President Trump's Tax Cuts and Jobs Act could increase taxes for U.S. citizens living in Canada

Tax reform in big letters written out of a dollar bill

Good News and Bad News in the U.S. Tax Changes

By John Connolly, BBA, CPA, CMA MRSB Group, Charlottetown, PEI – DFK Affiliate Firm

President Trump signed the Tax Cuts and Jobs Act into law on December 22, 2017. While the title promises tax cuts, the legislation includes a number of measures that could result in tax increases for U.S. citizens living in Canada. Here is a brief overview of some of the changes.

Personal tax rates will go down by 0% to 4% depending on what tax bracket you are in. For single filers, the threshold for the top tax bracket is increased to income over $500,000, and the standard deduction almost doubles to $12,000. The child tax credit is doubled to $2,000 per child, and the income threshold for the elimination of the credit increases to $200,000.

There are also positive changes for individuals with business income. For example, bonus depreciation rules will allow 100% current deduction for qualifying property, and are extended to 2022. There is a new deduction for 20% of Qualifying Business Income” if your business is unincorporated and is not a “specified service” business. “Specified service” businesses include health, accounting, legal, and consulting businesses among others.

There are also some unfavourable changes. The $4,050 personal exemption is eliminated. If you claimed itemized deductions, the deduction for state and local taxes is now capped at $10,000, and foreign property taxes are no longer deductible. Mortgage interest was previously deductible on up to $1,000,000 of purchase debt. That cap is reduced to $750,000. Interest on up to $100,000 of home equity debt was previously deductible. That deduction is eliminated. Many of the miscellaneous itemized deductions are eliminated; including unreimbursed employee expenses, investment fees, home office deductions, and tax preparation fees. The deduction for moving expenses is eliminated, and moving expense reimbursements must now be included in income.

Starting in 2018, U.S. corporations that receive dividends from a foreign (non-U.S.) subsidiary may be eligible for an exemption from tax on those dividends. A number of tests related to the percentage of shares owned and the amount of time the shares were owned must be met to qualify for the exemption. The fallout from this exemption is a new one-time transitional tax that the U.S. shareholders must pay on the undistributed “earnings & profits” of the foreign subsidiary.

This transitional tax applies to U.S. shareholders, including U.S. citizens living abroad, who own at least 10% of the votes or value of a foreign company that is controlled by U.S. shareholders. There are deemed ownership rules that complicate and expand who this transitional tax will apply to. This transitional tax is not a separate tax. The U.S. shareholder’s pro-rata share of the undistributed “earnings & profits” of the foreign company is run through a complicated formula to determine an amount that is added to the U.S. shareholder’s other taxable income. The U.S. shareholder’s income is then taxed at the applicable regular income tax rate for that shareholder.

For a U.S. citizen living in Canada, the effective rate of the transitional tax is expected to range between 2% and 18% of their pro-rata share of the undistributed “earnings & profits.” The effective rate will depend on the tax bracket the U.S. shareholder is in, and what sort of assets make up the undistributed “earnings & profits.” The tax applies based on the foreign corporation’s last taxation year that begins before 2018. That means the tax applies to 2017 for many taxpayers and must be dealt with during the current personal tax season. There is an election to pay this tax over eight years.

There is another new addition to the taxable income of U.S. shareholders of foreign companies. Again, there are complicated rules based on share ownership to determine whether or not this income addition applies to you. The new income inclusion is called “Global Intangible Low-Taxed Income” or GILTI. If your foreign company earns a return in excess of 10% of the cost for U.S. tax purposes of its tangible depreciable assets, then the excess may have to be added to your taxable income.

The Tax Cuts and Jobs Act is over 500 pages long. U.S. tax law was always complicated. Now it’s more complicated. This is a limited overview of a few of the changes. You should not make any tax planning decisions without contacting a U.S. tax specialist.