety of substantial tax benefits that can make private insurance much more palatable in terms of affordability.

Note also that once snowbirds officially exit Canada and become tax residents of the US, they will lose their provincial health care coverage in Canada. Snowbirds may therefore want to obtain coverage for the months spent in Canada post-move. This can be achieved by ensuring that private insurance premiums include travel insurance or by purchasing Medigap.

Life Insurance Issues

Since most Canadians have life insurance policies in place before they move to the US, it is important for us to review such policies prior to departure to confirm that they reflect our clients’ current, 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 Canadian whole life and universal life policies may not be tax-exempt in the US as they are in Canada. This issue can lead to Canadians having to pay tax to the IRS on income earned inside the investment component of Canadian policies. Another issue is these policies’ potential for triggering the egregious Passive Foreign Investment Company (“PFIC”) rules.

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

We also advise clients on the tax filing requirements associated with retaining these policies as US residents, should they choose to keep them, particularly the Foreign Account Tax Compliance Act (“FATCA”) requirements, which is the legislation that governs US persons’ reporting requirements for foreign accounts and other financial assets located outside the US.

For US life insurance policies purchased after moving stateside, we highlight potential estate tax liabilities and recommend estate planning solutions that can mitigate tax exposure, such as the irrevocable life insurance trust (ILIT).

Canada taxes only its residents on worldwide income. As such, after exiting Canada, Canadian citizens no longer pay taxes to the CRA on worldwide income.

Instead, as US tax residents, they must file US income tax returns, reporting their worldwide income to the IRS. However, such clients may still need to file Canadian income tax returns for Canadian-source income that they receive, paying any tax owing on that income to the CRA.

US residents will typically receive foreign tax credits for tax paid to Canada that can be used to offset tax owing to the US. If planned accordingly, foreign tax credits present exciting cross-border financial planning opportunities for our clients – opportunities that are ongoing and can be capitalized upon each year after implementing a cross-border financial plan.

Needing to file income tax returns in two countries necessitates organization and careful planning. Since US tax residents must report foreign bank accounts and financial assets that they retain offshore to the IRS, US tax filings can become complex, with several moving pieces.

Canadians who move south of the border and retain bank accounts and financial assets in Canada may have to meet FATCA filing requirements. Reportable financial assets under FATCA range from bank accounts to Canadian partnership interests and stocks and securities issued by non-US corporations. US residents with Canadian assets may also have to file FinCEN 114, the Report of Foreign Bank and Financial Accounts, commonly known as the FBAR.

US income tax filers must not only manage many moving pieces, but there are also different methods of filing in the US than there are in Canada. In Canada, all taxpayers file individually. In the US, taxpayers can choose whether they would like to file as individuals, as married filing jointly, as married filing separately, or as the head of their household.

Each type of filing status has advantages and disadvantages that affect our clients in unique ways, depending on the timing of their exit from Canada. We therefore assist our clients with selecting a US taxpayer filing status, as well as with organizing their filing obligations and planning for maximal foreign tax credit use.

Introduction to US Immigration for Snowbirds

Snowbirds are used to counting the number of days that they spend in the US each year so as not to exceed the 182-day limit imposed on Canadian visitors to the US by US Citizenship and Immigration Services (“USCIS”). When moving to the US, snowbirds must obtain a visa that allows them to extend their stay beyond this 182-day period. Ideally, a snowbird’s path to US immigration will lead to obtaining permanent residency via a Green Card.

Designing and executing an optimal immigration path is the most key component of a cross-border financial plan. There are typically two US immigration options that we first explore with our snowbird clients, although others, such as the employment-based visa option, may also be appropriate for snowbirds moving to the US.

We work with each client to determine the most suitable path for that individual’s situation. If available, the family-based path to US immigration is ideal.

Family-Based Immigration

Snowbirds who have US citizen children (or parents) who reside in the US can benefit most from the family-based immigration option. Since USCIS supplies an unlimited number of these visas each year, snowbirds with US citizen children (or parents) can move to the US with this visa relatively quickly as there is no wait list.

While snowbirds with US citizen siblings may also apply for a family-based visa, there is a long wait list for these types of visas, which fall into the “family preference category”.

If the family-based immigration path is not open to our snowbird clients, the investor-based path may offer a viable US immigration opportunity.

Investor-Based Immigration

The two most popular investor-based visas are the E-2 visa and the EB-5 visa.

The E-2 visa is available to Canadians who purchase or start a US business or Canadians who want to move to the US to work as an employee of a company that is majority-owned by Canadians. For those who invest in a US business, the investment must be in a significant amount and with funds that are at risk, according to USCIS regulations. This E-2 visa is beneficial because it is renewable on an unlimited basis, but it does not lead to a Green Card.

The EB-5 visa is more flexible than the E-2 visa, and, in contrast, it leads to a Green Card. The current minimum investment amount is $500,000. Canadians who invest at least the minimum amount of funds in a bona fide EB-5 project receive conditional Green Cards; once their investment creates at least 10 jobs for American workers, the conditional Green Card can be turned into a permanent Green Card. If desired, naturalization (becoming a US citizen), can be taken as a next step farther down the line.

It is important for our snowbird clients to choose the immigration path that’s right for them. Our clients set goals and objectives for their future and embark on the immigration path that will lead to the fulfilment of those goals and objectives.