US Professionals Living in Canada: Why US Tax Reform Matters

For US individuals living in Canada, particularly professionals who have incorporated their businesses, the recently enacted US tax reform legislation is likely to give rise to additional complexity and tax costs for the foreseeable future. Gone are the days when the requirement for such individuals to file a US tax return was simply an administrative exercise without cash flow consequences: the transition tax and the tax on global intangible low-taxed income (GILTI) are here.

In Canada, professionals have often incorporated their businesses, a strategy that has allowed them to defer tax on their earnings and reinvest funds into their corporations. If such corporations are controlled by US persons, their classification as controlled foreign corporations (CFCs) for US tax purposes may now cause their income to be subject to two new US taxes.

First, for the 2017 tax year, US persons owning more than 10 percent of a CFC will be subject to the transition tax (IRC section 965). The transition tax is a one-time tax designed to move taxpayers into the new regime by including previously untaxed amounts, which are essentially post-1986 earnings and profits (E & P) held within the corporation and not yet distributed to the shareholders, in income. (For additional detail, see "Unfavourable Guidance on Section 965 Tax," Canadian Tax Highlights, May 2018.)

Second, for 2018 and future tax years, individual shareholders of such corporations may be subject to tax on GILTI. Despite the mention of "intangible" in its name, GILTI encompasses income from virtually any kind of business, including medical practices and engineering firms. Corporations with annual earnings that exceed 10 percent of the cost (as determined for US tax purposes) of tangible assets held in the corporation will be subject to the GILTI computation.

The GILTI computation is intended to ensure that a US corporate shareholder is not subject to any incremental US tax on undistributed earnings of a CFC as long as the CFC has paid tax on such earnings at a rate of at least 13.125 percent in the foreign jurisdiction. However, such relief may not be available to individual shareholders, since they do not have access to the deduction available to corporate shareholders. The result is that individuals may not be able to defer US tax on undistributed income, and they may pay US tax even if the corporation operates in a higher-tax jurisdiction. The tax on GILTI will likely penalize corporations with few tangible assets and those whose tangible assets have a low cost for US tax purposes, such as medical professional corporations.

One option might be for a US individual to make an election under IRC section 962 to allow an individual shareholder who is subject to subpart F income to be taxed at the same rate as a domestic corporation. This approach might allow the individual shareholder to calculate his or her GILTI as if he or she were a corporate shareholder. However, such an election is highly complex and will require additional detailed analysis specific to the taxpayer's situation. In addition, uncertainties abound: until the US government provides further guidance, one can only speculate about how to mitigate the negative impact of the transition tax and the tax on GILTI for US individuals who live abroad.

Lynn Wu and Mark Clements
Deloitte LLP, Ottawa

Canadian Tax Focus
Volume 8, Number 3, August 2018
©2018, Canadian Tax Foundation