Starting a Business
in the US
Business opportunities abound in the US, and since US corporate & personal income tax rates are typically lower than the Canadian ones, many Canadians decide to move south of the border to capitalize on this attractive situation.
Generally, finding an appropriate immigration pathway to the US remains the biggest concern for Canadians planning a cross-border move. Fortunately, Canadians who move to the US to start a business may be able to benefit from investor visas designed specifically for foreigners moving south to establish or invest in US businesses. Questions about whether your spouse and children can live and work in the US under these visas are important to explore.
In addition to questions surrounding the immigration process, Canadians moving to the US to start a business typically wonder how to obtain adequate health care, how their social security payments will be affected by leaving Canada, and what to do with RRSPs and Canadian assets such as homes and cottages.
As the above questions illustrate, making the decision to move to the US necessitates careful pre-departure tax, estate, retirement, investment, and immigration planning. Canadians relocating to the US to start a business must also be familiar with the US
health care system, as well as potential cross-border tax filing requirements.
Keep reading for more information about these cross-border financial planning topics as they apply to Canadians who are starting a business in the US. 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.
- Tax Planning
- Estate Planning
- Retirement Planning
- Investment Planning
- Health Coverage & Insurance
- Tax Filing Requirements
Different Types of US Corporations
When you establish a business in the US, you can choose from three different corporate structures: the Limited Liability Company (“LLC”), the S corporation, and the C corporation.
Each of these structures provides business owners with liability protection for the debts of the business. However, since LLCs and S corporations are flow-through entities, they tend to be more tax-advantageous business structures than C corporations.
C corporations’ profits are taxed at the corporate level and then again at the personal level when shareholders receive dividends. LLCs and S corporations, however, avoid double taxation: profits from these structures are taxed only at the personal level.
If you are moving to the US to start your business, you can benefit from establishing an LLC or S corporation. If you are starting a US business but plan to remain a Canadian resident, though, choose your corporate structure carefully; Canada Revenue Agency does not recognize the flow-through nature of LLCs, so setting up one of these structures could lead to double taxation. The same applies for S corporations, however non-residents of the US cannot setup this structure.
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.
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.
US Retirement Plans
Americans who work as employees typically have either a 401(k) retirement savings plan through their company, or a private Individual Retirement Account (“IRA”). US small business owners usually choose to establish other retirement plans that are more suitable for the size of their business and their individual needs.
For instance, many small business owners in the US establish the Simplified Employee Pension IRA (“SEP IRA”). Like the Canadian RRSP, SEP IRAs allow pre-tax contributions, provide tax deductions, and offer tax-free growth on income (tax is levied only upon withdrawal from the plan).
In addition to the above benefits, the SEP IRA has a higher yearly maximum contribution limit than the traditional IRA. In 2018, the maximum yearly contribution to the SEP IRA is $55,000, which is far more attractive than the maximum yearly contributions to the traditional IRA of $5,500 for those aged 49 or younger and $6,500 for those 50 and older.
If you have employees, yet another benefit of the SEP IRA is that it enables employers to contribute to retirement savings accounts for their employees.
Another popular retirement savings vehicle for US small business owners with employees is the Savings Incentive Match Plan for Employees IRA, commonly known as the SIMPLE IRA.
The Self-Employed 401(k) is also attractive for US small business owners as it allows for a high yearly maximum contribution level. However, this plan cannot cover employees (it only covers the employer/self-employed individual and that individual’s spouse employee).
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.
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 top-tier 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.
Create Your Own Group Plan
Canadians who move to the US to start a business are in the fortunate position of being able to create their own group health insurance plan. However, in some cases, it may be more advantageous to purchase private health insurance on an individual basis. There are a variety of pros and cons to consider when making the decision to either set up a company plan or to enroll in a private health insurance plan.
As always, tax is a primary consideration. There are many tax benefits available to small business owners who set up their own group insurance plan. For example, certain small businesses that provide employees with a health care plan through the Small Business Health Options Program Marketplace can take advantage of the small business health care tax credit.
In addition, small business owners can deduct health insurance expenses from income tax owing; for instance, the portion that an employer pays for their employees’ monthly health care premiums are typically classified as business expenses and eligible for tax deductions. Note that tax benefits of group health insurance plans can vary depending on the type of business entity you establish in the US, so it’s best to weigh the pros and cons of establishing a group plan once you are clear on the type of structure your US business will have.
Health Savings Accounts (“HSAs”) are also important tools to consider. You can establish an HSA if you choose a high-deductible health insurance plan. Contributions to HSAs are tax-deductible, and the interest earned inside such accounts grows on a tax-deferred basis. Moreover, all HSA withdrawals (including interest earnings) that are used for health care costs are withdrawn on a tax-free basis. Note that HSA contributions can be made only up to a certain annual limit.
Canadian IT professionals operating their own businesses in the US must be aware of the American legal landscape, which is far more litigious than the Canadian one. Lawsuits can be lucrative, with businesses subject to paying crippling amounts of money should they be sued. In certain circumstances, business owners may also be personally liable for business-related liabilities. Business owners in the US therefore need a strategy to protect both their business and personal assets.
Creating a business structure such as an LLC, S corporation, or C corporation is one way to protect your personal assets from becoming embroiled in a lawsuit. However, these structures don’t offer total protection from personal liability; for instance, if your personal actions or negligence cause injury to a customer, the corporate veil will not protect you. Purchasing professional liability insurance, or errors & omissions insurance, can be a helpful strategy for increasing your liability protection even when you operate your business within a corporate structure.
General liability insurance is also an important option to consider for US business owners. This type of insurance protects business assets in case a lawsuit arises as a result of the regular operations of the business, such as an employee getting injured at work.
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.
Canadians who move to the US to start a business generally select one of two popular investor visas: the E-2 visa or the EB-5 visa.
E-2 visas are available to investors making significant investments in US businesses with funds that are considered “at risk” by United States Citizenship and Immigration Services (“USCIS”). An E-2 investor’s spouse and children may also enter the US. These visas are generally issued in two-year increments that can be indefinitely renewed; however, once the investor stops working for the business to which they are tied, the visas expire, and the investor and their family must return to Canada. There is no direct path to permanent residency as a result of holding an E-2 visa. To apply for a different visa at that time, talk to a US immigration attorney.
In contrast, the EB-5 investor visa leads to a Green Card and permanent residency for the investor and their family. To qualify for the visa, you must make a minimum investment with “at-risk” funds as determined by USCIS. There is an option to either start a new business and assume a managerial role or to invest in a US business through a “regional centre” where you are a passive investor.
As a US Green Card holder, you eventually have the option to become a US citizen via the naturalization process. Becoming a US citizen has cons as well as pros, though; we therefore recommend weighing all factors in a considered fashion before making the decision to become a US citizen.
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