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New U.S. tax law could have substantial impact on Canadians

The U.S. tax reform could have a significant impact on both Canadian companies and individuals looking to conduct business south of the border, U.S. tax accountant Brandon Vucen tells AdvocateDaily.com.

On Jan. 1, 2018, several changes introduced by the Tax Cuts and Jobs Act came into force, with the potential implications for Canadian businesses and individuals ranging from a significant cut in the corporate tax rate, reduction in individual income tax rates, to higher limits to the estate tax exemption, explains Vucen, a principal of U.S. Tax IQ.

Corporate tax implications

On the corporate side, one of the most significant changes, says Vucen, is the government’s move to lower the corporate tax rate — from the highest marginal rate of 35 per cent to a flat tax rate of 21 per cent — which, he says, has levelled the playing field between the U.S. and Canada. In addition, the bill repeals the corporate Alternative Minimum Tax, but that change is unlikely to benefit a lot of businesses due to net operating loss limitation.

“Where some Canadian businesses may have been hesitant to expand into the U.S. because of the higher corporate tax rate, they may have rather an incentive to operate in the U.S. under the new law,” he adds. 

The tax rate decrease will also impact Canadians looking to invest in real estate in the U.S., he adds. Holding U.S. real property through a Canadian corporation may be an option.

Capital assets and interest expense deduction

Another positive development for businesses, says Vucen, is the ability to depreciate or write off 100 per cent of the capital cost of qualified property in the year the property is acquired, as opposed to the previous method of writing it off over a number of years, as well as increase in the expense limitation provision to US$1 million.

Less favourably, however, businesses that finance their operations through intercompany debt and pay interest to a foreign-related party could previously deduct up to 50 per cent of adjusted taxable income; this threshold has now been reduced to 30 per cent.

Net operating losses

Under the old law, business losses from prior years could be deducted in future tax years at 100 per cent (although there could be alternative minimum tax implications), Vucen says. Now, in any given year, companies will only be able to use a maximum of 80 per cent of their net operating losses, he says.

“This provision is especially disadvantageous for certain taxpayers in cyclical industries, such as mining, where you are limited to the amount that can be utilized in a given tax year," Vucen says.

Tax implications for Canadians

Overall, the recent changes have resulted in a tax rate reduction for individuals in the U.S. In the highest personal income tax bracket. For example, Vucen says, the marginal tax rate was previously 39.6 per cent and is now 37 per cent.

"The new law has also increased the standard deduction from US$6,350, to US$12,000 for single filers and from US$12,700 to US$24,000, for married couples filing a joint return," he says. "In addition, the personal exemption was suspended.  The new law repealed several itemized deductions. The repeal of certain itemized deductions, such as the employee business expenses will have significant impact on professional athletes who incur substantial employee expenses, such as agent fees. Although their tax rate will decrease, they may have an overall higher tax burden.

“With the tax reform, the Trump administration wanted to reduce the tax burden on lower-income families and middle class. In addition, the tax reform was designed to simplify the existing tax framework so that taxpayers would not need to itemize deductions,” Vucen says.

However, Canadians working in the U.S. or have a business south of the border may be slightly worse off due to the changes, as there is no standard deduction for nonresidents, and they are limited to the types of itemized deductions they can take, Vucen says.

For example, he says, individuals could take an unlimited state income tax deduction as an itemized deduction. For someone working in California making US$200,000, the state income tax liability would be approximately US$16,000, which could have been taken as an itemized deduction under the old law, whereas now the deduction is limited to only US$10,000.   

“For a Canadian resident who is working in the U.S., although there’s a lower overall tax rate, their taxable income could potentially be higher under the tax reform than it was previously,” Vucen says.

The Act will also no longer allow a deduction for moving expenses by an employee and any moving expenses reimbursed by an employer will not be considered a taxable benefit for employees. This, says Vucen, could have an impact on Canadians looking to relocate to the U.S. for job opportunities as it means a higher relocation cost for companies south of the border.

Partnership interests

Significantly, he adds, the U.S. has also changed the law around the taxation of a gain or loss on the disposition of partnership interests, which impacts nonresidents.

“Generally, a Canadian with interest in a U.S. partnership would have benefited from capital gains treatment on a sale of that partnership interest. So, in this scenario, the person would only be taxed in Canada and not the U.S.”

Under the new law, however, the gain would be considered “effectively connected income,” and therefore taxed in the U.S.

“They’re essentially saying it’s not a sale of the partnership interest, it’s the sale of the underlying assets in the partnership, therefore it’s effectively connected income and it’s taxed in the U.S. first,” Vucen says.

Estate and gift tax

The new law has also doubled the lifetime estate and gift tax exemption from US$5 million to US$10 million (for 2018, this amount would be indexed for inflation and is expected to be US$11.2 million), Vucen explains.

"The higher exemption amount will help Canadians with worldwide assets not exceeding that threshold, but Canadians would still want to carefully review their tax planning opportunities and ensure that they file all applicable U.S. tax returns and forms," he says.

Ultimately, most of the personal tax changes, says Vucen, are subject to a sunset provision, such that they are only effective until the end of 2025.

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