David A. Altro featured in the Montreal Gazette Monday, February 20, 2012

Tax Strategy: Marriage affects tax exemption on principal home

David A. Altro is a frequent contributor to Paul Delean’s business column in the Montreal Gazette. Click here to view the article online or scroll down to read David’s answers to the second and third questions.

The Gazette
Monday, February 20, 2012

The impact of marriage on the principal-residence exemption and tax obligations in the U.S. for Canadian citizens were among the topics raised in the latest batch of reader letters. Here’s what they wanted to know.

Q: “If two people who own their own homes get married, how does the principal-residence exemption apply?”

A: A couple can designate only one property as principal residence, so marriage has the effect of eliminating the exemption for one of the two properties. If you keep both and real estate continues appreciating, the increase in market value of one property from the time of the marriage has tax implications. If you sell one property before the marriage, that’s not an issue since each partner is entitled to claim the principal-residence exemption for the years they were on their own.

Q: “I have a daughter who is a Canadian citizen but has permanent residency in the U.S. and is married to a U.S. citizen. She’s currently at home raising a daughter, but when she gets employment will she have to pay U.S. taxes and report her income in Canada as well?”

A: No. Cross-border tax expert David Altro says that if she isn’t a resident of Canada, she won’t pay tax to Canada unless she has certain types of Canadian-sourced income.

Q: “About seven years ago, I inherited a home in San Diego where I spend my winters. Am I affected by changes in the maximum tax rate on U.S. property to 55 per cent from 35 per cent?”

A: The tax you are referring to is U.S. estate tax, which applies to your U.S. property upon death. “Under current U.S. law, if you are Canadian, there will be no tax if the property market value is under $60,000 on death,” Altro said. “If above, there will still be no tax if your worldwide estate is under the exemption of $5 million. But on Jan. 1, 2013, the exemption drops to $1 million and the tax rate on U.S. property increases to a maximum of 55 per cent from 35 per cent.” Altro said it could be advantageous owning the property in a cross-border irrevocable trust to avoid taxes and probate costs.

Q: “I have an adult son with Tourette’s and severe OCD (obsessive-compulsive disorder) for whom it was recommended, by a specialized team, to hire a behaviour therapist to work with him at hospital and at home. He is under public curatorship and receives welfare. Since I paid all expenses, can I claim a deduction on my tax return?”

A: The first step should be asking the Canada Revenue Agency for a ruling. Because of the public curatorship, he may or may not meet the definition of dependant. If he does, costs would be deductible (allowable medical expenses for other dependants). There might also be eligibility for the disability tax credit.

The Gazette welcomes reader questions on tax and investment matters. If you have a query you’d like addressed in this column, send it to Paul Delean, Montreal Gazette Business Section, Suite 200, 1010 Ste. Catherine St. W., Montreal, Que., H3B 5L1, or by email to pdelean@montrealgazette.com

© Copyright (c) The Montreal Gazette

Dollars and Sense Radio Show – February 2012

Montreal, Quebec – February 23, 2012

On the February 23rd episode of Dollars and Sense on CJAD 800 AM, host, Matt Altro and legal expert David A. Altro discuss cross border issues including how the U.S. presidential election will affect Canadians who own property in the U.S. Specifically, the upcoming changes to the U.S. estate tax laws.

David explains capital gains tax rates in the U.S. and the various tax rates for different ownership structures.

Matt and David take a caller question from Seth about fees for Canadians upon purchasing U.S. property and explain the issue of probate using an example from a real-life client.

In Part 3, Dino calls in with a question about various structures to hold title of U.S. property. Lyne is also concerned about putting an inherited property in her name.

Sheldon is very concerned about tax after a meeting with his accountant in Canada. David explains the taxes owed for Canadians who own property in the U.S. including U.S. estate tax exposure, gift tax and more.

Part 1

Part 2

Part 3

Part 4

Part 5

David A. Altro Published in STEP Journal – February 2012

Frozen Over
By David A. Altro and Ben Jeske

Estate freezes have been in Canada since the introduction of federal capital gains taxation 40 years ago. Along with the capital gains tax (CGT) on properties sold by taxpayers, the so-called death tax was also brought in. Essentially, when a taxpayer dies, they are deemed to have sold all their assets at fair market value, and will be assessed for CGT on all accrued gains. The estate freeze, in essence, is an attempt to cap the value of the assets owned by a taxpayer that would be subject to the death tax. Therefore, the estate freeze generally involves the conversion or exchange of assets susceptible to capital appreciation for assets that retain a fixed monetary value.

Capping CGT

In the context of a closely held private corporation, the estate freeze consists of the well-known mechanism of the taxpayer exchanging common shares (susceptible to capital appreciation) for fixed-value preferred shares. Immediately thereafter, the taxpayers’ children, or a trust established for their benefit, subscribes for new common shares. Following the completion of the estate freeze, all the corporation’s assets continue to generate income and/or growth for the family – at the level of the shareholders the shares to which such future growth is attributed are the common shares, which are now no longer part of the taxpayer’s property, but are safely in the hands of the next generation. Thus, unless the shares of the corporation are sold to a third party, accrued gains on these shares will not be subject to CGT until the death of the taxpayer’s children. The taxable capital gain being realised on the taxpayer’s death is now capped at today’s current value of the taxpayer’s shares.

Market value

Any one of a number of provisions in the Income Tax Act placed at taxpayers’ disposal allow such share exchanges to take place on a fully tax-deferred basis, but for such common-to-preferred share exchange to be tax-deferred, the taxpayer must ensure the frozen preferred shares they receive have fair market value equal to the value of the exchanged common shares. The safest and surest way of ensuring the frozen preferred shares have the correct value is to:
- obtain an independent valuation of the corporation
- provide an adjustment clause whereby the value of the frozen preferred shares will be adjusted if the tax authorities disagree with the taxpayer on the value of the common shares prior to the freeze; and
- provide that the frozen preferred shares are redeemable at the option of the shareholder.

Where shareholder effectively has a ‘put’ option on the shares, the shares are referred to as being retractable. Canada Revenue Agency is of the view that preferred shares lacking a retraction feature are not worth their stated value.

Accrued gain

When the freeze is complete, the taxpayer’s exposure to the death tax is capped. Now you can look at ways of reducing or eliminating the death tax by reducing the value of the frozen preferred shares held by the taxpayer. Often a taxpayer who implements such a freeze still wishes to draw income from the corporation through either salary or dividends. If the corporation is a Canadian-controlled private corporation and earns investment income, a portion of the corporation’s tax payable on such investment income is added to the corporation’s refundable dividend tax on hand (RDTOH). When a corporation with RDTOH pays taxable dividends to its shareholders, it receives a tax refund of one dollar for every three dollars of dividends paid. Finally, if the corporation sells any of its capital property and realises a capital gain, one-half of the gain is added to the corporation’s capital dividend account and is available for tax-free distribution to the corporation’s shareholders by way of dividends.

Golden opportunity

A well-known provision of the Income Tax Act stipulates when a corporation redeems shares of its own capital stock from a shareholder, the amount paid to the shareholder (less the stated capital attributable to the redeemed shares) is treated as a dividend for all purposes of the Act. This provision affords taxpayers who have implemented estate freezes a golden opportunity to reduce the frozen preferred shares’ value, reducing the eventual death tax.

Whenever the taxpayer would otherwise wish to draw dividends from the corporation, either to extract the corporation’s tax-free capital dividend account, to allow the corporation to obtain its RDTOH refund, or simply to provide personal funds to the taxpayer, redeeming some of the frozen preferred shares is recommended. The taxpayer will be treated as having received dividends, but the value of the frozen preferred shares will be diminished and the eventual death tax reduced.

Price adjustment

While redeeming frozen preferred shares is an excellent strategy for reducing the death tax, if not structured properly, it is fraught with difficulty. For the freeze to be tax-deferred, it is always advisable to include a retroactive price adjustment clause in the valuation of the frozen preferred shares. Although the price adjustment clause ensures a fully tax-deferred freeze, it is dangerous to redeem shares whose value could be subject to retroactive adjustment.

To illustrate this danger, take the example of a taxpayer who holds 100 per cent of a corporation valued at CAD 10 million. To freeze this taxpayer’s estate, they convert their common shares of the corporation into 10 million preferred shares, each redeemable for CAD1, subject to the aforementioned adjustment clause. When the taxpayer wishes to receive a CAD 1 million dividend, it is tempting to have the corporation redeem 1 million frozen preferred shares, reducing the taxpayer’s shareholdings to 9 million preferred shares, and reducing the eventual death tax.

But if the tax authorities subsequently intervene, and successfully assert that the pre-freeze value of the corporation was not CAD 10 million but CAD 14 million, to retain the tax-deferred nature of the freeze, the retroactive price adjustment would be invoked and the frozen preferred shares would be retroactively valued at CAD 1.40 per share. Now, although the taxpayer receives only CAD 1 million on the redemption, they are deemed to have retroactively received the new fair market value attributable to the redeemed shares, namely CAD 1.40 per share. The result is tax on an extra CAD 400,000 dividend that the taxpayer didn’t even receive.

Negative tax consequences also flow if the value of the frozen preferred shares is overstated. Suppose that in the earlier example, the tax authorities successfully assert that the pre-freeze value of the corporation was only CAD 7.5 million, not CAD 10 million – and, therefore, pursuant to the adjustment clause, the frozen preferred shares are retroactively valued at CAD 0.75 per share. When you reconsider the redemption of 1 million preferred shares, the taxpayer was entitled to receive only CAD 750,000. But as they received CAD 1 million they run the risk of being taxed as if they appropriated CAD 250,000 of corporation assets.

Thus, the garden-variety estate freeze, involving the exchange of common shares for frozen preferred shares subject to a typical price adjustment clause, is effective in capping a taxpayer’s CGT on death exposure. If you want to do better, if you want to allow the taxpayer to erode their potential death tax exposure, and if you want to do so without tax risk, a properly structured estate freeze will involve issuing at least two separate classes of preferred shares to the taxpayer on the exchange, one class of which would expressly not be subject to the price adjustment clause.

So, while the Income Tax Act offers an interesting planning opportunity to reduce or eliminate exposure to estate CGT, it also contains traps that could translate in high-tax liabilities if affairs are not carefully arranged.

Creditor protection

Now consider another client concern: protection from creditors. As mentioned, one of the requirements to effect a tax-deferred estate freeze is that the frozen preferred shares must be retractable. While this achieves tax objectives, it places the taxpayer at considerable risk should they subsequently face action from personal creditors. While the constituting documents of all private corporations contain provisions restricting the transfer or seizure of shares, the effectiveness of such restrictions to defeat a creditor is far from certain; and if a creditor succeeds in seizing retractable preferred shares, the creditor can demand payment from the corporation.

As all bankruptcy and insolvency lawyers agree, the time to plan creditor protection is when there are no known creditors, so the implementation of a tax-driven estate plan is the ideal time to plan for protection against future unknown creditors.

Although you cannot remove the retraction feature attached to the frozen preferred shares, other structures can be put in place. One possible solution is to interpose a new holding corporation (Newco) between the taxpayer and the original corporation (Oldco). The taxpayer would own Newco, and Newco would now hold the retractable frozen preferred shares. Generally, as long as the common shareholders of Oldco are related to the taxpayer, the retractable frozen preferred shares could be redeemed in the hands of the Newco on a fully tax-free basis in exchange for a demand note. After the demand note is issued, Newco would recapitalise the note’s value in non-retractable preferred shares. Therefore, while the taxpayer would continue to hold all the Newco shares, its only asset would be the hard-to-realise-upon non-retractable preferred shares of the original corporation.

© Copyright (c) Society of Trust and Estate Practitioners. Article first published in STEP Journal Volume20/Issue1.

Ask the Experts Radio Show – February 2012

On the February 2012 episode of Ask the Experts on Newstalk1010, Managing Partner David A. Altro and Chief Operating Officer Matt Altro speak about the many issues that Canadians need to be aware of when considering buying property in the U.S. and moving to the U.S.

David discusses his book, Owning U.S. Property – The Canadian Way, 2nd Edition and host Iain Grant reads real life examples about probate, incapacity and U.S. estate tax.

Matt discusses the advantages of moving to the U.S. and what Canadians need to be aware of before they move.

Iain opens up the phone lines for caller questions. Diane calls in to ask David about buying short sales and foreclosures in the U.S. Sally asks about types of ownership and Bob, a dual citizen (U.S. and Canada) wants to know about his U.S. estate tax exposure.

In part 4, David talks about the state of the U.S. real estate market and the deals to be had for Canadians! Peter calls to ask about properties owned in personal names for couples in same-sex relationships. Douglas has a question about transferring his timeshare in Florida to his children.

Listen to the program below and don’t forget to tune in the show, the first Saturday of every month at 5 PM EST on Newstalk1010.

Part 1

Part 2

Part 3

Part 4

Dollars and Sense Radio Show – January 26, 2012

Montreal, Quebec – January 26, 2012

On the January 26th episode of Dollars and Sense on CJAD 800 AM, host, Matt Altro and legal expert David A. Altro discuss all the important issues surrounding Canadians buying property in the U.S. and moving to the U.S.

They discuss renting vs. buying property in the U.S., the questions to consider when choosing the right structure to hold title of your property, the state of the real estate market in Florida, how to protect yourself and your family from the U.S. probate procedure, creditors, taxes and much more.

David takes caller questions about inheriting U.S. property, starting a business in the U.S. and moving to the U.S.

Part 1

Part 2

Part 3

Part 4