Background

As you are well aware, the U.S. tax system imposes a tax on the transfer of wealth at death.  This tax is referred to as the “estate tax”.  To deter “deathbed” transfers, the United States also has a gift tax system.  Gift and estate taxes are imposed at the same rates.  Gift and estate taxes are imposed on the entire fair market value of the asset transferred (unlike a capital gains tax).  The effect of this system is to tax over and over again the very same wealth as it moves from one generation to the next.  Attempts to avoid this recurring taxation (for example by leaving assets directly to a grandchild) are deterred by a generation-skipping transfer tax which is imposed in addition to the gift or estate tax that applies to the gift or bequest.

What We Are Doing Now

In 2012 we are undertaking the following estate planning for our clients who are U.S. citizens or residents.

• For taxpayers who die in this year it will be possible to shelter $5,120,000 from estate taxation ($10,240,000 in the case of married couples) (the “Estate Tax Exemption”).

• For individuals that survive beyond 2012 they can take advantage of their Estate Tax Exemption, gifts of up to $5,120,000 can be made without payment of any gift tax ($10,240,000 for married taxpayers) (the “Gift Tax Exemption”).

• Although use of the Gift Tax Exemption also exhausts the Estate Tax Exemption,

• Income produced by the transferred property is exempt from estate taxation at the transferor’s death, and

• Appreciation in the transferred asset after the gift also escapes estate taxation.

• For those who use their Gift Tax Exemption to make direct or indirect gifts to grandchildren, up to $5,120,000 of those gifts (the amount of the “Generation-Skipping Transfer Tax Exemption”) can be permanently removed from the U.S. estate tax system so as to benefit successive generations of family members without ever becoming subject to U.S. gift or estate taxation again.

• For those who are married and would prefer to not give their assets before death to their children or grandchildren in order to take advantage of the current Gift and Generation-Skipping Transfer Tax Exemptions, those Exemptions can be used by transferring assets to a trust for the benefit of the transferor’s spouse.

• The transferor’s spouse may transfer another $5,120,000 in assets to a trust for the benefit of the transferor, thereby taking advantage of the spouse’s Gift and Generation-Skipping Transfer Tax Exemptions.

• For those who prefer not to make gifts to anyone, assets may be transferred through various arrangements which allow the transferor to retain much of the cash flow from the transferred property, thereby shifting future appreciation in the asset out of the U.S. estate tax system.

• Even without making gifts to children or grandchildren, careful design of a husband and wife’s estate planning documents will allow all of the couple’s assets to receive a complete basis “step up” to fair market value when the first spouse dies so as to minimize or eliminate capital gains taxes after the first spouse’s death.

• This basis increase may be repeated at the death of the surviving spouse to further minimize or eliminate capital gains taxes incurred after the survivor’s death.

• Proper structuring will also allow income tax liabilities to be shifted so that assets that are exempt from U.S. estate taxation as a result of the prior planning will also be exempt from U.S. income taxation thereby allowing the assets to grow and compound income-tax free.

• Through the use of asset protection trusts inherited assets can be protected from litigation and spousal property claims which could be asserted against the beneficiaries’ personal assets (including claims of ex-spouses).

• Generation-skipping trusts can permanently remove assets sheltered by the transferor’s Generation-Skipping Transfer Tax Exemption ($5,120,000 for gifts and bequests made in 2012) from the U.S. estate tax system.

• Interests in family businesses can be the subject of the gifts discussed above and transferred with conservative discount of between 25% to 30% for lack of marketability and lack of control.

2013

All of the preceding opportunities are possible today, but are potentially at risk.  If Congress does nothing the following things will happen on January 1, 2013.

• The $5,120,000 Gift Tax and Estate Tax Exemptions will revert to $1,000,000 for gifts made and decedents dying after December 31, 2012.

• The Generation-Skipping Transfer Tax Exemption will revert to approximately $1,400,000.

• The maximum gift and estate tax rates will increase from 35% to 55%.

Proposed Legislation

It is uncertain what action (if any) Congress will take before the end of this year.  Given that it is an election year, Congress may do nothing to change the tax laws of the Unites States.  However, as a possible outcome, the budget released by the Obama administration on February 13, 2012 has the following revenue raisers.

• Maximum gift and estate tax rates will be set at 45%.

• The Estate Tax Exemption will be set at $3.5 million.

• The Generation-Skipping Transfer Tax Exemption will be set at $3.5 million.

• The Gift Tax Exemption will be limited to $1 million.

• Generation-skipping trusts will be limited to ninety years.

• Opportunities for entity discounts will be significantly curtailed.

• Opportunities to transfer assets while retaining income will be significantly curtailed.

Conclusion

To date no legislation has been introduced which will implement the revenue raisers proposed by the Obama administration.  Traditionally, completed gifts (including generation-skipping transfers) have been grandfathered.  The time to act is now, not November or December.

A Case Study

Jack and Jill are U.S. citizens who have accumulated a significant net worth but not so significant that they are necessarily comfortable making large gifts to their children and grandchildren before their deaths.  However, they are concerned that changes in the U.S. estate tax laws in 2013 will cause a significant estate tax burden for their children and grandchildren and would like to take advantage of the exemptions currently available to them without losing the financial benefit of their assets.  Each of them decides to set up a trust for the benefit of the other.  The two trusts are not set up at exactly the same time and have many differences, but for as long as Jack or Jill is alive all of the assets held by both trusts will be available to meet their living and medical expenses until (if necessary) the assets are completely exhausted.  Further, Jack and Jill remain in control of their assets by acting as their own Trustees.

Jack’s trust provides that for as long as Jill is alive, Jill will be assured of receiving whatever amounts are necessary to maintain her lifestyle or pay any medical bills (including nursing home costs) that may arise.  The trust will provide that the trustee can buy Jill a vacation home in San Diego or anywhere else Jill might like to spend the winters.  If Jack survives Jill, the assets of the trust will be held for Jack’s benefit after Jill’s death with similar provisions. When both of them are no longer alive, the trust will divide into separate shares for their children.  Each adult child will become his or her own trustee to manage the child’s trust and will be entitled to receive whatever the child and her children need for living expenses, medical expenses, or educational expenses.  In fact, the trust will go one like this, one generation after the next, protecting the assets from litigation claims, spousal property claims, and U.S. gift and estate taxation for as long as any assets remain in the trust.  Jill’s trust contains substantially the same (but not identical) directions for Jack and their children and grandchildren.  Thus, even though Jack and Jill have made an irrevocable transfer of their assets thereby taking advantage of the $5,120,000 Gift and Generation-Skipping Transfer Tax Exemptions that current law provides, neither of them has lost the benefit of the assets which they own because their trusts benefit each other.

Each trust is an irrevocable trust.  Once assets are transferred to the trust they may only be distributed to the persons who are identified as the beneficiaries.  However, Jack and Jill see this as an advantage because they know that whenever there have been changes to the gift and estate tax laws, those changes have usually grandfathered irrevocable trusts.  Jack and Jill recognize that it is possible future changes could require that the assets that they have placed in their trusts will be “counted” in computing the estate tax at their death.  However, the assets will be counted at the value when transferred to the trust instead of the value those assets have at Jack or Jill’s death.

As Jack observed, “What we’ve done does not have to be foolproof.  As long as Jill and I can continue to enjoy what we’ve worked and saved for and know that we have done what we can to protect it for our children, then we have done what we feel comfortable doing.”

Comment: This is an example of what one client did.  Your situation and choices may be different and as such please contact a competent professional before implementing any estate tax planning strategies.

For more information on the above strategies and how they fit within your specific situation please contact us here.

Effective for your 2011 US tax returns the IRS has released a new filing requirement, Form 8938.  The form will be required by certain taxpayers with specific types and amounts of foreign financial assets or foreign accounts.  The information reported is similar to TD F 90-22.1 or (FBAR forms) but does require some more specific information; furthermore, the filing of form 8938 will not relieve you of the requirement to file the FBAR form.

Form 8938 is required to be attached to your annual return and is due on the date that the annual return is due, including extensions.  The form is applicable for anyone who files the following forms:

• Form 1040
• Form 1120
• Form 1065
• Form 1041
• Form 1120-S
• Form 1040NR
  .

There are a number of different criteria to determine if you are required to file this form depending on whether or not you are living in the US or abroad.  Here is a quick breakdown of the requirements for each:

Married filing separately or single individuals living in the US:

• You are required to do the filing of 8938 if the total value of your specified foreign financial assets is more than $50,000 on the last day of the year or more than $75,000 at any time during the year.
  .

Married filing joint and living in the US:

• You are required to do the filing of 8938 if the total value of your specified foreign financial assets is more than $100,000 on the last day of the year or more than $150,000 at any time during the year.
  .

Married filing separately or single individuals living abroad:

• You are required to do the filing of 8938 if the total value of your specified foreign financial assets is more than $200,000 on the last day of the year or more than $300,000 at any time during the year.
  .

Married filing joint and living abroad:

• You are required to do the filing of 8938 if the total value of your specified foreign financial assets is more than $400,000 on the last day of the year or more than $600,000 at any time during the year.
  .

Failing to file Form 8938 when required could result in a $10,000 penalty, with an additional penalty up to $50,000 for continued failure to file after IRS notification.  A 40 percent penalty on any understatement of tax attributable to non-disclosed assets can also be imposed. Special statute of limitation rules apply to Form 8938, which are also explained in the instructions.

A copy of the form can be found at http://www.irs.gov/pub/irs-pdf/f8938.pdf and a copy of the detailed instructions can be found at http://www.irs.gov/pub/irs-pdf/i8938.pdf

If you would like further guidance as to how these new reporting requirements apply to your specific situation please contact us to arrange an appointment by calling our reception at 250-381-2400.

On January 9, 2012 the Internal Revenue Service (“IRS”) reopened the offshore voluntary disclosure program (“OVDP”).  More details are expected to be released over the coming month but the program is similar to the 2011 OVDI program which ended September 9, 2011.  The penalty’s associated in the new program have increased and the penalty framework requires individuals to now pay 27.5%, up from 25%, of the highest aggregate balance in their foreign bank accounts over the eight year required filing period.  Some taxpayers may be eligible for a reduced penalty rate of 5% or 12.5% depending on their specific situation.  For example people whose offshore accounts did not surpass $75,000 in any calendar year covered by the new OVDP will qualify for the reduced 12.5% rate.  As full details have not yet been released, based on the prior program, the reduced 5% rate was eligible for those individuals who are foreign residents and meet the following three conditions:

1. Resides in a foreign country;
2. Made a good faith showing that they have complied with all the tax reporting and payment requirements in the country of citizenship; and
3. Has 10,000 or less of U.S. source income each year.

To date these programs have brought in over $4.4 billion to the U.S.   Entering the OVDP should not be taken lightly as it does require a complex package to be submitted requiring a lot of information and disclosure; furthermore, the costs can be significant not only for the penalty but also the cost associated with preparing the full submission.

What are your options if you want to get compliant with the U.S. but do not want to enter into the 2012 OVDP?  Following much press on the matter in the latter half of 2011 the IRS made a formal release on December 13, 2011 disclosing some additional information for Dual residents residing outside the U.S.  This statement followed numerous comments and pressure made by Canada’s Minister of Finance stating that Canada would not cooperate in the collection of many of the penalties and the reasonableness of the required filings for honest, taxpaying Canadians.  The IRS’ statement essentially stated that for those individuals who have become aware of their filing requirement and would like to become compliant that they should file the past 6 years of filings including a letter stating the reason why they have not previously filed.  The IRS further stated that penalties will not be imposed in all cases and that the IRS will use reasonableness when assessing things such as the FBAR returns.  Furthermore, a taxpayer who owes no U.S. tax will not owe any failure to file penalty or failure to pay penalty.

If you would like to discuss the specifics of your situation and potential implications and options please contact us to arrange an appointment by calling our reception at 250-381-2400.

Duties will include:

• Preparation of corporate and personal tax returns
• Preparation of financial statements
• Bookkeeping
• Other accounting related tasks as required

Skills and experience required:

• Minimum of 2 years experience in accounting and tax
• CGA, CGA student or Accounting Technician
• Computer and technological proficiency
• Well-versed in Microsoft Word, Excel and Outlook
• Experience with Caseware Working Papers
• Strong interpersonal and communication skills
• Excellent written correspondence
• Organized and detail oriented
• Able to multi-task and produce results under pressure

Benefits:

The successful candidate will have the opportunity to receive the following benefits:

• Group extended health and dental insurance
• Flexible work schedule
• Incentive bonus arrangement

How to apply to this job: Applications may be submitted by email to admin@hutcheson.ca and should include a cover letter and resume.

Duties will include:

• Preparation of corporate and personal tax returns
• Preparation of financial statements
• Assisting partners with tax planning and compliance
• Other tax related tasks as required

Skills and experience required:

• Minimum of 3 years experience in accounting and tax
• Chartered Accountant or CGA designation
• Computer and technological proficiency
• Well-versed in Microsoft Word, Excel and Outlook
• Experience with Caseware Working Papers
• Strong interpersonal and communication skills
• Excellent written correspondence
• Organized and detail oriented
• Able to multi-task and produce results under pressure

Benefits:

The successful candidate will have the opportunity to receive the following benefits:

• Group extended health and dental insurance
• Flexible work schedule
• Incentive bonus arrangement

How to apply to this job: Applications may be submitted by email to admin@hutcheson.ca and should include a cover letter and resume.

Holders of RESP and TFSA

The US has determined that these plans are classified as foreign trusts in the US and as such are required to complete two additional forms, 3520 and 3520A, to fulfill the proper filing requirements in the US.  Both of these forms are quite extensive in terms of the information needed to complete them.  A breakdown of the forms are:

3520 Annual Return to Report Transactions with Foreign Trusts

• Required to be filed

o    if the US person received a distribution from a foreign trust or

o   You are a US person who is treated as the owner of any part of the assets of a foreign trust under the grantor trust rules

• Return is due on the date that your income tax return is due, including extensions
• Penalties if not timely filed or incomplete or incorrect is up to 35% of the value of the property
• Form is a 6 page form see  http://www.irs.gov/pub/irs-pdf/f3520.pdf for a copy of form.
  3520A Annual Information Return of Foreign Trust

• Required to be filed if the foreign trust has a US owner, in order to allow US owner to satisfy their filing requirements
• Return is due by the 15^th day of the 3^rd month after the end of the trusts tax year; assuming Dec 31 YE due Mar 15.
• Penalties if not timely filed or incomplete or incorrect is equal to 5% of the gross  value of the portion of the trust’s assets treated as owned by the US person
• Form is a 4 page form see http://www.irs.gov/pub/irs-pdf/f3520a.pdf for a copy of the form
  
  Holders of Non-US Mutual Funds/Income Trusts and Pooled Funds

Earlier in the year the IRS determined that Canadian mutual funds should be classified as a corporation rather than a trust for US tax purposes.  The classification as a corporation for US tax purposes may result in the investment being classified as a passive foreign investment company (PFIC).  A PFIC is a non-US corporation that meets either an income or asset test.  The income test is met if 75% or more of the foreign corporation’s income is passive in nature (interest, dividends, rents, royalties, etc.).  The asset test is met if 50% or more of the assets held by the non-US corporation are used to produce passive income.  If either of these tests are met then the holding is subject to the PFIC rules for US tax purposes.

For 2010 and earlier the PFIC rules require an individual to file form 8621 which may or may not be required annually.  For 2011on, the Obama administration is in the process of revising form and requirements.  The PFIC rules are very complicated and currently there are three methods that an individual can use to comply with the regulations:

1. Qualified Electing Fund:

Under the first method the investor of a PFIC can elect to be treated as a Qualified Electing Fund (only available if the PFIC provides the investor with the necessary information).  If elected they are subject to tax  on their pro rata share of net capital gain and ordinary earnings, which will be taxed as ordinary income regardless if such amounts are actually distributed.

2. Excess Earnings Distribution:

Under the second method if no QEF election is made they are taxed under the special excess distribution provisions.  Here, a U.S. investor is permitted to defer tax on the PFIC’s undistributed income until the U.S. investor either disposes of the stock or the PFIC makes an excess distribution.   This option is highly punitive.

3. Mark to Market:

Under the third method you can do a Mark to Market election (assuming it is a marketable stock).  If the election is taken then they would recognize a gain or loss on the shares each year based on the fair market value at years end.  A loss would be realized to the lessor of the current year loss and the amount that has been brought into income in the prior years.

There is no specific penalty for not filing but the advantage is that an individual can make an election to avoid the punitive tax on excess distributions on future distributions.  The form is attached to the personal return (1040) and is due when the personal return is due.   For a copy of the form see  http://www.irs.gov/pub/irs-pdf/f8621.pdf .

If you would like to further discuss these changes please contact us.

Jamie looks at both the tax savings advantage of dividends over salary and the tax deferral advantage of leaving funds inside the company vs. paying them out immediately. Click here to read the report.

• the shares are prescribed shares (reg 6204)
• amount payable to acquire the shares under the agreement is not less than the excess of the FMV of the shares at the time agreement was made over any amount paid by the taxpayer to acquire the rights
• immediately after the option is granted the taxpayer is dealing at arms length with the corporation involved (less then 10% holding)

This benefit used to be able to be deferred and not recorded until the shares where actually disposed for CCPC and for public companies shares (up to $100K of benefit in the year for public companies).  However the March 4, 2010 budget has repealed this deferral for public companies thus this deferral is only available for CCPC.   Also remember that if the CCPC shares are not held for 24 months prior to sale that they income deduction is based under rule 110(1)(d) and not 110(1)(d.1) thus meaning that they can only get the deduction if the exercise price is greater or equal to the FMV at the time the option was granted.

Once the shares are acquired the normal capital gain/loss treatment is applicable.  If the shares subsequently turn into a loss and are disposed of prior to 2015 and an election had previously been made on the optioned shares to defer the tax then there is also a special relief provision to limit the tax liability to the ultimate share sale proceeds received.  The elective relief will be adjusted to take into account capital losses arising from the disposition of the shares and their application against capital gains from other sources.

For options exercised after Jan 1, 2011 Section 153 has been changed such that regular employee withholding is required on the exercise of the option to the same extent as if the benefit was paid in cash.  This withholding requirement will not apply to CCPC or if the options included a written condition to the effect that the shares must be retained by the optionee for a period of time after exercise or if they donate the optioned shares to a registered charity.  The withholding can be achieved by having the company sell some shares on the behalf of the employee to meet the tax obligation.

Cashed-out stock options (options that allow employees to opt to be paid in out their gains in cash rather then actual stock) the budget made it no longer possible for the employee to claim a stock option deduction with respect to a cash payment received under a stock option plan unless the employer waives its rights to a deduction for the cash payment; this would need to be done in an election.  Thus only the employee or the employer can claim a deduction if cash is paid instead of actual shares being issued.