There is Nothing so Certain as Death and Taxes

Or so the saying goes.  This certainly is true in Canada where there is a “deemed disposition” when a taxpayer dies.  What this means is that a taxpayer is deemed to dispose of all his or her assets at fair market value immediately preceding death. 

How does this affect your assets?

• For certain assets (e.g. stock investments, company shares, revenue property, collectibles), if the fair market value is greater than the adjusted cost base then capital gains will result.
• Fifty percent of capital gains are included in the deceased taxpayer’s income.  
• Revenue property could also attract additional tax in the form of recaptured depreciation.

There are some exceptions

• Assets which are left to a spouse will have the gain deferred until the spouse dies or disposes of the asset.
• A principal residence is not subject to capital gains.
• Shares that the deceased owned in a Qualifying Small Business Corporation may qualify for the Lifetime Capital Gains Exemption where the first $750,000 of capital gain is exempt from taxation.

Registered Funds receive different tax treatment

RRSP, RRIF, TFSA and Pension Funds

• A spouse who is left registered funds by her husband or his wife may roll those funds into his or her Registered Savings Plan or Retirement Income Fund and avoid paying income tax.
• Registered funds left to anyone other than a spouse or qualifying disabled child are fully taxable as income.  Some rules also apply to minor dependent children which involve spreading the tax by purchase of a qualifying annuity for 18 years less the age of the child at the time of acquiring the annuity.
• Amounts paid to a beneficiary of a Tax Free Savings Account are not subject to income tax.

Other fees and costs

• Funeral and other last expenses;
• Probate fees;
• Administrative costs and possibly legal fees.

Reduce or avoid the impact 

Estate planning and life insurance solutions

Freezing the estate which has the effect of fixing the amount of tax payable on assets upon death and passing future growth to the next generation;

• In conjunction with the above, the use of a family trust with the objective of multiplying the number of Lifetime Capital Gains Exemptions on shares in a Qualifying Small Business Corporation distributed to other family members.
• The use of joint accounts.  This strategy should be used with careful consideration and professional guidance.
• Effective use of life insurance, both personally and corporately owned, which can provide sufficient liquidity at death to pay taxes with insurance proceeds rather than “hard dollars”.  This can be especially true by using Joint Second-to-Die life insurance which will provide proceeds to pay the deferred tax upon the death of the surviving spouse.

While we often complain about the cost of living, the cost of dying can also be extremely high and could create significant problems for those we leave behind.  With sound advice and planning the financial impact on your family and business partners can be softened and, sometimes, even eliminated. 

Do You Fly South for the Winter?

What Snowbirds Need to Know About Residency Rules

After another harsh winter, many Canadians dream of joining the large number of Snowbirds who make their way to the dry warmth of California, Arizona and Florida each winter season.  If you are contemplating, or already are, becoming a Snowbird and whiling away the winter months in warmer climes south of the border it is important to understand how the new U.S. Tax laws apply under these circumstances. The last thing you would want is to find that the Internal Revenue Service considers you a US resident making you liable for U.S. income tax or subject to U.S. penalties or both.

There are many Canadians who have the long held belief that as long as they spend less than 183 days in the US there is no problem.  This is no longer the case as the IRS has introduced a complicated formula as part of their Substantial Presence Test under which you will be considered to be a U.S. resident if:

• The weighted total of the number of days you have spent in the U.S. over the last three years (as determined by the formula shown below) equals or exceeds 183 days, and:
• You have been in the U.S. for more than 30 days in the current year.

The Substantial Presence Test uses the following formula in determining U.S. Residency:

• Number of days in the U.S. this year,

PLUS

• 1/3 of the number of days in the U.S. last year,

PLUS

• 1/6 of the number of days in the U.S. the previous year.

If this formula returns the answer of 183 days or more, then you will be considered to be a resident of the United States making you subject to U.S. tax and filing requirements.  Under the calculations above, if you were to regularly spend 4 months a year in the U.S. you would be considered to be a U.S. resident.

It is also important to consider what the IRS considers to be a “day”.  Any portion of a day spent in the U.S. (for example, leaving in the early morning on a flight home) is considered a full day.  There are some exceptions to this, such as an inability to leave due to a medical condition that developed while in the U.S. or days in transit while en route to another country.

Should you be considered a U.S. resident there are two courses of action.  The first of these is to claim the closer connection exception allowed under the Internal Revenue Code.  To claim the closer connection exception and show that you have closer connections to Canada than the U.S. you must file IRS Form 8840 no later than June 15th of the following year.  Some factors which indicate a closer connection with Canada include:

• Having a permanent residence in Canada;
• Having family in Canada;
• Banking in Canada;
• Carrying on a business in Canada;
• Having a Canadian driver’s licence;
• Voting in Canadian elections;
• Having personal belongings in Canada.

You are prevented from claiming this exception if you have spent more than 183 days in the U.S. in the current year or if you have or applied for a U.S. green card.  Also your request will be denied if you do not meet the June 15th filing deadline.

The second course of action is to claim a treaty exemption.  This applies in situations where a Canadian cannot claim the closer connection exception and now is considered to be a dual resident of both Canada and the U.S. In this event there are “tie-breaker rules” under the U.S. – Canada Tax Treaty which would alleviate the requirement to pay income tax in the U.S. but would still require you to comply with filing requirements.

In those situations where the closer connection exception is being claimed, and even in the rarer situation where the tie breaker rules indicate a U.S. and not a Canadian residency, professional advice should be sought as the rules become more complicated.

Since many of us aspire to spend extended periods of time in the sun during our winter months, it is a good idea to be well acquainted with the U.S. rules governing residency when that day comes.