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.

Tax Rates:

Prior to this law being passed, the Bush tax cuts were set to expire at the end of 2012. All rates would have gone up for all taxpayers. As part of the ATRA, the 2012 tax rates were made permanent with one additional bracket. This new bracket will begin at $400,000 for single filers, $425,000 for head of household and $450,000 for those filing jointly. With these rates now being permanent and being indexed annually for inflation, individuals will be able to plan their affairs without worrying about rates expiring. The following tables will show the expiring rates, what the rates would have been without the ATRA and what the rates will be going forward.

Note that rates for those married filing separately are always 50% of the married filing joint.

Impact on Canadians

This new law will be beneficial to Canadians. With the lower rates being made permanent, most working Canadians will be able to continue not owing very much each year to Uncle Sam. However, those wealthy individuals who have large deductions in Canada might find themselves in a situation where they are unsure from year to year as to whether they owe money.

Extension of Capital gains and dividend rates:

Prior to this law, the reduced rates on Dividends and capital gains would have been eliminated. This would have resulted in dividends and long term capital gains being taxes as ordinary income. Under the Bush cuts, qualified dividends and long term capital gains were taxes at 15% flat. In addition, those people in the 10% bracket paid no tax on dividends or long term capital gains. The new law extends the 0 and 15% rates across the board and establishes a 20% tax on those in the highest income tax bracket.

Impact on Canadians:

The extension of these tax rates is beneficial. Had this law gone into effect, these items would be taxed as ordinary income and that would have resulted in much higher taxes on these items in the USA than in Canada. This could have left many average Canadians with taxes payable in the USA each year. This would have especially hit retirees hard with much of their incomes being investment based, rather than employment based. With these new rates in effect, the current system where Canadian taxes should cover the American taxes due will continue. The only people who are likely to have taxes due are the wealthier Canadians with long term gains as Canada generally taxes these at lower rates.

Alternative Minimum Tax (AMT)

Prior to this law being passed, AMT was expected to hit in 2013 at $33,750 for individuals, $45,000 for couples & $22,500 for those married but filing separate returns. This would have meant many Americans being caught by AMT. Even more so, those living abroad and filing separately as their spouse has no obligation, would almost certainly be caught by AMT. With this law, the AMT hits now at $50,600 for individuals, $78,750 for those married filing jointly and half of that for those filing apart from their spouse.

Another benefit to this law is that now AMT is to be indexed annually for inflation. It used to be that congress needed to pass a patch for AMT annually in order for it not to keep capturing more and more people. With this indexation, fewer people will be trapped annually.

Impact on Canadians:

Once again, this law brings positive news to Americans in Canada. With the higher exemption amounts, fewer Canadians will be caught. In addition, with the rates being fully indexed for inflation, there will be no annual worries as to whether someone will be caught by AMT.

Estate tax:

Prior to this law passing, it was expected that the estate tax rate for 2013 and subsequent years would be 55% for estates valued at above $1M. For those dying in 2012, the tax rate was 35% on estates larger than $5.12M.  With this new law, the 2012 limits are now permanent and will be indexed for inflation. The expected exemption for 2013 is approximately $5.2M. The tax rate on these estates will be 40%. In addition, the exemption amount can now be transferred between spouses, allowing for a much larger exemption for a family.

Impact on Canadians:

This law will impact all Canadians who have US estate tax liability. However, those families with estates between 1M and 5.2M will now not be required to pay anything. This will greatly reduce the number of Canadians with exposure to US estate tax.

Another group who may benefit from this are those who own real estate in the US. As estate tax is charged on all US property, Canadians owning property can be subject to estate tax. The increased threshold and reduced rate from what were the expected rates is a welcome change as it will exempt many Canadians from these taxes. The same formulas as before will be in place to calculate non-resident exemptions so this will just increase the exemption amount from what was expected.

Child tax credit/Additional child tax credit:

This is one of the few refundable credits available to Americans living abroad. In 2012, this credit was worth $1,000/child and it was scheduled to become $500 in 2013. However, with the passage of this law, the credit is permanently restored at $1000/child going forward. The refundable portion is set at $1000/child through 2017.

Impact on Canadians:

The extension of these credits is good news for Americans in Canada who are raising children. Through proper tax planning, they will now be able to get a refund of $1000/child without paying anything into the system up front.

These are some of the key features in the fiscal cliff law that will impact Americans in Canada. There are some other general clauses or businesses laws in place as well. For a summary of the law and other attributes, check out the following website. http://www.parkertaxpublishing.com/public/ATRA_2012_Analysis.html?goback=.gde_1884032_member_201223333

If you have any questions regarding how the fiscal cliff impacts you, your family or your business, make an appointment with our tax experts to guide you through and to help you plan for dealing with the American tax code.

1)     Tax Free Savings Accounts (TFSA):

For ordinary Canadians these are great vehicles for saving money and avoiding taxes. Unfortunately, the USA doesn’t view them in the same manner. For American purposes these investment vehicles come with 2 problems.

1. All income earned in the TFSA is taxable in the USA. This may result in taxes payable in the USA on the income as there may not be sufficient tax credits available to avoid American taxes.
2. TFSA accounts are considered by the IRS to be a foreign trust. This results in a significant amount of additional paperwork to be attached to a tax return.

These problems make these investment vehicles unfavorable for an American residing in Canada. However, if the account is closed before December 31, we can file a final return for the trust in 2012 and there will be no hassles subsequently.

2)     Registered Education Savings Plan (RESP):

Similar to a TFSA described above, these vehicles are a great tool for saving for a child’s college education. Unfortunately, this vehicle has similar constraints to the TFSA.

1. In Canada, income earned in the RESP is taxable in the hands of the beneficiary when the money is withdrawn to pay for college. In the USA, the income, including government grants, is taxable annually when it is earned. This can result in double tax with the child paying tax on the income in Canada, and the parent paying tax in the USA.
2. RESP accounts are considered by the IRS to be a foreign trust. This results in a significant amount of additional paperwork to be attached to a tax return.

These problems make an RESP unfavourable for Americans in Canada. One solution would be to have a non-American spouse or grandparent open the account for the benefit of the child.

3)     Mutual Funds/ETF/REIT

Mutual funds are a standard form of investment. However, if you are an American in Canada, they are taxed in a highly punitive manner. In order to avoid the punitive taxes, a timely election must be made to reduce the penalties. The elections available are:

1. to record the income attributable to oneself in the current year; or,
2. to mark the investment to market which results in the reporting of the unrealized gain on the fund in the current year.

This can easily result in paying taxes on this income in both Canada & the USA as the credits may not be available on a timely basis. However, failure to make any election places you in a situation where the taxes will be punitive. The best solution to the mutual fund problem would be to sell off all Canadian mutual funds by the end of the year and replace them with ordinary stocks and bonds.

These are some key investment vehicles and how they impact Americans in Canada. For further information or specific questions regarding your situation, please send us an email (http://www.ustaxesincanada.com/contact/ ) or make an appointment with our US tax specialists (1-888-877-2505).