A major factor in the U.S. fiscal crisis was the policies which encouraged banks to give out sub-prime mortgages. Canada did not impose such policies on their banks and thus avoided the crisis almost entirely. Not one Canadian bank had to be bailed out. The Minister of Finance ended all government-backed insurance of low down payments and low amortization periods for home mortgages. Taxpayers are no longer responsible for taking on risky debt.

A speech explaining the government’s view of this crisis can be viewed here.

There are 2 components to the Obamacare taxes:

1)     Medicare payroll tax increase on earned income

2)     Unearned Income Medicare Contribution Tax

1)   Medicare payroll tax increase on earned income:

Currently, the Medicare tax is 2.9%. It is imposed on wages, salaries, business and farming income.  This tax is paid 50% by the employee and 50% by the employer. Self employed individuals pay both components directly. This tax is part of the social security deductions taken directly from an individual’s salary. The new tax is to be .9% on earned income above $200,000 for single individuals, $250,000 for joint filers or $125,000 for those married filing separately. This .9% is in addition to the 2.9% currently charged.

WHAT is the IMPACT of THIS on AMERICANS in CANADA ?

The good news regarding this tax is that it will have a minimal impact on Americans living in Canada. This is because the medicare tax is considered a payroll deduction and those are covered in a separate totalization agreement between the USA and Canada. For those working in Canada, this tax can be avoided by ensuring that they are properly paying and reporting CPP/QPP, EI and any other required payroll deductions. Once these taxes are paid, individuals will not be required to pay US deductions as well.

2)   Unearned Income Medicare Contribution Tax

This is a new tax of 3.8% on the investment income. This tax is imposed on the investment income component of Modified Adjusted Gross Income (MAGI) at the following levels. The levels are as follows:  $200,000 for single individuals, $250,000 for joint filers or $125,000 for those married filing separately. MAGI is composed of investment income, (interest, dividends), earned income, (wages, commissions), or withdrawals from a qualified retirement plan. Earned income that was excluded in the foreign earned income exclusion is to be added back in calculating MAGI. The tax is imposed on the lesser of investment income, or MAGI above the threshold. To demonstrate how this will play out, see the following examples. For simplicity sake, these examples will be used for single people only.

A)     Jim has MAGI of $250,000. This is composed of $175,000 in wages and $75,000 in investment income. His MAGI is 50,000 above the threshold. Jim will owe the new 3.8% tax on the 50,000 because it is the lesser of investment income or income above the threshold.

B)     Jill has MAGI of $300,000. This is composed of $225,000 in wages and $75,000 in investment income. His MAGI is $100,000 above the threshold. Jim will owe the new 3.8% tax on the $75,000 as it is the lesser of investment income or income above the threshold.

WHAT is the IMPACT of THIS on AMERICANS in CANADA ?

This tax can impact Americans living in Canada; those married to Canadians are most vulnerable. This is due to the reduced MAGI limit of $125,000 for those who are married and file separately. For those who have income in or around the threshold, proper planning is necessary.

If you or anyone you know are an American citizen living in Canada and are concerned as to how these new taxes may impact you or your family, please make an appointment with our US tax advisors today. Don’t let these new taxes catch you off guard.

US tax residency is determined through the Substantial Presence Test. This test determines residency by the following method. If an individual meets the criteria, they are considered a US tax resident for the year. This will result in the individual being considered a resident alien and will be obligated to file a full tax return for the year including the disclosures of all non-US owned asset forms. The test consists of 2 different questions and individuals must answer yes to both questions to be considered a resident. Note that any part of a day spent in the USA counts as a full day.

1. Did the taxpayer spend 31 days or more in the USA during the current year?
2. Did the taxpayer spend more than 183 days in the USA over the past 3 year period with the days weighted as follows?
   • Number of days present in the current year ADDED TO . . .
   • 1/3 the number of days present in the USA in the prior year ADDED TO . . .
   • 1/6 the number of days present in the USA in the 2^nd prior year.

Note that if an individual spends more than 121 days a year in the USA they will meet the substantial presence test. To avoid the onerous requirements of US residency and tax filing, the individual can consider the following two options.

1. File form 8840 requesting a Closer Connection Exemption.
2. If the Closer connection exemption is not available, an individual can use tiebreaker criteria under article IV of the Canada US income tax treaty.

1. File form 8840 requesting a Closer Connection Exemption

To claim a Closer Connection Exemption, individuals will need to be able to demonstrate they have a closer connection to Canada than the USA. To be eligible for this approach, an individual must meet the following 3 criteria:

• The individual must be present in the USA for fewer than 183 days during the current year.(A greater presence will also result in being in violation of immigration law)
• The individual must maintain a “tax home” in a Canada or outside the USA.
• The individual must be able to demonstrate that they have a closer connection to the foreign country than to the USA.

Examples of this could include owning a home in Canada while not owning one in the USA, or keeping active government health insurance and maintaining a Canadian drivers’ license. All individual cases are judged independently on the merits of the case in question. To claim this exemption, form 8840 must be timely filed with the IRS by June 15^th of the following year, or October 15^th if an extension request is filed.

2. Use tiebreaker formulas under article 4 of the Canada-US income tax treaty.

The treaty produces a method whereupon no individual can be claimed as a resident of both countries. There are 5 items used to determine which country has the primary residency. They are as follows:

• Location of permanent home: (Where does the individual maintain a home)
• Center of Vital Interests: (Where does the individual work, bank, invest)
• Habitual Abode: (Where does the individual regularly live)
• Citizenship: (This would be a determining factor for Canadian citizens because if the individual is an American citizen, they would have to file anyway)
• A panel is assembled to adjudicate the case: (If the above 4 tests are not decisive then the case is to be determined  by a panel who will issue a final ruling)

To determine which country is primary, start at the top of the list. If the answer is clear, then ignore the other questions. If it is unclear, keep going down the list until it can reasonably be determined. To claim the treaty benefits, file form 8833 with a US tax return. One point to consider though in using the treaty is that states are not bound by federal tax treaties. Therefore if someone is spending the winter in California, they may have state tax issues as well as the federal ones.

If you, or someone you know, may be unsure if you may have American filing responsibilities, please check out our Substantial Presence Test Calculator . If you have any other questions or are unsure as to what your next steps should be, please contact one of our tax experts for a free consultation.