Financial Checkup: Cross-border tax issues loom large

George and Susan want to know which country they should retire in and, if it is Canada, whether George should obtain Canadian citizenship.

George has US$101,500 in a cash account and $451,600 in an individual retirement arrangement (IRA), both in the U.S. He receives US$30,048 a year in U.S. social security benefits and $1,811 from the Canada Pension Plan (CPP); he expects to receive $15,600 from an Ontario Municipal Employees Retirement System (OMERS) pension.

Susan’s Canadian financial assets include $170,200 in cash, $108,500 in Canadian mutual funds, $47,500 in a spousal RRSP and $28,200 in a tax-free savings account (TFSA). She also has US$68,600 in a U.S. IRA and a US$126,700 variable annuity.

In addition, George and Susan have joint assets of $41,400 in cash and $214,000 in Canadian mutual funds.

The couple own a $650,000 home with a $162,000 mortgage. They plan to sell it in the coming months and retire, either to British Columbia – Victoria or Nanaimo – or to Sandpoint, Idaho.

The couple have two financially independent adult children, both of whom are dual citizens and live in Canada.

The couple don’t have any life or medical insurance but should qualify for U.S. Medicare benefits to last their lifetimes.

The couple want to spend $72,000 a year in today’s dollars during retirement and want to ensure that they can do so to age 95.

The recommendations: Ritchie says George and Susan should be fine financially, whichever country they retire to. His projections show that if they retire to B.C., they could spend $72,000 a year in today’s dollars to age 95 and still leave an estate of around $800,000. The estate would be bigger – around US$1.1 million – if they retire to Idaho, where tax rates, the cost of living and housing prices are lower. Those projections are based on an average annual rate of return after fees of 6% and inflation of 3%.

However, financial considerations aren’t the only factors to consider, says Barrett: “In my experience, the biggest consideration in such decisions is health care, followed by the location of retirement funds and quality of life.”

Before discussing these issues, there are some things George and Susan should do, regardless of where they settle.

First, Barrett and Ritchie both suggest that George should become a Canadian citizen. This would not prejudice a move to the U.S. now and would facilitate a return to Canada.

Susan must clarify her status in the U.S. Ritchie recommends that she talk to a U.S. immigration lawyer to clarify if her green card is still valid. Even if the couple decide to stay in Canada, that document would make it easier to move to the U.S., should they later decide to do so.

Next, Susan must amend her prior Canadian tax returns to include the accrued income attributable to her from the U.S. variable annuity she holds. Such income is tax-deferred in the U.S. but not in Canada.

George should amend his U.S. tax returns for the past three years by refiling a “married joint” return with Susan. This would include her TFSA income and completing a variety of U.S. Internal Revenue Service (IRS) compliance forms that relate to her TFSA, RRSPs, Canadian mutual funds and bank accounts. Neither Barrett nor Ritchie believes Susan will face any additional income taxes because the couple’s joint net Canadian taxes paid can be applied as foreign tax credits on the amended U.S. returns.

Susan also should collapse her TFSA because income from it will be taxable on the couple’s U.S. joint tax returns.

George has to declare his portion of the capital gains on the Toronto house when filing his U.S. tax return. The U.S. levies capital gains taxes on sales of principal residences because the IRS allows a deduction for mortgage interest. However, there is an exemption for the first US$250,000 in capital gains and, given that George and Susan will be filing a joint married return in the U.S., Susan also will get this exemption.

Barrett suggests that when the couple buy their new house, they buy it jointly in an effort to keep George’s portion of the capital gains to below US$250,000 when the house eventually is sold. If the house starts to appreciate quickly, George could gift some of his portion of the house to Susan over a period of years. (U.S. citizens can gift up to US$145,000 a year to a non-U.S. citizen spouse without having to file IRS Form 709 for gifting.) The idea is to keep George’s portion of the capital gains below US$250,000 and have the rest in Susan’s name because she will be in a lower tax bracket.

George and Susan should draft new wills and medical and property powers of attorney in whatever jurisdiction they end up living.

Here’s a look at the pluses and minuses of moving to B.C. vs Idaho – excluding lifestyle reasons, which are beyond the scope of this article (although they may, in the end, be the deciding factor).

– Moving to B.C. Health care isn’t an issue, as it’s provided publicly. B.C. charges a “medical services plan” premium, but it’s currently only $125.50 a year for a family of two.

Housing is more expensive in B.C. than in Idaho. Ritchie notes that the median price for a family home in Victoria is $483,000-$542,000; $360,000 in Nanaimo; and US$285,000 in Sandpoint.

Most of George’s income is in U.S. dollars (US$), so what he receives in Canadian dollars (C$) will vary with the exchange rate.

Tax rates are higher in B.C. Ritchie says that if George and Susan had combined 2013 income of $87,987 in Canada or an equivalent US$86,140 in the U.S., they would pay a total of $9,589 in Canada but US$3,062 in the U.S.

Furthermore, Ritchie says, once the couple start taking distributions from their registered accounts, the differential between what they would pay in Idaho vs B.C. will widen even more: “This is a function of the overall lower marginal tax rate and the broader base of deductions and exemptions available in the U.S.”

Both George and Susan will have to file both U.S. and Canadian tax returns, and both spouses will be subject to the new U.S. regulations, which require Canadian financial services institutions (and, ultimately, the Canada Revenue Agency) to report to the IRS any non-registered Canadian holdings greater than $50,000 held by of U.S. “tax persons.”

– Moving to Idaho. Health care can be extremely expensive in the U.S. However, in this case, both George and Susan qualify for Medicare, which, Ritchie believes, will meet the couple’s needs if they purchase the Medicare supplement insurance plan.

There is normally no premium for Part A (basic hospital coverage) if the applicant has accumulated more than 40 quarters of U.S.-based earnings, as George has.

The premium for Part B (the supplemental insurance), which covers medical costs, would normally be US$104.90 a month for each spouse. But the couple will have to pay an additional US$83.92 each month for six years as a “late” penalty because George didn’t apply when he was 65 years old.

Moving to Idaho will mean that George and Susan will become non-residents of Canada and will have to file only U.S. tax returns. Canada does not require income-tax filing by non-residents on the types of Canadian-source income that George and Susan will be receiving. There will be no Canadian withholding taxes on George’s and Susan’s CPP. There will be a 15% Canadian withholding tax on George’s OMERS pension and on his and Susan’s registered retirement income fund (RRIF) withdrawals – as long as the latter are not greater than 10% of each RRIF’s previous year’s end value or two times the required mandatory (based on age) withdrawal.

George and Susan should sell their Canadian mutual funds. According to Ritchie, the IRS considers these to be “passive foreign investment companies” and subjects them to onerous taxes.

The couple will be subject to an exit tax on their Canadian non-registered investments. That is, those investments will be deemed to be sold and any capital-gains taxes due on them will have to be paid. Both Barrett and Ritchie advise that these investments be sold outright before George and Susan leave Canada. The proceeds could be used to acquire U.S. investments but, with the C$ currently worth only about US91¢, George and Susan may want to keep this money in C$ until the exchange rate is more favourable. This money must be held with a firm that is licensed to act for U.S. residents, as Ritchie’s firm is.

Ritchie suggests that Susan seek a lower-cost provider for her variable annuity. To do so, she must initiate a “1035 exchange,” which would allow her to transfer insurance products to another provider on a tax-deferred basis.

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