2018 U.S. Individual tax – impact to U.S. Citizens living in Canada

By Edelkoort Smethurst CPAs LLP

This article provides an overview of how the 2018 U.S. individual income tax changes impact U.S. Citizens living in Canada.

Preface
On December 22, 2017, the U.S. Administration enacted the Tax Cuts and Jobs Act (TCJA), which introduced broad based and sweeping changes to U.S. corporate, and U.S. personal tax changes. It is important to keep in mind that these changes pertain to federal income tax, as administered by the Internal Revenue Service (IRS). Each U.S. state has its own separate income tax regime.

U.S. citizen residents of Canada must file two returns each year – a Canadian income tax return because they reside in Canada, and a U.S. return based on being a U.S. citizen. The Tax Treaty between Canada and U.S.A. has several mechanisms available know as foreign tax credits, to make sure the person does not have to pay taxes to both countries for the same income.U.S. Citizens living in Canada file Form 1040 and schedules to the IRS as well as states if applicable, and IRS filings will usually include one of more of the following;

1040 – U.S. Individual income tax return
1116 – Foreign Tax Credit
2555 – Foreign Earned Income Deduction
Schedule B – Interest and Dividends
Schedule C – Profit or Loss from Business
Scheduled D – Capital Gains and Losses
3520 and 3520A – Foreign Trust Reporting for Tax Free Savings Accounts
8621 – Passive Foreign Investment Company for Mutual Funds
5471 – Information Return for U.S. Citizens with interests (greater than 10%) in foreign corporations
- (Example – U.S. citizens owing Canadian private corporations -CCPCs).
Form 114 (FBAR) – Foreign Bank Account Reporting

Summary of changes to U.S. Federal Individual income tax as it pertains to U.S. Citizens living in Canada. The Tax Cuts and Jobs Act impacts tax years beginning January 1, 2018 and onwards

TJCA changes to U.S. individual income taxes are temporary, and the majority of tax changes will revert back to where they were in 2017, on December 31, 2025.

Changes in U.S. Individual Tax Rates
For 2018, most U.S. individual tax rates have been reduced. This means most U.S. citizens living in the U.S. will pay less tax starting this year. The 2018 tax rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Keep in mind that in most situations, U.S. citizens living in Canada can eliminate or significantly reduce U.S. taxes owed to the IRS using Form 1116 – Foreign Tax Credit, and Form 2555 – Foreign Earned Income deduction. This was the case prior to 2018 and remains the same for 2018 and beyond.

Changes to Standard Deduction
The standard deduction is a dollar amount that reduces the amount of income which is taxed and varies according to filing status.

The standard deduction reduces the income subject to tax. The Tax Cuts and Jobs Act nearly doubled standard deductions. When taking the standard deduction, you can’t itemize deductions for mortgage interest, state taxes and charitable deductions on Schedule A, Itemized Deductions.

The amounts are higher if taxpayer or spouse are blind or over age 65.

Most taxpayers have the choice of either taking a standard deduction or itemizing. If you qualify for the standard deduction and your standard deduction is more than your total itemized deductions, you should claim the standard deduction in most cases and don’t need to file a Schedule A, Itemized Deductions, with your tax return.

Elimination of Personal Exemption
A significant change introduced in the 2018 Tax Cuts and Jobs Act (TCJA), was the elimination of the Personal Exemption. For 2018, taxpayers can’t claim a personal exemption deduction for themselves, spouse, or dependents.

However, changes to the standard deduction amount and Child Tax Credit may offset at least part of this change for most families.

Child tax credit and additional child tax credit
For 2018, the maximum credit increased to $2,000 per qualifying child. Up to $1,400 of the credit can be refundable for each qualifying child as the additional child tax credit. In addition, the income threshold at which the child tax credit begins to phase out is increased to $200,000, or $400,000 if married filing jointly.

Social security number required for child tax credit
Beginning with Tax Year 2018, a child must have a Social Security Number issued by the Social Security Administration before the due date of the taxpayer’s tax return (including extensions) to be claimed as a qualifying child for the Child Tax Credit or Additional Child Tax Credit. Children with an ITIN can’t be claimed for either credit.

Credit for other dependents
A new credit of up to $500 is available for each of your qualifying dependents other than children who can be claimed for the child tax credit. The qualifying dependent must be a U.S. citizen, U.S. national, or U.S. resident alien. The credit is calculated with the child tax credit in the form instructions. The total of both credits is subject to a single phase out when adjusted gross income exceeds $200,000, or $400,000 if married filing jointly.

THIS MEANS THAT…taxpayers may be able to claim this credit if they have children age 17 or over, including college students, children with ITINs, or other older relatives in your household. But, once again, the qualifying dependent must be a U.S. citizen, U.S. national, or U.S. resident alien. This essentially eliminates any such credit for U.S. citizens living in Canada with dependents who are not U.S. citizens.

CHANGES TO ITEMIZED DEDUCTIONS
Each year, taxpayers can elect to take the Standard Deduction, or itemize their deductions, whatever method works to their advantage. In 2018, the increase in the Standard Deduction, is offset by many revisions to the itemized deduction rules. The changes to itemized deductions are fairly significant and are summarized below.

Limit on overall itemized deductions suspended.
U.S. citizens may be able to deduct more total itemized deductions if the itemized deductions were limited in the past due to the amount of adjusted gross income. The old rule that limited the total itemized deductions for certain higher-income individuals has been suspended.
Deduction for medical and dental expenses modified
U.S. citizens can deduct certain unreimbursed medical expenses that exceed 7.5% of 2018 adjusted gross income. Before this law change, unreimbursed medical expenses had to exceed 10% of adjusted gross income for most taxpayers in order to be deductible. (This reverts back to 10% in 2019).
Deduction for state and local income, sales and property taxes modified
The total deduction for state and local income, sales and property taxes is limited to a combined, total deduction of $10,000 ($5,000 if Married Filing Separate). Any state and local taxes you paid above this amount cannot be deducted. No deduction is allowed for foreign real property taxes. Property taxes associated with carrying on a trade or business are fully deductible. THIS MEANS THAT… U.S. citizens who do itemize… can deduct state and local income, sales, and property taxes but only up to $10,000 ($5,000 if Married Filing Separate). Furthermore, foreign property taxes on a personal residence cannot be deducted as an itemized deduction for U.S. citizens living in Canada.
Deduction for home mortgage and home equity interest modified
The deduction for mortgage interest is limited to interest paid on a loan secured by your main home or second home that you used to buy, build, or substantially improve your main home or second home. THIS MEANS THAT…if you do itemize… that interest paid on most home equity loans is not deductible unless the loan proceeds were used to buy, build, or substantially improve your main home or second home. For example, interest on a home equity loan used to build an addition to an existing home is typically deductible, while interest on the same loan used to pay personal living expenses, such as credit card debts, is not.
New dollar limit on total qualified residence loan balance
If the loan was originated or treated as originating on or before Dec. 15, 2017, you may deduct interest on up to $1,000,000 ($500,000 if you are married filing separately) in qualifying debt. If your loan originated after that date, you may only deduct interest on up to $750,000 ($375,000 if you are married filing separately) in qualifying debt. The limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home. THIS MEANS THAT…if you do itemize…for existing mortgages, you can continue to deduct interest on a total of $1 million in qualifying debt secured by first and second homes but for new homeowners buying in 2018 and beyond, you can only deduct interest on a total of $750,000 in qualifying debt for a first and second home.
Limit for charitable contributions modified
The limit on charitable contributions of cash has increased from 50 percent to 60 percent of adjusted gross income.
Miscellaneous itemized deductions suspended
This includes unreimbursed employee expenses such as uniforms, union dues and the deduction for business-related meals, entertainment and travel, as well as any deductions you may have previously been able to claim for tax preparation fees and investment expenses, including investment management fees, safe deposit box fees and investment expenses from pass-through entities.
Deduction and Exclusion for moving expenses suspended
The deduction for moving expenses is suspended. During the suspension, no deduction is allowed for use of an automobile as part of a move.
Alternative minimum tax (AMT) exemption amount increased
The AMT exemption amount is increased to $70,300 ($109,400 if married filing jointly or qualifying widow(er); $54,700 if married filing separately). The income level at which the AMT exemption begins to phase out has increased to $500,000 or $1,000,000 if married filing jointly.
Repeal of deduction for alimony payments
Alimony and separate maintenance payments are no longer deductible for any divorce or separation agreement executed after December 31, 2018, or for any divorce or separation agreement executed on or before December 31, 2018, and modified after that date.

Reporting Health Care Coverage
Under the Tax Cuts and Jobs Act, U.S. citizens must continue to report coverage, qualify for an exemption, or report an individual shared responsibility payment for tax year 2018. For U.S. citizens living in Canada this has been a non-issue because of Canada’s universal health care system.

Section 199A Deduction
Tax Cuts and Jobs Act introduces a new 20% deduction of taxable income for small business. Section 199A grants owners of a sole proprietorship, rental property, S-Corporation (not applicable for Canadians who are not resident in the U.S.), or partnerships to claim a deduction against ‘qualified business income’ (QBI) earned by the business. The business income must be from U.S. domestic sales / services – it does not apply to foreign business income.

A qualified trade or business is any trade or business, with two exceptions:

Specified service trade or business (SSTB), which includes a trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, investing and investment management, trading, dealing in certain assets or any trade or business where the principal asset is the reputation or skill of one or more of its employees. This exception only applies if a taxpayer’s taxable income exceeds $315,000 for a married couple filing a joint return, or $157,500 for all other taxpayers2. Performing services as an employee

The rationale for the Section 199A deduction is to provide a measure of tax relief, so as to align tax rates for flow-through entities, with the much reduced U.S. corporate tax rate of flat 21%.

Section 199A will reduce taxable income for the business and rental properties owned by U.S. citizens living in Canada, but only if the business income is earned in the U.S. This deduction will NOT be available for Canadian sourced business income or rental income.

Transition Tax (IRC 965)
One of the most controversial tax changes brought into effect with the Tax Cuts and Jobs Act (TCJA) was the ‘Transition Tax’, which introduced a new requirement for U.S. citizens/ shareholders having a controlling interest (greater than 10%) of foreign corporations. The Transition tax basically requires U.S. citizens to pay tax to the IRS on the undistributed retained earnings of the foreign corporations as of Dec 22, 2017. This would include U.S. citizens that own Canadian private corporations (CCPCs). The calculations are complex, and allowed for various deductions.

The 965 Transitions Tax filings were required to be submitted as part of the 2017 U.S. income tax filings. Although this was a ‘one-time tax’, the payments could be spread over 8 years, and it will be necessary to remit the annual payments to the IRS, and track and report the distributions from these retained earnings to avoid duplicate taxation for the 2018 tax year and beyond. In addition, the new tax regime will require U.S. citizens owing CCPCs to include future undistributed retained earnings in their U.S. individual income tax returns. The IRS rules for this are complex, and once again, deductions are allowed to reduce or eliminate this tax by filing various elections available. Please contact a tax professional to discuss the details.

Estate Tax and Gift Tax
Unlike Canada, which does not have an estate tax, the U.S. has an additional tax that needs to be considered upon the death of a U.S. citizen. The Estate tax is based on the value of a person’s estate upon death. The threshold is fairly high. It is $11.18 million USD for deaths occurring in 2018. (Increased from $5.49 million in 2017). The amount is adjusted annually for inflation. The decedent’s estate can elect to allow the unused portion of the exclusion amount to be transferred to the surviving spouse, bumping up the exclusion to about $22 million for married couples.

The U.S. also has a Gift tax which applies to the person gifting the amount to someone else. There are many rules, limitations, and exclusions but generally the Gift tax applies to gifts over $15,000 for 2018. If the donor’s wife is not a U.S. citizen, the annual exclusion is $152,000 for 2018. The amounts are adjusted annually. Form 709 is the Gift Tax filing form and must be filed annually if gifts were made above the exclusion. Taxpayers are able to defer the Gift tax by including the reportable gift(s) in the estate, which essentially reduces the Estate tax threshold for the taxpayer by the amount of the reportable gift(s) during their lifetime.

Summary
The Tax Cuts and Jobs Act enacted significant tax changes to U.S. individual income taxes. For the most part, for U.S. citizens living in Canada, the overall impact of these changes probably will not result in taxes owed to the IRS, but each taxpayer will need to determine this for themselves, or contacting our firm for support.

Once again, the TJCA changes to U.S. individual income taxes are temporary, and the majority of tax changes will revert back to where they were in 2017, on December 31, 2025.

Other articles of interest can be accessed using these links:

U.S. citizens living in Canada
IRS Streamline Program

We hope you have found this article useful. For more information on this please visit our web-site for other articles, and contact our firm to discuss how Edelkoort, Smethurst, Schein CPAs LLP can assist you with your U.S. and Canadian individual tax planning and filings. We look forward to hearing from you. Thanks for taking the time to read this article, and best wishes.

Disclaimer – This article is about the 2018 U.S. individual tax consequences of U.S. Citizens living in Canada. Readers are cautioned that information in this article is for general purposes only and does not purport to provide specific advice. The focus of this article is to highlight tax changes. It is not a comprehensive list of all filing requirements or forms. Individuals should consult with a tax professional. The author bears no responsibility for the use or dissemination of this information.

Derek Edelkoort, CPA, CGA
IRS registered paid tax preparer and IRS Certified Acceptance Agent
Partner
Edelkoort, Smethurst, Schein CPAs LLP