U.S. tax law expiry potentially ‘a big deal’

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When key provisions of the U.S. Tax Cuts and Jobs Act (TCJA) are scheduled to sunset on December 31, 2025, the tax implications for taxpayers, including some Canadians, could be profound.

The TCJA came into effect on January 1, 2018, and featured wide ranging tax relief for both individuals and corporations. It was hailed as the most comprehensive and substantial tax reform passed by the United States government since the Tax Reform Act of 1986.

Canadians with U.S. “situs assets,” or assets located in the U.S., like a permanent business, a vacation home, shares of public and private corporations, bonds, retirement plans or annuities like an IRA or a 401K, could be significantly impacted, says Kris Rossignoli, a cross-border and tax financial planner with Cardinal Point Capital Management ULC in Toronto.

It is possible that new legislation could prevent these provisions from expiring, perhaps contingent on the outcome of the 2024 U.S. elections, but tax planning, including for Canadians who are considering a business expansion into the U.S., must take into account the possibility that the U.S. tax landscape on January 1, 2026 will be very different than it is today.

Personal and corporate tax rates

One of the biggest changes introduced by the TCJA was a flat 21-per-cent U.S. corporate tax rate. This is not scheduled to sunset on December 31, 2025. “It was a permanent change,” says Rossignoli.

“This makes it more advantageous for Canadian corporations to expand to the U.S. after exceeding their CAD$500,000 small business deduction threshold, as the U.S. tax rate, assuming no or low state tax, can be lower than the Canadian corporate tax rate on active business income in excess of $500,000,” he explains.

However, on the individual tax side, a key issue impacting ultra-high-net-worth investors is that the marginal tax rate at the highest level decreased from 39.6 per cent to 37 per cent under the TCJA, and is scheduled to revert back to the higher level under the sunset provisions.

In addition to the individual rates going up, the speed at which the graduated brackets kick in will decrease, and this will have an especially negative impact on an ultra-high-net-worth individual in the U.S., says Noreen Marchand, the national managing partner of specialty tax for Grant Thornton LLP in Toronto.

Another point to consider, says Marchand, who practices in cross-border personal taxation, is that the deduction for pass-through business income is scheduled to expire.

“Because corporate tax rates with TCJA came down from 34 per cent to 21 per cent, if an individual was earning income through a pass-through entity, there was an individual deduction allowed by TCJA to reduce the effective tax rate paid on business income to try and create some parity,” she says.

But if that expires as scheduled, income coming through those pass-through entities is going to revert to the pre-TCJA tax rate, which, for an ultra-high-net-worth individual paying tax at the highest marginal rate, will increase from 37 per cent to 39.6 per cent.

“For a U.S. person, that’s a big deal,” says Marchand.

Andrew Stevens, a senior manager with EY LLP in Toronto, notes that individuals who are subject to tax in both Canada and the U.S. are subject to a foreign tax credit for most items, and must therefore not consider U.S. tax decisions in isolation.

“You really only pay one global rate of tax. That global rate is ultimately going to be the higher of the two rates. So in the case of a high-net-worth Canadian it’s usually going to be the Canadian rate that’s going to be the highest,” he says.

For example, if the top U.S. marginal tax rate reverts back to 39.6 per cent instead of 37 per cent, somebody with a tax connection to both the U.S. and Canada might wonder whether to hold off on deductions until they are able to get “a bigger bang for the buck” in the U.S.

Furthermore, many itemized deductions have been frozen by the Tax Cuts and Jobs Act, but if that provision sunsets as scheduled, they will be available again.

“If they say ‘I’m going to hold off until I can get that deduction in the States,’ ultimately that’s one of those situations where you would bring your U.S. rate down, but your global rate would stay the same. So it might make more sense to just lock in that deduction today,” adds Stevens.

State and local tax (SALT) deductions

The TCJA introduced a $10,000 cap on the allowable deduction of state and local income, as well as sales in lieu of income, property taxes, and foreign income taxes, excluding foreign real property taxes, for taxpayers who itemize their deductions. This did not affect property taxes associated with carrying on a business or trade, which remained fully deductible.

“A lot of people that were itemizing their deductions are now just using the standard deduction, which makes tax preparation a little easier on U.S. tax filers because they don’t have to collect and record all their itemized deductions. They just take the standard deduction, which occurs automatically,” says Rossignoli.

This provision is scheduled to sunset at the end of 2025, at which time the $10,000 cap on this deduction would be removed, allowing taxpayers to deduct all eligible itemized deductions. Most higher income people would typically use itemized deductions on things like state and local tax, as well as for medical expenses, and charitable donations, says Rossignoli.

Although this will likely reduce U.S. federal tax if the state and local tax cap is removed, that advantage might be offset by the 39.6-per-cent top federal tax bracket being reintroduced, which would “probably hurt a lot of ultra-high-net-worth people,” says Rossignoli.

Estate and gift tax exclusion

Another major provision of the TCJA that is set to expire at the end of 2025 is the U.S. estate and gift tax exclusion. That amount more than doubled to US$11.18 million in 2018, up from $5.49 million in 2017, when the TCJA took effect.

After being adjusted annually for inflation, the exclusion amount is currently $13.61 million for 2024. It will index for inflation again in 2025, and then assuming the sunset occurs as scheduled, revert on January 1, 2026, back to the 2017 amount, adjusted for inflation, which will likely be between $6 and $7 million, explains Rossignoli.

That is a major consideration for Canadians with U.S. situs assets, because the top tax bracket for U.S. estate tax is 40 per cent, which is a large tax, says Rossignoli.

“If your worldwide assets are above that U.S. estate tax exemption, currently at $13.61 million, but set to decrease to $6 to $7 million, then you may have a U.S. estate tax issue when you pass away,” he adds.

The Canada-U.S. Tax Treaty has a provision called the “unified credit,” which allows eligible Canadians to prorate their U.S. situs assets as a percentage of their worldwide assets when using the U.S. estate tax exemption, Rossignoli says.

“The strategies we are discussing with our clients to utilize the higher U.S. estate and gift tax exemption before December 31, 2025, are: gifts to family members; utilizing one’s spouse’s U.S. estate and gift tax exemption; and gifting to spousal lifetime access trusts,” he notes.

Marchand says the biggest impact of the scheduled sunset clauses for the TCJA for ultra-high-net-worth Canadians subject to U.S. tax will be with respect to estate planning.

“When TCJA expires, it’s going to drop significantly, and so that means that more people are going to be subject to estate tax,” she explains.

“In the context of a Canadian, this has an even greater impact, because you need to look at it on a proportionate basis of your worldwide assets. And so that ultra-high-net-worth individual who is a Canadian and has some U.S. real estate or stocks and securities in their portfolio, only gets a percentage of that unified credit, equal to what their U.S. assets are over their worldwide assets,” says Marchand.

She suggests that, for people in that situation, “over the next couple of years, while that unified credit is still high, take advantage of lifetime gifting in order to transfer assets to the next generation if that’s what you’re inclined to do in order to take advantage of that higher amount before it drops down.”

“A really good planning technique is to accelerate either the gifting or the usage of an individual estate and gift tax limit,” says Ameer Abdulla, a partner with EY in Waterloo. “And so a lot of people are considering accelerating any plans that they may have otherwise had, and a common one involves using trusts,” he adds.

But, he notes, Canadians must take into account that there is now a much higher scrutiny and reporting requirement for trusts in Canada.

“Where you have Canadian folks with either U.S. situs assets or a U.S. reporting obligation, it’s so critical to look at these issues on both sides of the border, because while a decision might look great for one side of the border there may be unintended consequences on the other, Abdulla warns.

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