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Consider Your Big Neighbour To The South

By: Robert Keats
September 2007

Most wealthy Canadians – after a long and successful career where they paid more than half of their earned income to the Canadian governments in the form of income taxes, sales taxes, goods and services taxes, land transfer taxes etc. – wonder whether there is relief available in their retirement. Many will move lock, stock and barrel to one of the tax haven islands in the middle of nowhere. Few will consider one of the best tax havens available to Canadians – the United States. Aside from the obvious fact that most Canadians can drive to the United States in about an hour, this article will discuss the main reasons why the United States may be one of the best retirement alternatives for many business owners, executives, and other high net worth/high income Canadians.

Neighbour

I spoke to a group of retired Canadians three years ago in Dublin, Ireland, who were looking at going offshore for their retirement. At the same event, there were speakers from virtually all the major tax havens in the world. The United States never came up in any of the conversations until I had my turn to speak.

NeighbourFEAR OF IRS

Initially, many guests thought I was crazy even to mention the United States and tax haven in the same sentence. One of the main reasons why most Canadians and their Canadian advisors never consider the United States to be a place in which they can get substantial tax benefits is the country’s venerable Internal Revenue Service (IRS). Over the years, the IRS has continually produced one of the most negative marketing campaigns ever. By throwing folks in jail and fining renegade taxpayers great amounts of money and then getting it splashed all over the newspapers, the IRS strikes fear into the hearts of many on both sides of the border. After all, it was the IRS that nabbed Al Capone – not the police or the FBI. This fear of the IRS ensures a much higher level of compliance to the rules by taxpayers.

However, the truth be known, for those who have a desire to follow the rules, the IRS rules are much clearer in most cases and the IRS can be easier to deal with than the Canada Revenue Agency (CRA).

One of the key benefits of using a country like the United States for your retirement is that Canada and the United States have a very practical, well-established tax treaty. The Canada/U.S. Tax Treaty may be used to reduce the level of taxes on residual income being paid from Canada for Canadians living in the United States to levels well below that of traditional tax havens. For example, if you have a Canadian pension or large RRSP/RRIFs (or any other Canadian registered plans for that matter), the treaty withholding rate for Canadians living in the United States for the periodic payments is only 15 per cent whereas a tax haven without the benefit of the treaty withholding rate would be 25 per cent – more than 50 per cent higher. The treaty rate for Canadian dividends collected in the United States is 15 per cent, whereas the non-treaty rate is 25 per cent, and the treaty rate for Canadian rental income is 25 per cent versus 50 per cent for the non-treaty rate.

Consequently, for someone who has these sources of income, by moving a few miles to the south across the 49th parallel, one can cut his or her income taxes substantially without any great deal of planning. However, with planning, someone with a large RRSP could reduce their taxes from, say, 46 per cent in Ontario to the treaty rate of 15 per cent for periodic withdrawals (25 per cent on lump sum withdrawals), a substantial reduction in taxes by itself. However, there is also an opportunity to recover the taxes withheld by the CRA through foreign tax credits. The IRS has a very well-defined foreign tax credit recovery set of rules which, when applied correctly to RRSP withdrawals, provides an even lower effective net tax rate – in many cases a zero tax rate – on the withdrawal of the RRSP which can be realized from the U.S. side of the border.

NET OF ZERO

The planning required to reduce your tax rate as close to a net of zero on your RRSPs or other Canadian registered plans requires a skilled cross-border financial planner. This is not a do-it-yourself project. The tax savings can be tremendous, particularly if you are one of the fortunate Canadians that have, say, $1 million in an RRSP where the tax savings could reach close to $460,000 over a retirement in Canada.

There are many cross-border planning tax reduction opportunities for business owners who have not yet sold their business and are looking to retire and for individuals that have large stock positions with very low cost basis. By applying a combination of Canadian domestic rules, U.S. domestic rules, and Canada/U.S. tax treaty rules, a competently drafted crossborder plan, when implemented, may reduce capital gains taxes substantially and, in many cases, eliminate capital gains taxes altogether. Most Canadian advisors are not aware of, or have little to no expertise in, these cross-border techniques. Therefore, they will generally ignore them when approached by a business owner who wishes to sell out and retire.

For example, a Canadian business owner with a business valued in excess of $15 million was told by his accountant that if he sold the business in the most efficient way the accountant could come up with, he would pay approximately $4 million in income tax. By reworking the sale of the business using a cross-border strategy, the tax was reduced to about $2.5 million, and there is a very good chance that all of the $2.5 million would be entirely recovered on the U.S. side of the border through foreign tax credits. Consequently, this would make the effective tax rate on the sale of this business close to zero for a total effect of tax savings of $4 million. This tax saving, created solely by a move to the United States, is more than enough to fund most people’s retirement.

ESTATE TAX

Probably the second most common reason why Canadian advisors tell their high net worth clients to avoid the United States, besides dealing with the Canadian exit tax, is the fact that they point out the country has an estate tax at death. However, generally for lack of understanding, what these advisors fail to tell their high net worth clients is there are many simple strategies to avoid or eliminate both Canadian and U.S. estate tax altogether through a cross-border planning move to the United States.

NeighbourAlthough the CRA technically does not have an estate tax, it certainly does have taxes due at death such as the deemed disposition tax and the tax on RRSPs at death. For Canadian couples who have a net worth under $5 million, the Canadian taxes at death will normally be higher if they stay in Canada rather than moving to the United States and facing U.S. estate taxes. For those with net worth over $5 million, there are very simple trusts that can be set up prior to immigrating to the United States that can provide not only estate tax protection, but also creditor protection on substantially all of the high net worth person’s assets. These trusts will provide virtually any amount of income or assets and other benefits to the couple for the rest of their lives and then to their children/grandchildren for their lives or until the money is eventually consumed.

The Canadian exit tax, which is the deemed disposition tax on all capital assets when leaving Canada for the United States or any other retirement location, is perceived to be a big hurdle for most Canadian advisors. It is, however, simply handled in a number of effective ways.

First, it should be mentioned that this exit tax, or deemed disposition tax on leaving the country, is not an additional or a punitive tax, but is simply accelerating the time from when the assets would normally be sold and capital gains taxes paid to the exit date. The simplest way to deal with any potential exit tax is to use the CRA provided fi ling options on the exit tax return when leaving Canada. These CRA rules allow you to defer the tax without interest until the time that the asset is actually sold. Consequently, this leaves the Canadian taxpayer in exactly the same position with respect to the capital gains tax had they stayed in Canada and sold these assets whenever they felt the timing was right. However, this option is not always the best and a good cross-border planning professional can help you reduce or eliminate the exit tax altogether using standard crossborder planning techniques.

Some additional reasons why the United States can be a good retirement haven for Canadians is that there are many immigration options for Canadians to obtain U.S. visa status or legal permanent resident status and, eventually, dual Canadian/U.S. citizenship. Although many of these options are not available to everyone, a good immigration strategy, combined with a good cross-border plan, will usually achieve the intended results. Canadians who are over 65 and have been a resident in the United States for fi ve years can qualify for U.S. Medicare for the remainder of their lives. Canadians in this position technically have access to the best of the Canadian and the best of the U.S. medical systems. This will provide them with the most options and the most fl exibility of the two best medical systems in the world for the remainder of their lives.

Finally, with the Canadian dollar at a 30-year high, this may be an opportunity of a lifetime to implement a retirement strategy in the United States.

This article is a very brief overview of what a high net worth individual’s retirement might look like in the United States. This topic is in a substantially more detailed form in The Border Guide, published by Self-Counsel Press and available in quality Canadian and U.S. bookstores and online at Amazon.com.

Robert Keats is the founder and president of Keats, Connelly and Associates, a feeonly wealth management firm specializing in managing U.S./Canadian crossborder planning. Keats is also the author of The Border Guide, the defi nitive guide to cross-border financial planning. For more information, or to sign up for Keats’ annual cross-border workshop, visit www.keatsconnelly.com.

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