Source: http://cadesky.tax/category/us-tax-tips/
Timestamp: 2019-05-21 16:46:33
Document Index: 768901455

Matched Legal Cases: ['§965', '§965', '§965', '§965', '§965', '§965', '§965', '§965']

US Tax Tips Archives - Cadesky Tax
Topic: US Tax Tips
One distinct aspect of the U.S. tax system is the ability for a taxpayer to extend the due date of a tax return. This allows the taxpayer additional time to complete and file an income tax return without being assessed a late filing penalty. Late filing penalties are assessed at the rate of 5% per month up to a maximum of 25%.
In most cases a tax return due date can be automatically extended by up to six months. All that is required is the filing of the proper extension form. No explanation from the taxpayer is required and the IRS cannot deny a properly filed extension. However, the timely filing of the form is crucial in order for the extension to be valid.
It’s important to realize that extending the filing due date of a tax return does not extend the tax payment due date. Taxpayers who do not pay at least 90% of the ultimate taxes due by the original due date will be assessed a late payment penalty. The penalty is imposed at a rate of 1/2% per month until paid. Interest will accrue, on both the taxes due and any penalties, from the original payment due date until payment is made. The rate of interest is equal to the short-term applicable federal rate (AFR) plus 3%.
If the due date falls on a weekend or a statutory holiday, the due date is extended until the next business day.
An individual taxpayer can obtain an automatic six-month extension of time to file by filing Form 4868, “Application for Automatic Extension of Time to File U.S. Individual Income Tax Return,” on or before the original due date of the return. No signature is required and the form can be filed electronically or mailed to the appropriate IRS office. A proper estimate of the tax due for the year must be made, but full payment is not required.
A U.S. citizen or resident who is “out of the country” on the regular due date of a return is allowed an automatic two month extension to file without filing Form 4868. However, if additional time is required beyond this extended due date, the taxpayer can file Form 4868 and will be allowed an additional four months to file the return.
U.S. citizens or residents who do not reside in the U.S. may also request an additional 2 month extension. This extension, however, is not automatic and can be denied by the IRS.
A corporation generally may obtain an automatic six-month extension of time for filing its income tax return by filing Form 7004, “Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns,” provided that the application is timely filed, properly signed, and a remittance is made of the amount of the tax properly estimated to be due. A seven-month extension is available for returns of C corporations with tax years ending June 30.
Partnerships, S Corporations, and Trusts
An automatic extension of time for a partnership, S corporation or trust to file an income tax return can be obtained by filing Form 7004, “Application for Automatic Extension of Time To File Certain Business Income Tax, Information and Other Returns.” The length of the automatic extension depends upon the type of return. For partnerships and S corporations, an automatic six month extension is available. For certain estate and trust returns, an automatic 5½ month extension is available.
A summary of U.S. tax return regular due dates and extended due dates is below.
Type of Filer Form RegularDue Date ExtendedDue Date
U.S. citizens and residents Form 4868 April 15 October 15
U.S. non-resident aliens with U.S. employment income Form 4868 April 15 October 15
U.S. non-resident aliens without U.S. employment income Form 4868 June 15 December 15
U.S. citizens and residents who reside outside of the United States receive an automatic two-month extension of time to file to June 15. No filing is required for this automatic extension.
Type of Filer Form Regular Due Date Extended Due Date
C Corporations Form 7004 15th day of the 4th month after the end of the tax year 15th day of the 10th month after the end of the tax year
Partnerships Form 7004 15th day of the 3rd month after the end of the tax year 15th day of the 6th month after the end of the tax year
Limited Liability Corporations Form 7004 15th day of the 3rd month after the end of the tax year 15th day of the 6th month after the end of the tax year
S Corporations Form 7004 15th day of the 3rd month after the end of the tax year 15th day of the 6th month after the end of the tax year
U.S. Resident Trust Form 7004 15th day of the 4th month after the end of the tax year First day of the 10th month after the end of the tax year
U.S. Nonresident Trust Form 4868 15th day of the 6th month after the end of the tax year 15th day of the 12th month after the end of the tax year
Foreign Trust with a U.S. Owner Form 7004 15th day of the 3rd month after the end of the tax year 15th day of the 6th month after the end of the tax year
Those U.S. states that impose an income tax also have a provision to extend a tax return’s due date. However, keep in mind that the regular due date and extended due date for a state tax return may be different than the federal dates. Also, each state has a different filing requirement for an extension — some states will recognize a federal extension form while other states have their own forms. It is important to review an individual state’s extension filing requirement.
For most individuals, their principal residence is their single most important asset. In Canada, when an individual sells their principal residence the gain on the sale is exempt from capital gains tax in most instances. A taxpayer must designate the property as their principal residence when they file their Canadian personal income tax return. This is one of the biggest gifts to individuals in the Income Tax Act.
Canadian residents who are also U.S. persons will also be subject to the U.S. rules surrounding the sale of a principal residence. These rules are quite different and for many taxpayers, given the increase in value of Canadian real estate, may give rise to an unpleasant surprise. For U.S. purposes, only the first $250,000 USD of gain on the sale of a principal residence is exempt from capital gains tax. For a married couple this exemption is $500,000 USD, but only if both taxpayers are U.S. persons. Amounts above the exemption will be subject to capital gains tax.
To calculate the gain for U.S. purposes, the proceeds from the sale are translated into U.S. dollars using the spot rate on the date of sale and the cost base is translated into U.S. dollars using the spot rate on the date of purchase. Using this method, any increase or decrease in the value of the U.S. dollar versus the Canadian dollar is also included with the sale.
In addition to the capital gains tax, U.S. persons who hold a Canadian mortgage on their principal residence may also be subject to tax when that mortgage is discharged. This tax comes into play when the value of the Canadian dollar has decreased against the U.S. dollar since the mortgage was obtained. This tax is best explained with an example:
Let’s take the example of Sam, who is a U.S. citizen resident in Canada. Sam purchased his principal residence in Canada and obtained a mortgage of $100,000 CAD when the Canadian dollar and U.S. dollar were at par (1 CAD = 1 USD). Therefore his mortgage was worth $100,000 CAD and $100,000 USD. He subsequently sold the property. At the time of disposition (and assuming he did not pay off any of the mortgage principal) the value of the Canadian dollar had decreased to 75 cents U.S. (1 CAD = .75 USD). At the time of discharge, his $100,000 CAD mortgage is now worth $75,000 USD. Because it takes fewer U.S. dollars to pay back his original obligation, the U.S. views this $25,000 foreign exchange difference as a taxable gain to Sam for U.S. income tax purposes.
This, of course, is a simplified example to illustrate the concept of a Foreign Mortgage Gain. The example does not take into account the principal on the mortgage that has been repaid by Sam, which is considered in an actual Foreign Mortgage Gain calculation.
The Foreign Mortgage Gain on a principal residence is considered foreign-source ordinary income and can be offset with foreign tax credits. The gain is allocated to the general foreign income basket, so if a taxpayer has sufficient accumulated excess foreign tax credits in this basket to offset the Foreign Mortgage Gain then no tax may be payable. A Foreign Mortgage Loss on a principal residence is considered a personal loss and is disallowed.
While technically a Foreign Mortgage Gain or Loss should be calculated on each mortgage payment made, the Internal Revenue Code states that a personal foreign exchange gain of $200 or less does not have to be reported. Therefore, in practice the Foreign Mortgage Gain calculations are not typically performed.
With the substantial rise in real estate values in most Canadian cities, we have seen many U.S. persons pay U.S. tax on the sale of their principal residence when they had assumed the sale would be tax-free. It’s important that U.S. persons become familiar with these rules and plan for any potential U.S. tax on the sale of their home.
The U.S. Repatriation Tax – IRC §965: Proposed Regulations Issued
On August 3, 2018 the IRS issued “final” proposed regulations implementing new section 965 of the Internal Revenue Code. IRC §965 is the “Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation”, aka the “repatriation tax”.
The document came in at 248 pages and attempts to clarify many of the questions proposed by the legislation itself. The IRS believes that IRC §965 will impact 100,000 taxpayers and that each taxpayer will spend approximately 5 hours complying with the law. Based on our Firm’s experience the 5 hours is vastly understated! That could, however, be the fact that very few, if any, U.S. citizens resident in Canada, who are “United States shareholders” in controlled foreign corporations, actually tracked earnings and profits (E&P) as required by U.S. tax law.
There is one clarification that will have a negative impact on these taxpayers.
First a little background. IRC §965 imposes either a 15.5% or 8% tax depending on whether the underlying E&P (tax retained earnings) is reflected on the balance sheet as cash (or near cash) or other assets.
For example, let’s assume that E&P, as of December 31, 2017, was $1,000 and that the cash balance on the balance sheet was $800. $800 of the $1,000 would be taxed at an effective rate of 15.5% and the remaining $200 would be taxed at an effective rate of 8%.
The U.S. corporate tax rate, however, prior to January 1, 2018 was 35%. In order to get an effective rate of 15.5% or 8% the legislation introduced a deduction from gross income known as the “participation exemption”. The deductions were computed as follows:
Cash (and near cash) (.35-.155)/.35 = .5571
Other E&P (.35-.08) /.35 = .7724
For the $800 of cash (near cash) E&P we would include $800 in gross income and then take a “participation exemption” of $446 ($800 x .5571) leaving taxable income of $354. $354 x 35% = $124. This is equal to the targeted rate of 15.5% of $800 = $124. A similar computation is done for the remaining E&P of $200. Include $200 in gross income and then take a “participation exemption” of $154 ($200 x .7724) leaving $46 of taxable income. $46 x 35% = $16. This is equal to the targeted rate of 8% of $200 = $16.
Since the legislation was introduced one potential form of planning was to pay a large enough dividend in 2018 (assuming the IRC §965 tax was reported on the 2017 U.S. tax return) to create enough Canadian tax that can be used as a foreign tax credit in the US to offset the 2018 U.S. tax, and then carry the excess foreign tax credit back to 2017 and file an amended 2017 U.S. tax return.
When the amount of IRC §965 “income” is included on the 2017 return it goes into a pool called “previously taxed income” or PTI. Any subsequent actual distributions (dividends) from the company would be tax free from further U.S. tax to the extent that there is a balance in the PTI pool (since the taxpayer has already paid U.S. tax on this income). If a dividend was paid in 2018 it would be tax free from U.S. tax (since it would first come out of the PTI pool) but be subject to Canadian tax. This would create an excess foreign tax credit position in 2018 since there is no corresponding U.S. income to claim the foreign tax credit against. At the time the tax community believed that the Canadian taxes could be claimed $1 for $1 as a foreign tax credit. The IRS had not issued any guidance on this issue.
The issued proposed regulations, however, state that is not the case. For foreign tax credit purposes, if previously taxed income will be claimed as a FTC against the IRC §965 tax, then the foreign taxes must be reduced by the amount of the “participation exemption.”
For example let’s assume that we only had $800 of cash E&P. As we see above the U.S. tax (pre-FTC) would be $124. If the taxpayer is at the highest 2018 Ontario marginal tax rate, to create Canadian tax of $124 (we are obviously not considered the foreign exchange issues) the company would need to pay a “non-eligible” dividend of $265. ($265 x 46.84% = $124) or an eligible dividend of $315 ($315 x 39.34% = $124).
Now, however, the amount of actual Canadian tax needs to be “grossed-up” to factor in the participation exemption. For cash E&P the gross up factor is .4429 (1-.5571) so the Canadian non-eligible dividend would need to be $265/.4429 = $598.
$598 x 46.84% = $280 of Canadian tax. Multiply this by .4429 = $124 of taxes eligible for FTC treatment against the IRC §965 tax. The required dividend is more than 2 times what was previously thought.
Many writers have expressed the opinion that this amounts to potential double taxation and is in violation of the Canada-United States Tax Convention (1980). The CBC also reported (on August 14th) that Finance Minister Bill Morneau revealed that “The Canadian government is talking to the U.S. government about the impact a retroactive tax signed into law by U.S. President Donald Trump is having north of the border.” It is clear, however, that a larger Canadian dividend would also enrich Canadian coffers first!
Whether these talks are successful or not, many U.S. citizens, who are resident in Canada, will now require a potentially larger Canadian tax bill to settle their U.S. taxes to avoid double taxation. This is potentially forcing taxpayers to take out larger amounts of dividends (and sooner) that what they may have originally planned (so much for saving for retirement)! Taking a larger dividend could also move them into a higher Canadian tax bracket.
Cadesky U.S. Tax Ltd stays on top of the latest U.S. developments. If you have any questions please do not hesitate to reach out to your Cadesky U.S. Tax contact.