On November 2, the House of Representatives released their tax reform legislation, the Tax Cuts and Jobs Act. The bill is the starting point for negotiations and will likely go through several revisions before it is enacted. The following synopsis highlights some of the significant impacts on individuals and businesses.
Changes in Tax Rates
- Individual Tax Rates: The number of tax brackets has been reduced from seven to four, and rates are generally reduced. However, since the Canadian tax rates are still higher, this is not likely to impact US citizens in Canada.
- Pass-through Entity Rate: The individual tax rate on business income from pass-through entities will be limited to 25%. Certain portions of the income from pass-through entities may be considered equivalent to wages and not subject to the pass-through tax rate.
- US Corporate Tax Rate: The corporate tax rate is reduced from 35% to a flat rate of 20%.
Estate and Gift Tax
- Double Estate and Gift Tax Exemption: The exemption for estate and gift tax will be doubled from US$5.49 million to US$10.98 million, and the estate tax is due to be phased out by 2023.
US Citizens and US Corporations with Ownership of Foreign (including Canadian) Corporations
- One-time Tax on Deferred Foreign Earnings: Earnings held in cash and liquid investments will be taxed at 12%, while earnings invested in capital equipment will be taxed at 5%. This will impact US citizens and US corporations with significant assets within their Canadian corporations.
- Current Taxation of Certain Active Business Income: Under a complex formula, US citizens and US corporations may be taxed currently on up to 50% of the undistributed income earned within their foreign (including Canadian) corporations that is considered “Foreign High Returns”.
- Foreign Dividend Received Deduction: For US corporations, dividends from more than 10%-owned foreign corporations will be non-taxable as long as the earning was not derived from passive income.
- Alternative Minimum Tax Repealed: Alternative minimum tax will be repealed for both individuals and corporations.
- Principal Residence Exemption: While the dollar amount remains unchanged at $250,000 per individual, individuals will have to have lived in the home for at least five of the previous eight years to qualify and the exemption can only be used once every five years. In addition, the exemption will be phased out when income exceeds a certain threshold.
- Bonus Depreciation: Businesses may elect to expense capital equipment placed in service. The eligible properties have been expanded to include used properties if it is the first time owned by the taxpayer, and the dollar limit has been increased from US$500,000 to US$5,000,000.
- Alimony Deduction: Individuals are no longer able to deduct alimony paid nor are the recipients required to include alimony as income. It is possible that without the deduction, a US citizen in Canada may be liable for US income tax because Canada allows such a deduction.
- Elimination of State Income Tax Deduction: Individuals are no longer able to deduct state and local income tax when calculating their federal taxable income. This should not apply to state and local income paid in earning business income.
While the Tax Cuts and Jobs Act will be revised in the coming days, the bill presents some of the most sweeping changes to US tax law in several decades. The current goal of the House and Senate Republican leaders is to finalize the legislation by the end of 2017. US citizens in Canada, especially the owners of Canadian corporations, as well as businesses with cross-border investments, will likely be affected by these proposals and may wish to review their current tax structure.
For more information on the proposed tax changes, contact one of Smythe’s US tax advisors below.