interest – Small bussiness accounting solutions

Consider if there is significant investment capital available, and a family member at a lower marginal tax rate

LOANS FOR VALUE: Income Splitting Tool

Special attribution rules prevent the shifting of income between certain related people (including a spouse, parent, grandparent, sibling, uncle or aunt). Consider the situation where high-earning Spouse A gives investments to low-earning Spouse B so that investment income can be taxed at Spouse B’s lower tax rate. The attribution rules prevent this by requiring the earnings to be taxed in the hands of the transferor, Spouse A. However, these rules do not apply where the low-income person pays fair market value for the capital received. One way to pay for such investment capital is with properly structured loans, commonly referred to as “loans for value”.

The loan must satisfy several conditions to facilitate income splitting:

the loan must bear interest;
the interest must be at a rate no lower than the CRA prescribed rate at the date the loan is advanced; and
the interest for every year must be paid no later than January 30 of the following year.

Missing a single interest payment invalidates the loan for the year in respect of which the interest accrued and all subsequent years. For example, interest for 2019 was required to be paid by January 30, 2020. If the interest was not paid, attribution would apply for 2019 and all subsequent years.

The borrower (commonly a trust for minor children or grandchildren) can then invest the borrowed funds and earn income. Because the borrowed funds are used to earn income, the borrower is entitled to deduct the interest incurred as a carrying charge. To the extent the return on their investments exceeds the interest, the difference will be taxable to the lower-income borrower.

This planning tool is of particular interest now as CRA’s prescribed interest rate declined to 1% (from 2%), as of July 1, 2020.

CRA has confirmed that the interest rate can be fixed at the time the loan is advanced, without further adjustment when the prescribed rate changes. However, where a pre-existing loan requires higher interest (such as the 2% rate in effect to June 30, 2020), the rate cannot be adjusted downwards as it is also locked in at initial advance. Where there is an existing loan at 2% (or higher), refinancing at the lower 1% rate would require that the borrower repay the original loan. A new loan could then be advanced at 1% interest. Where appreciated assets must be transferred or sold to repay the loan, accrued gains would need to be reported.

ACTION ITEM: Consider setting up a loan for value if there is significant investment capital available, and a family member at a lower marginal tax rate.

IRS announced a new process to facilitate eligible individuals in becoming compliant with their U.S. tax obligations, in conjunction with renouncing their U.S. citizenship

U.S. EXPATRIATES New Relief Procedures

On September 6, 2019, the IRS announced Relief Procedures for Certain Former Citizens, a new process to facilitate eligible individuals in becoming compliant with their U.S. tax obligations, in conjunction with renouncing their U.S. citizenship (IR-2019-151). There was no announced specified termination date; however, a closing date will be announced in the future.

Eligible individuals will be required to file U.S. tax returns, including all relevant disclosure filings, including financial account disclosures, for the year they renounce their citizenship and the five preceding years. Eligibility criteria include the following:

Only individuals (not corporations, trusts, partnerships, estates or other entities) are eligible.
Past non-compliance must be non-willful.
The individual must never have filed as a U.S. citizen or resident (an FAQ question indicated that prior filing of a 1040NR return, in the belief the individual was neither a resident nor a citizen will not disqualify them).
The individual’s net assets cannot exceed $2 million U.S. at either the date of relinquishing citizenship or the date of the submission under these procedures, and their average net income tax for the five years preceding loss of citizenship cannot exceed an inflation-adjusted amount ($168,000 U.S. for 2019).
Taxes payable for the six years required to be filed cannot exceed $25,000 in aggregate after foreign tax credits and before penalties or interest are calculated. This does not include the “exit tax” which might apply outside the procedure, but is also not reduced for any U.S. withholdings.
The individual must have relinquished U.S. citizenship after March 18, 2010.
The individual must obtain a Social Security Number, if they do not already have one.

Assuming these criteria are met, no penalties or interest will apply, and any taxes payable for the six years, up to the $25,000 maximum, will be waived entirely. The individual will also be exempt from the “covered expatriate” rules, which could otherwise impose additional tax and filing requirements. However, the IRS will process submissions by non-eligible individuals under the ordinary rules, potentially attracting significant interest and/or penalty charges.

ACTION ITEM: Often, children of U.S. parents are surprised to learn that they too are considered U.S. persons and subject to U.S. taxation. This program may assist them in correcting their affairs and obligations.

Tag: interest

LOANS FOR VALUE: Income Splitting Tool

U.S. EXPATRIATES New Relief Procedures