INCORPORATION: THE AMERICAN TAXMAN GETS INVOLVED
However, the incorporation of a professional offers a number of tax advantages. These include the taxation of active income at a rate of 19% on the first $500,000, the possibility of income splitting with family members using a family trust, the payment of certain eligible expenses by the corporation, tax deferral on income in excess of that required to meet living costs, etc.
However, when a physician is an American citizen residing in Canada, this compromises the incorporation of his or her professional practice. The problem lies on the other side of the border…
Canada taxes the worldwide incomes of its residents, not those of its citizens. For its part, the US tax authorities tax its citizens on all their worldwide income, regardless of where they live.
As a result, U.S. citizens living in Canada must, in addition to filing their Canadian federal and provincial income tax returns, file a U.S. income tax return (Form 1040) each year.
Incorporated or not, U.S. citizens must file a tax return and several other information forms with the U.S. tax authorities every year. In general, under the terms of the tax treaty between Canada and the U.S., U.S. citizens living in Canada will not have to pay U.S. tax, but they should not forget to file the required documents!
In addition, mainly because of the complexity of filing information forms with the U.S. tax authorities, U.S. citizens living here should avoid, among other things, investing in Tax-Free Savings Accounts (TFSAs), mutual fund units (mutual funds) or Canadian exchange-traded funds (Canadian ETFs). Moreover, U.S. citizens living in Canada should not forget that their estate will be subject to U.S. inheritance tax, even if they own nothing on U.S. soil at the time of their death!
AND INCORPORATES…
The situation becomes more complicated when an American citizen living in Canada wishes to incorporate and directly or indirectly holds 10% or more of the shares of a private company. In such a case, U.S. Form 5471 must also be completed, either once or… every year, as the case may be!
What’s more, the US tax authorities take an even harder line with shareholders who hold shares in a so-calledControlled Foreign Corporation (CFC).
Let’s return to the case of a Canadian doctor who is an American citizen. Since he is often the sole shareholder of his Dr.Inc. company, he holds more than 50% of the voting rights or value of a Canadian company. As a result, he will be affected by these U.S. tax measures concerning CFCs. In such a case, he will have to file Form 5471 every year in even greater detail, considering the Subpart F income. The application of these complex rules will mean that he will be personally taxed in the U.S. on the Canadian income earned by his Dr. C. company. Inc.
These measures specifically target interest and dividend income, known as passive income. In addition, income from his medical profession qualifying as personal service income should also be disclosed to the U.S. tax authorities. In other words, the tax deferral benefit on income generated in the corporation that a Canadian physician enjoys by incorporating his or her professional practice is lost from a U.S. perspective.
The Canadian corporation, which allows tax deferral in Canada, does not offer this advantage in the U.S. to a physician living in Canada simply because he or she is a U.S. citizen and sole shareholder of a corporation.
SOLUTIONS
Renouncing one’s U.S. citizenship is certainly an option for doctors wishing to incorporate, but this solution must be thoroughly analyzed, as it is not without tax and financial consequences.
A detailed analysis of the physician’s situation, including U.S. and Canadian tax requirements, not to mention the cost of producing all the required documents, forms and declarations, would make it possible to quantify the financial benefits of incorporation and find a solution tailored to the objectives and reality of the U.S. citizen physician.
It’s strange to realize just how much of an impact citizenship can have on taxation!
This article was originally published in: Finance and Investment | Incorporation: the U.S. tax authorities get involved
Incorporation: the US taxman gets involved
| October 15, 2013
Incorporation: the US taxman gets involved
| October 15, 2013
