Transcript | Tax Strategies For Snowbirds

Sarah Widmeyer 0:16 

Welcome to Conversations on Wealth, a podcast dedicated to helping Canadians with your total financial picture. I’m Sarah Widmeyer, Director of wealth strategies at Richardson wealth. And joining me today is Sean Hsu, a Senior Tax Specialist at Richardson Wealth. Thanks for being here with me today, Sean.

Sean Hsu 0:36 

Thanks for having me, Sarah.

Sarah Widmeyer 0:38 

We often remind our clients that tax strategy should be applied throughout the year to maximize their impact on your tax bill. Shawn, why may Canadians who are snowbirds, for example, who spend time in the United States on an occasional basis need to worry about US taxes?

Sean Hsu 0:59 

Because there’s not enough on the list of things to worry about in life, right? But jokes aside, Canadians who Snowbird or spend time in the US have so many things to get into order, like making sure mail is going to the right place, making sure there’s somebody available to take care of the home while they’re away. Chances are US taxes is not Top of Mind, especially because people do not think of having to pay tax or reporting come to a jurisdiction that they’re not really domiciled in. But unfortunately, things are never that easy. People who spend time in the US, and even people who don’t spend time in the US, but have US assets as part of their wealth, should understand that they could become exposed to the US tax system. And they need to understand what the various taxes are in the US what they’re applied on, and how they can manage them as part of their overall financial planning. And the topic of US taxes is timely, because with Biden, now as President, there is a risk that more Canadians, with some sort of connection to the US will become exposed to the reach of Uncle Sam.

Sarah Widmeyer 2:15 

Yeah, well, I guess, given what we’ve all just gone through, governments are going to be looking for more sources of income. So it shouldn’t be surprising that the US would expand their net. But we’re not talking about a simple trip to Disney World are we we’re not talking about it, you know, a two week three week trip down to the beach.

Sean Hsu 2:34 

No, we’re talking more long term periods of time spent in the US. And I think we’ll even talk about people who don’t ever step foot in the US. But to their surprise, they’re still exposed to, to the US taxes, and they don’t even know about it.

Sarah Widmeyer 2:51

Wow. Okay, so let’s talk about that a little bit more. So how does a Canadian spending time in the US become exposed to the country’s tax rules.

Sean Hsu 3:01 

So in order to understand the extent to which you’re exposed to taxes in the US, you need to first figure out whether you’re considered a US person. And that’s because if you are a US person, then you’re subject to US taxes on your worldwide income, and worldwide assets, no matter where they’re located or held. But if you’re not a US person, then you’re only subject to US taxes on income and assets that are considered to have a connection to the US so much more limited in scope. People who are not US citizens can be US persons, if they’re considered what are called resident aliens. It’s weird. It’s a weird way to describe people. But yeah, if you’re not a citizen of the US, you’re considered some sort of alien. And I think Biden is even looking to replace the term alien with non citizen because it can be viewed as derogatory.

But that aside for Canadians who are US citizens or green card holders, becoming quote unquote, resident alien, under US rules, is usually a result of meeting what’s called the substantial presence test, or SPT for short. So, if you spend extended periods of time each year in the US, you may have been told that you need to monitor the number of days that you’re spending in the US each year. And that’s in direct relation to this substantial presence test. And this test is of formulaic day count test that deems you to be a resident of the US for tax purposes. So if you meet the substantial presence test, you would at first instance have to pay income tax on worldwide income to the IRS. So most snowbirds want to avoid this. So this is the one test in life that you actually want to fail.

Now the counting of days in the US under substantial presence test appears simple on its surface. And what I commonly hear, and I’m sure my colleagues commonly hear from Snowbird clients is some variation of the following statement, which is, as long as I don’t spend more than six months in the US each year, that I’m completely in the clear, and I don’t need to file anything with the IRS. And that sort of statement is a bit misleading, because the substantial presence test, it’s actually not that simple. It’s not looking just at the number of days you spend in the current year in the US. But instead, it’s actually looking over a three year period, and you wait the number of days each year. And if you add those numbers up over the three years, at a total number of days is at least 183 days, which is where I think that six months comes from, you meet the substantial presence test, and are a resident of the US for that year. So if you follow the actual math and the formula, if you don’t want to be considered a resident under the substantial presence test, then in reality, you can’t spend more than 121 days each year in the US. So that’s more like four months, not six months.

Sarah Widmeyer 6:12

Wow. So maybe you’ve already answered this a bit. But then how does a Canadian who spends too much time in the US get out of the rules? So one thing would be to shorten your number to 121 days.

Sean Hsu 6:24 


Sarah Widmeyer 6:25

But what else?

Sean Hsu 6:26

So the other main out, so if you consistently spend more than approximately four months year in and year out, so that you always meet this substantial presence test, the one out that you want to look at with your tax advisor is what’s called a closer connection, exception statement, lots of terms, and this out to use this exception, you actually need to file something with the IRS. And this statement is where you essentially tell the IRS that, okay, I’ve spent enough days each year in the US to be treated as a tax resident under your day count rules. But notwithstanding that, I have a closer connection to Canada. Here’s why. And please do not treat me as a resident of the US. So if you follow the statement on time, IRS doesn’t come back, then you’re in the clear, and you’re not a resident of the US.

Sarah Widmeyer 7:16

So that I’m wondering if I’ve kept my time period 121 days, and I’ve filed my statement that I have closer ties to Canada than US. Do I have any other US tax and estate planning issues to consider?

Sean Hsu 7:31

Yeah, so it’s a bit complicated. So if you’re under 121 days, year in and year out, then you don’t meet the substantial presence test. So you don’t even need to rely on this closer connection exemption statement. Now, if you are over four months, then to get out of the residency rules, then you want to look at whether you qualify for this closer connection exception.

And so there’s two things to note with this special exception.

So the first thing is that there is a separate 183 day test with this. So you can qualify for this exception, as long as you spend less than 183 days in the current year. So another six months test. But it’s important to distinguish that it’s separate from the 183 day threshold for the substantial presence test. So very confusing.

We’ll summarize it very clearly. But uh, yeah, so there’s a separate 183 day test. And then the other thing is, you actually need to file the statement with the IRS on time. So even if you meet the conditions, but you don’t file this form on time with the IRS, then you don’t qualify. So you still have the issue where you meet the substantial presence test. And you can’t rely on this closer connection exception to get out.

So really big picture in terms of counting your days, what a Snowbird really should think about and should consider with respect to the number of days is, as long as you keep your days, year in and year out to a maximum of 121 days each year, then you’re not a deemed resident of the US under the substantial presence test. You don’t need to follow any statements with the IRS. Otherwise, if you’re more than 121 days, then you can keep your US stays to a maximum of 182 days each year and still be considered a non resident, provided that you file this closer connection statement every year to the IRS. So there’s a little tiny, almost 60 day period where you can have time in the US but still be considered a non resident if you file the appropriate form with the IRS. So more paperwork involved in some people don’t realize that they just think that as long as I am under six months each year, I’m fine from a tax perspective.

Sarah Widmeyer 9:58 

Wow, and I guess every time you cross the border, there’s a record of you crossing border.

Sean Hsu 10:03

Absolutely. And so we always recommend people to keep track of their days. Have a travel log. And, you know, even the days that you fly in and fly out partial days are, at first instance, considered full days in the US. So you have to be careful with that as well.

Sarah Widmeyer 10:23 

Wow. Wow, really quite complicated, isn’t it?

Sean Hsu 10:26

Yeah. We always recommend people work with their tax advisors, but they need to understand that there’s an issue or a risk exposure in the first place to know where to go for help.

Sarah Widmeyer 10:37 

Yeah, so what I’m hearing is there’s a great deal of personal accountability in terms of tracking your days and understanding the time limitations around those days. But then, absolutely, working with a tax advisor is critical to navigating this very complex. I don’t know what else to call it other than complexity, or rules, laws, and Wow. So let’s say I’ve made it very simple for myself, and I don’t travel to the US, I traveled to France, I go to Europe, I’m not spending any time in the US. Do I still have to worry about US estate tax and tax issues?

Sean Hsu 11:19 

You do. That’s why we’re here today to have our chat. Yeah, even if you spend a little vacation and Disneyland in the US or, or you are Snowbird, but you carefully keep track of your days in the US, doesn’t mean you’re completely out of the clear when it comes to the US tax system. And that’s because the US can still get their hands on non residents, if they own certain types of assets in the US, and they can charge their different taxes like an income tax and estate tax, a gift tax. And if you own certain types of assets in the US, they can attract all of these taxes.

And one very natural example of this is US real estate. So often new snowbirds may start off by renting but as they spend more time in the US and start enjoying, you know, spending a portion of their time each year in the US, they may start to think about potentially purchasing a property and setting some sort of root down there. And at our firm, we emphasize the importance of planning proactively, rather than reactively. And this type of approach is important for all sorts of financial decisions. But it’s especially important, I’m a bit biased when it comes to decisions, like purchasing US real estate. And the reason for that is because how you plan your purchase of an asset like US real estate can carry US tax implications throughout the entire life of owning that asset.

So, for example, if you want to rent out the property for some time, while you’re back in Canada, that can create US income tax implications on the rental income that you’re earning. If you sell it, in the future, you want to downsize, you don’t want to spend any more time in the US and you want to sell the property that can also create US income tax implications. If you want to gift the property, or transfer the property during your lifetime, say to a child or to a friend, if you’re really generous, that can create gift tax in the US. And if you die owning the asset, the US can still get their hands on a piece of the pie because they have an estate tax that can be charged on the property.

So this one asset that you enjoy, can give rise to a number of different US taxes. And on top of all of that you’re still resident in Canada. And so you still got to think of all our Canadian rules that can reach on the US property. So it’s a lot of tax issues that can arise with just one asset.

And the other thing a lot of clients often don’t think about is beyond tax. What if you spend time and maybe own property in the US and suddenly become incapacitated? Or, God forbid you pass away? How will your Canadian estate planning document your wills, your powers of attorneys that you have, hopefully drafted here. Will they work in the state that you have this US property in? Or is it better to have maybe separate wills and powers of attorneys done in the jurisdiction that you have US property and to more easily facilitate decision making and administration when these sorts of difficult decisions arise?

So with all of that in mind, we often get asked about people who are in tune with the sorts of things, ask us know how should I own property in the US that I’m interested in? Should I buy it directly? In my own name? Should I hold a jointly with my wife with my husband, perhaps a friend or a neighbour, as mentioned, I’ll put it in a corporation or put it in a trust. But do these ideas and options Make sense? And your unique circumstances. Are the tax savings worth adding additional complexity to you and your family? So there’s a lot to think about. And we try to help our clients understand all of these options, so they feel more comfortable and more educated when it comes to making these sorts of decisions that apply even if they don’t, you know, aren’t residents of the US?

Sarah Widmeyer 15:48 

It’s amazing, really. And I’m glad you bring up the firm because at Richardson Wealth, we do you have a dedicated tax and estate planning team that is here to help guide clients through these types of scenarios and options. And, Sean, yo, you  are part of that team. And we’re very lucky to have you. Another question that I’ve got. And I had understood that if I have a portfolio of equities, that are US companies, US equities, depending on the amount of assets that I hold in those securities, I may also be subject to some sort of US tax.

Sean Hsu 16:28 

Yes, it’s true. And that’s where, that’s where I find a lot of the clients that I speak to get the most insulted and, like most surprised, so, so what you’re, what you’re referring to is, is the US estate tax. And it often, it comes as a surprise to Canadians because it applies, even if people don’t live in the US or have assets physically located in the US. So it seems really unfair that Canadians have to pay an estate tax to the US, to a country that they don’t spend time in or benefit from. And the estate tax is also unfamiliar to Canadians, because we don’t have an estate tax here in Canada, at least not yet. In our tax rules, sort of pretend like you’ve sold your assets when you pass away. And our country seeks to tax the underlying appreciation on the assets that you hold when you die. Whereas the estate tax in the US is different in that it applies just on the value of the of the assets that you hold, rather than the underlying appreciation.

So you could have bought a stock of a US company for $100. And if you die the next day, it’s $100 that the US could potentially charge their tax on. So, so for Canadians, the US estate tax applies on what are called US situs assets that you own on your debt. And the word situs sounds like situated. So if we were to go back to that example of US real estate, that is considered a US situs asset. And it doesn’t seem unreasonable that the US could charge an estate tax on US real estate because it’s property physically located there. So I don’t think it is necessarily unfair at its surface that an estate tax could be charged on an asset like US real estate. But what you’re talking about with US stocks is another type of US situs asset. And these US stocks in your portfolio don’t have to be in an account in the US, they can be in Canadian accounts, they can even be in Canadian registered accounts. They could even be in an RSP or TFSA. The US rules look through registered accounts when it comes to these things. So US US stocks in Canadian accounts, can expose you to the US estate tax and so simply having exposure to the US as part of having a diversified investment portfolio could lead to this exposure. And it can be a very expensive tax if, if you’re subject to it, because again, it’s it’s on value, not on appreciation. And the top rate right now for US estate tax currently is 40%. So 40% on value. That’s, that’s a big tax bill.

Sarah Widmeyer 19:39 

So Sean, then two quick questions, because we could go on forever, because it’s really quite fascinating. Two quick questions then before we wrap up, is there a threshold so like, if I have $50,000 in US securities, I’m subject or, or I’m okay, is there a limit to which this kicks in and then the second question is, what if those funds are held within a discretionary account where I’m not actually choosing the allocation or a mutual fund of US equities, does it matter? So maybe there’s three quick questions before I let you go.

Sean Hsu 20:16 

Ya, no they’re great questions.

So to your first question, there are several thresholds that you have to look at in determining whether you ultimately have to write a check, or your executor ultimately has to write a check to the IRS. So the first threshold is, if you hold US situs assets, the value of all of your US situs assets, so US stocks, US real estate, all of them. If the value is under $60,000. And that’s in US dollars, then you don’t have to worry about US estate tax, don’t have to file anything with the IRS. That’s a very low threshold, most people would hit it, just on the US stocks.

So the second threshold is where we see a lot of sensitivity. And that’s because it’s the second threshold that Canadians can take advantage of, is tied to an exemption amount that people in the US could claim when they die and have to calculate whether they’re subject to the estate tax. And that exemption amount is very sensitive to changes in political power. And so currently, the exemption is very high. It’s, over $11.5 million, I think, specifically $11.7 million US dollars. So any Canadian, that has a total net worth, so not just the US assets, a total net worth under $11.7 million would not have to pay a state tax to the IRS, even if a component of that total net worth is comprised of US assets. Now, the risk is that that exemption amount is going to drop, because Biden’s now the president, it’s a different political party, and chances are they’re going to be looking to reduce that exemption amount. And so what that means for Canadians is, more and more Canadians will have an exposure to US estate tax, based on their total net worth, to the extent that some of those assets consist of US assets like US stocks, US real estate.

Sarah Widmeyer 22:28 

And US mutual funds are no, you’re okay in the US mutual.

Sean Hsu 22:32

Yeah. So when we talk to clients about how to reduce their US estate tax exposure, at least from an investment perspective, changing the type of product is one way so instead of investing directly in shares of a US company, you invest through, like a Canadian mutual fund, or an ETF that has you know that itself invests in the US. That’s one way we can use investment products that still have exposure to the US. But without the potential cost of US estate tax. But sometimes product, it can’t solve everything. So sometimes, you still want to have direct exposure to US stocks, because it makes sense from an investment perspective. So then we look at more complicated methods of structuring assets to maybe reduce the US estate tax exposure. And that’s where you need the right advisors that can identify the issues in the first place, so that you can figure out who you need to turn to to find planning opportunities and implement them.

Sarah Widmeyer 23:41 

Yeah, we could go on and let’s have another conversation on another day. It’s really fascinating and I’m so glad you mentioned working with a skilled investment advisor backed by a powerful team of tax and estate experts very knowledgeable, is so critical as we navigate these rules.

Sarah Widmeyer 24:12

So I’d like to say if you have any questions about some of the ideas or strategies from this episode, please reach out to your Richardson Wealth advisor or your tax professional to discuss the impact of your own situation. And remember to follow Richardson Wealth on LinkedIn for the latest in wealth strategies, or visit our website for more tax planning ideas. Conversations on Wealth is available wherever you get your podcasts. Thank you all for listening. Thank you, Sean. And join me again next time.