“Financial Checkup” is an ongoing series that discusses financial planning options. In this issue, Investment Executive speaks with two advisors knowledgeable about Canada/U.S. cross-border financial issues. Terry Ritchie, a partner with Transition Financial Advisors Group Inc., works out of both its Calgary and Gilbert, Ariz., offices. Dale Franko is a tax professional with Moodys LLP Tax Advisors in Calgary.

The Scenario: Tom, age 45, has the opportunity to move within his company to its U.S. affiliate in Houston. On the surface, the move appears to be a great opportunity for Tom and his wife, Sarah, 42, as it would mean an increase in his salary by about $25,000. However, there are good reasons for Sarah and their 14- and 16-year-old daughters to stay in Canada. Tom and Sarah want to know whether they can afford to maintain two households for the next four years until their youngest daughter is in university.

Tom will be making US$225,000 a year. Sarah and the girls would need $80,000 to maintain their mortgage-free home, which is worth about $500,000, and cover their living expenses. Tom thinks he will need US$36,000. They will also need about $15,000 a year to pay for flights so they can get together for at least a weekend every month. They have $40,000 in a family registered education savings plan and want to pay the full cost of four years of university for both daughters.

Tom plans to retire in 15 years, at which point he and Sarah will move back to Canada. He thinks they would need $100,000 after taxes a year in today’s dollars during retirement.

Tom has $300,000 in RRSPs and he and Sarah each have $10,000 in tax-free savings accounts. Tom and Sarah also share a joint brokerage account worth $800,000. Some of this was from a $500,000 inheritance that Tom received upon the death of his father in the autumn of 2008, which he was able to invest shortly after the market collapsed.

One question is whether Tom should rent or buy a house in Houston, where he understands house prices have fallen. Another is whether he should sever his Canadian tax ties, which, he has heard, can be beneficial. But he wants to know what the implications would be while Sarah and the girls remain in Canada.

The Recommendations: Both Ritchie and Franko say Tom’s and Sarah’s goals are achievable, even though Tom can’t get the benefit of lower U.S. taxes — which Ritchie estimates would be almost $20,000 a year — as long as Sarah remains in Canada and the couple maintains a home here.

Tom can’t simply decide to sever his tax ties with Canada. The Canada Revenue Agency will look at his situation and decide if he is still a Canadian resident for tax purposes. In determining residency, the CRA will first look at where Tom’s permanent home is and will then consider where his “vital interests” — such as his family, clubs, church affiliation, bank accounts, driver’s licence, etc. — are located, Franko says.

The CRA would definitely consider owning and maintaining a home in Canada in which his wife and daughters live as evidence that Tom is still a Canadian resident for tax purposes. Ritchie agrees, citing his own experience. He and his wife live primarily in Arizona but can’t sever their Canadian tax ties because they also maintain a home in Calgary.

Thus, Tom will have to continue to file Canadian tax returns and will have to pay the difference between the taxes he paid on his U.S. earnings and the higher amount due on those earnings in Canada.

This will give Tom and Sarah a few years to decide whether they want to sever their Canadian tax ties and become solely U.S. tax residents once Sarah moves down to Houston.

They don’t have to wait to buy a house in Houston, but Ritchie would advise not rushing into that. He notes that “many believe there is still more bleeding to come in the U.S. real estate market,” so the couple may well not have to spend as much in another year or so. Ritchie notes that they can get a house similar to the one they have in Calgary for much less in Houston, noting that the median home price in Calgary is $467,000 compared with US$209,000 in Houston.

Nor does Tom have to wait to take advantage of more generous retirement savings vehicles in the U.S. Ritchie assumes that Tom will be eligible to participate in a 401(k) plan— similar to a group RRSP in Canada — through his employer while he’s working in the U.S., even if he remains a Canadian tax resident. This would allow contributions of up to US$17,000 annually and up to US$22,500 a year once he’s 50.

Both advisors emphasize the importance of making sure that Tom’s and Sarah’s Alberta wills are up to date while they remain Canadian residents for tax purposes. But Tom will also need to have a health directive and power of attorney drafted under the requirements of Texas.

Sarah will need to do the same when she joins him. And if they decide to sever Canadian tax ties, they will need to re-evaluate their estate plans and have wills or a trust drawn up in Texas, assuming that’s where they end up.

When Sarah moves to the U.S. to join Tom, there are several issues that they need to consider before deciding whether to sever tax ties with Canada:

> Tax Savings. Tom would pay less taxes in the U.S. — almost $20,000 less given his current salary.

> Canadian Home. If Tom and Sarah decide they want to sever their Canadian tax ties, it would be advisable to sell their Calgary home.

They could rent it out, but that might make the CRA wonder if they still have “vital interests” in Canada.

They should also consider how many trips to make back to Canada for the first couple of years. The CRA will keep a close eye on the couple for a few years, and too many trips to Canada could make the CRA decide that Tom’s and Sarah’s vital interests are still here. Thus, it could be good idea for them to remain in the U.S., says Franko.

> Exit Taxes. Tom and Sarah would have to pay capital gains taxes — of 19.5% in the case of Alberta residents — on all their non-registered financial assets, both in Canada and elsewhere, as they would be deemed to have disposed of those assets on the day they leave Canada. It’s worth noting that this will move up their tax base to their exit date for the purposes of calculating U.S. capital gains.

> U.S. Tax Residency. Tom will become a U.S. tax resident — although also still a Canadian tax resident — after his move and the start of his U.S. employment.

His first year of filing U.S. taxes will require him to file on a dual status basis. This would not provide him with the significant U.S. tax benefits that are available for a married couple filing jointly.

However, Tom can take a specific election under the U.S. Internal Revenue Code to treat Sarah and the girls as U.S. tax residents. This would qualify him for lower U.S. tax rates as he will be able to file on a married joint basis.

This does not require that Sarah and the girls have U.S. immigration visas, although they will each have to get a U.S. taxpayer identification number. They should apply for these numbers when Tom files his first U.S. tax return.

As U.S. tax residents, they will need to file any applicable forms related to tax residents’ holdings in a foreign country. A likely one is the foreign bank account reporting form, known as FBAR, which details holdings in foreign banks and has to be filed every year with the U.S. Treasury Department. The penalty for not filing this can be as high as US$10,000.

There is also a new form as of the 2011 taxation year — Form 8938 — that is filed along with tax returns and lists any foreign financial assets of more than US$400,000.

Another is Form 3520, which also goes along with tax returns and details holdings in foreign trusts. Given that Tom and Sarah each have TFSAs and RRSPs  and hold a family RESP for their daughters, this form will be required each year.

> Estate Taxes. The U.S. has estate taxes, both federally and in many states, while Canada does not. The federal tax has a history of changing frequently and dramatically.

Currently, it is charged on estates of more than US$5 million at a rate of 35%, but that is only until the end of 2012. U.S. President Barack Obama’s current budget proposal is for the exemption to be lowered to US$1 million, with the rate rising to 55% in 2013, says Ritchie.

> Gift Tax. The U.S. also has a tax on gifts of more than US$13,000, or US$26,000 from a couple; this tax does not exist in Canada.

This tax, however, excludes gifts between two U.S. taxpayer spouses. There is also a “generation-skipping transfer” on gifts of more than US$1 million. This applies to gifts given to grandchildren and unrelated persons who are more than 37.5 years younger than the donor.

> Principal Residence. U.S. taxpayers can deduct mortgage interest and property taxes paid on a principal residence. Canada does not have this deduction.

The U.S. exempts only US$250,000 in capital gains on primary residences for an individual — or US$500,000 for a married couple — as long as the taxpayers have owned and lived in the home for two of the previous five years and as long as the proceeds are used to purchase another primary residence. Canada exempts capital gains on all sales of a principal residence.

> Canadian Mutual Funds. The U.S. considers Canadian mutual funds to be “passive foreign investment companies” for which the Internal Revenue Service requires information not normally provided by the funds.

Both Ritchie and Franko recommend selling Canadian mutual funds in their non-registered accounts because Tom will be a U.S. tax resident as well as a Canadian one. After Tom and Sarah sever Canadian tax ties, they will likely not be able to maintain non-registered accounts in Canada. But registered Canadian accounts are fine and would not be considered PFICs.

> Retiring In Canada. If Tom and Sarah follow through with their plan to retire in Canada, they could become Canadian tax residents again by following similar procedures to those they took to become U.S. tax residents.

They might have to pay a U.S. “exit” tax on capital gains greater than US$651,000 on their worldwide assets, including a primary residence in the U.S. and other real estate.

This would only apply if they choose to abandon their U.S. green cards after having held them for more than eight years. If they return to Canada before eight years, then the U.S. expatriation rules would not apply.

If they decide to do this, they would have to give up Tom’s green card — and Sarah’s if she has one. This wouldn’t affect the couple’s ability to travel to the U.S., says Franko. However, if they become U.S. citizens and gave that up, they could find that they wouldn’t be allowed back. IE