New 3.8% Obamacare Tax on investment income - Canadian tax

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Phil Hogan, CA
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New 3.8% Obamacare Tax on investment income - Canadian tax

Post by Phil Hogan, CA » Fri Sep 27, 2013 5:50 pm

Has anyone considered the implication on the Canadian returns with respect to foreign tax credits available on the 3.8%?

Let assume taxpayer A earns 100% of their investment income from US sources. Will they be able to claim a foreign tax credit for the 3.8%. It's really an interesting questions.

Regularly interest will be 0 rated and dividends will be limited to 15%, does that mean the full 3.8% will be limited on dividends and interest?

What about capital gains that are resourced for US purposes?

Is a Canadian FTC is available on US source income how would you allocate between Canadian and US source income above the threshold?

Has anyone given this some serious thought?

Phil
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nelsona
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Post by nelsona » Sat Sep 28, 2013 1:55 pm

Phil,
You mentionned the solution yourself: re-sourcing. This applies to interest dividends and cap gains.

Since you are talking Cdn tax, then the person is a Cdn resident, meaning all cap gains are Cdn-sourced (except for resource and real property), so normal FTC applies.

Tax on interest and dividends earned in US are US-sourced, and to the extent that canada will not credit US tax, (0 for interest 15% for dividends), one re-sources this income to get the tax back from IRS.
Not really much of a change to a Cdn tax return of someone who already has (as in your example) many US investements.

The real change is to US tax returns of Cdn residents, who in the past paid no tax without the bother of re-sourcing. Now, they *may* have to work a little harder to get credit in US.
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Phil Hogan, CA
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Post by Phil Hogan, CA » Sat Sep 28, 2013 6:07 pm

Hi Nelsona

I should have been more clear. I'm really talking about Canadian residents with US citizenship that need to file both US and Canadian tax returns.

Phil
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Post by nelsona » Sun Sep 29, 2013 11:49 am

So am I. Did I not say " then the person is a Cdn resident".

US citizens living in Canada with ANY investments already have to use FTC and re-source FTC to reduce there US tax to Nil. All that is changing is the US taxrate on those investments.

No real mechanical change.

Re-read my previous answer.
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Phil Hogan, CA
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Post by Phil Hogan, CA » Sun Sep 29, 2013 1:02 pm

ok then. So lets use an example:

US citizen living in Canada reports a $100,000 capital gain and pays (for argument sake) 15% plus 3.8% tax.

Before the 3.8% came in the taxpayer would pay $0 taxes because the gain was resourced.

Are you saying that they now will still pay $0 US taxes because the full amount is resourced (15% + 3.8%)? Even though the 3.8% falls well below the FTC line on the 1040.

Getting US taxes down to nil would make sense if the 3.8% was included above line 47 on the 1040, but it's reportable on line 60 where it won't be offset by resourced tax credits.

Thanks again for the insight.
Phil Hogan, CA, CPA (Colorado)
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nelsona
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Post by nelsona » Sun Sep 29, 2013 5:10 pm

First on re-sourcing (for other readers):

Remember, the gain is re-sourced, but only to the extent that the US tax was denied as a credit on one's Cdn return, thus also limited by how much the Cdn tax on that income was.


For cap gains and interest, that would be the entire gain only if the Cdn tax was higher than 15% (or 18.8% i your example). If the Cdn tax was lees than 15%, or now say less than 18.8%, then the re-sourcing would not be the entire cap gain or interest, only enough to cover the denied credit.

For dividends, only if the Cdn tax was greater than 15%, would a portion of the US dividends be resourced, to get back the extra amount. So, in your example, only sufficient US dividends would be re-sourced to get the 3.8% back (ie. the portion that was denied.)

Typically the US taxrate, after taking into account 2555 and other crdits and deducttions, is rarely 15% in any event, so there is no need to re-source.

That is why it is called "re-sourced by treaty". It is there for taxpayers on other counties who are not allowed to use US tax that arises solely due the fact that they are US citizens.

Now, to your other concern that it is reported on line 60, and one cannot have a negaite result from FTC. That is true (not your original question, but true). It is in effect a surcharge that gets around FTC.

Technically it won't matter where the source of the unearned incom will be (is that correct?). So, I'm not sure why you were concerned about US-sourced or Cdn sourced income.

We'll need to see how it ois calculated.
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Post by nelsona » Mon Sep 30, 2013 9:26 am

Remember too, that any US tax that is prevented by the treaty from being claimed as a credit is automatically a line 256 deduction, regardless of how it is eventually handled on 1040.
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Post by MGeorge » Mon Sep 30, 2013 2:30 pm

From what I have been reading, there is no way a Canadian resident US citizen can use an 1116 FTC to offset the 3.8% investment tax. I even looked at the draft forms for tax year 2013 and it confirms this.

The only possibility might be to include some of the 3.8% as a foreign tax credit on the Canadian return for US source dividends. Most folks with US dividends will pay 0-15% on the US return, so as long as the total is below 15%, it is recoverable on the Canadian return. Personally, I don't like the idea of the CRA missing out on tax revenue because of this Medicare contribution (tax).

Although the 3.8% tax on investment income isn't specifically mentioned in the tax treaty and the totalization agreements - it certainly is a contribution to Medicare. Since it should be covered in the treaty, I would just enter $0 on the appropriate line of 1040 (line 65 I think) and include an 8833 to explain. They can't update the treaty every year...certainly the "spirit of the treaty" covers it.

I plan it ignore line 65 of 1040, and form 8960. Probably won't be able to efile if I do this. Maybe consider filing "head of household" since the limits are higher.

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Post by nelsona » Mon Sep 30, 2013 9:50 pm

Exactly. That is what I said. However given the high thressholds for this tax kicking in, the effective tax rate is bound to be more than 15%.

Has anybody actually looked at the regs?
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Post by MGeorge » Tue Oct 01, 2013 8:36 am

I haven't looked at the regs - they are too long. Forbes has been putting out info on the regulations and they have an analysis.

I would be very interested in the instructions for form 8960. There are lines 7, 9a-d, 10 which have names like "other modifications to investment income, expenses, state income taxes etc" each saying "see instructions". Maybe foreign taxes paid will be one of the allowed ajustments. We'll have to wait for the instructions. Logically it would make sense that foreign taxes paid in excess of line 47 FTC should be allowed.

It really scares me that they come out and say that income excluded using form 2555 must be added back on to the adjusted gross income for the purposes of applying the 3.8% investment income tax. Basically, they're saying "we don't care if you don't live here".

I'll stop writing - as nelsona pointed out no one has claimed to have read the regulations....

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Post by nelsona » Tue Oct 01, 2013 2:26 pm

I doubt if a few millionaires out there will get too worked up about a 3.5% tax, on a portion of there investemnts. Otherwise they would have left canada years go.
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Post by MGeorge » Mon Oct 07, 2013 10:51 am

I just got the preview version of "TaxAct". I can see how someone can get hit with the 3.8% investment tax - and I don't see a way out via foreign tax credits.
We'll have to wait and see. The only option I can see to avoid paying it:
1. File as head of household if spouse is NRA and you have a kid.
2. File on paper (you won't be able to efile if you override line 60) and claim a treaty benefit to reduce line 60 to zero.

Are there any tax accountants out there with an opinion on this? It might just be that the treaty should cover it, but doesn't officially yet because this NII medicare tax is so new.

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Post by MGeorge » Wed Oct 16, 2013 8:29 am

More updates on the 3.8% tax on investment income.

According to the preview version of TaxACT 2013, the line 60 medicare tax on investment income doesn't seem to be affected by PFIC mark-to-market income from form 8621, and distributions from an RRSP. As an experiment, I entered $10,000 in taxable 8891 income from an RRSP and it didn't feed through to the medicare tax form. Note that for the purposes of this experiment, I used "Married filing Separately" and entered an employment income that exceeds the threshold for the medicare tax (>$125,000).

As a test I entered a $10,000 mark-to-market PFIC gain and this did not feed through to form 8960 - the medicare tax on investment income form.

I wonder if this is for real - or maybe just because it is only the preview version.

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Post by nelsona » Wed Oct 16, 2013 10:35 am

I would not rely on draft tax software to accurately calculate something that is still in drafyt form.

You have draft software of a draft form.

Pretty shaky.
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tdiddy
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Post by tdiddy » Fri Jul 04, 2014 2:17 pm

Has there been any updates on how this is all working out?

My wife will be over the income for the tax to apply. Are RRSPs subject to this tax? How about when they are withdrawn upon retirement?

Can someone confirm that a dual citizen living in Canada cannot claim FTC for this tax? I'm assuming her investments will not be from the USA

Thanks!

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