Common financial pitfalls for snowbirds

BMO director addresses main considerations for Canadians fleeing the harsh winter for their place in the sun

Common financial pitfalls for snowbirds

We’ve all dreamed of owning a second property in the sun that allows us to retreat from the harshness of the Canadian winter.

For many clients, of course, especially high-net-worth ones, being a snowbird in the US is a wonderful reality, albeit one that comes with a number of potential pitfalls.

In part one of our interview, Erika Toth, director, Eastern Canada – BMO ETFs, BMO Global Asset Management, talked to WP about the main considerations for advisors when dealing with this scenario. In part two, she will explain six investment options for snowbirds.

Top of mind for an advisor should be important thresholds with regards to tax implications. For HNW clientele, if worldwide assets exceed US$11.4 million – between real estate, stocks and bonds – and US assets exceed US$60,000, they could have a massive potential US estate tax liability, with US estate tax rate starting at 18% and going up to 40% if you have more than US$1 million.

Toth added: “If this individual passes away and has a surviving spouse, assets are rolled over to them on a tax-exempt basis. If not, they could be on the hook for tens or hundreds of thousands in estate tax payable to the IRS.”

So, what can be done? Well, whenever possible, for non-registered money, an advisor should seek out US-denominated investment solutions that are Canadian-listed. These are treated as a Canadian domiciled trust for tax purposes and avoids US Estate Tax liability.

BMO ETFs offers 12 $USD-traded ETFs to help investors reduce currency conversion costs if assets are already in USD to eliminate US estate tax liability. Some of these will be explored in the second part of this interview.

Another crucial element for an advisor to consider is to determine their client’s US tax status. Are they considered a “US person”? This can be done by conducting the US Substantial Presence Test (SPT). If they are a “US person”, they will need to file a tax report with the IRS, as US persons are taxed on worldwide income.

The SPT determines whether you are a "US person" based on the following: if you’ve spent four months-plus a year in the US over the most recent three years; if you are a US resident (green card); or if you are a US citizen.

Toth explained that if the client has been in the US for under 182 days in the current tax year you may be able to claim a “closer connection to Canada” and get an exemption from filing a US IRS tax return if: your permanent home, family, belongings, driver's licence and country of residence documents all state “Canada” and you derive most of your income in the current year in Canada as well. To get this exemption, you must file IRS form 8840.

She added: “It is best to consult with a cross-border tax specialist for each individual’s circumstances as this can be a complex determination.”

If a client is not considered a US persons for tax reasons, they can hold any Canadian-listed ETF (CAD or USD denominated) with no negative implications. However, if they are considered a US persons for tax reasons, there are a number of points to consider.

Firstly, within an RRSP, RRIF or RPP, they can buy any Canadian-domiciled ETF they want ($USD or $CAD denominated), just as any other Canadian investor would be able to do. But for non-registered money, this is where IA needs to be familiar with Passive Foreign Investment Corporations (PFICs) rules.

Toth explained: “Most Canadian funds, ETFs and REITS are considered ‘PFICs’ by IRS. US persons have to fill out an additional form (8621) for any of these that they are holding, as long as it amounts to over $25k US in total.

“This form must be filled out in order to avoid high US tax/ interest penalties, and in order for any price appreciation in these assets during the year to be treated as capital gains. Otherwise, it would be taxed as income, which is taxed at the highest marginal rate.”

BMO offers 44 ETFs, including four in US dollar, and three mutual funds that produce the PFIC paperwork needed in order to fill out that 8621 form.

Toth said she is often surprised to meet advisors with US dollars on their books who don’t know that there is no estate tax exposure on the BMO solutions because they're listed in Canada.

She said:  “I find that’s a bit eye-opening for some of the advisors that I sit down with and people should become more familiar with that. Our solutions also have no 1135 filing either, which is a foreign income verification statement on foreign investment. That's another benefit of having a US dollar denominated but Canadian listed exposures.

“The knowledge around those two things is improving but sometimes there's still professionals that may be a bit surprised to know that or maybe they knew it at one point and forgot. It’s a good thing to remind them, for sure.”

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