tax returns. The sale of the principal residence is reported on the Canadian tax return. This has the effect of alerting the US tax preparer to the sale of the Canadian principal residence and the need to pay US capital gains tax on the sale.
4. Creating Taxable Income For The US – Reducing The Tax Rate On Corporate Income May CREATE US Subpart F Income For US Citizens
It is common in non-US countries for individuals to run their businesses through small business corporations. When these businesses are organized by US citizens their small business may become “Controlled Foreign Corporations” (CFCs). CFC’s are subject to the US Subpart F rules found in Sections 951 – 965 of the Internal Revenue Code.
The purpose of the CFC rules is to attribute income earned by the CFC directly to the shareholder. CFC income includes both traditional Subpart F income and GILTI income. In each case a change in the corporation’s tax rate will impact whether the individual US shareholder will be required to include a portion of the corporation’s income in the shareholder’s personal income. To the extent that income earned in the corporation is taxed at a rate of at least 90% of the US corporate tax rate (currently 18.9%) the individual shareholder will NOT be subject to US Subpart F income inclusions. In this way, a reduction in the Canadian rates of taxation on income earned by those corporations may create US taxable income for the US citizen shareholder.
5. Increasing The US Tax As The Share Of Total Tax Payable – Reducing Tax Paid To The Country Of Residence Reduces The Tax Credit To Offset US Tax Payable
Tax credits are designed to facilitate the use of payment of tax in one country to offset the tax owing in the second country. Generally tax credits result in the taxpayer paying total tax at a rate which is equal to the tax paid in the country which has the higher rate of tax. Imagine a situation where the United States has a tax rate of 30% and country B has a tax rate of 30%. If country B lowers its tax rate to 25%, US citizen residents of Country B will NOT receive the tax reduction that other residents enjoy. They will pay 25% tax to Country B and 5% tax to the United States.
Conclusion and general message
Tax changes in other countries (where a US citizen is “tax resident”) can have an impact on one’s “tax relationship” with the United States. Americans abroad who are continually subjected (because of citizenship taxation) to the unintended consequences of changes in US tax law, should also be conscious of changes in the laws of their country of residence. These changes may create changes in their “tax relationship” with the United States. Note that these changes may also impact the application of various kinds of treaties.
This reality increases the risk of for US citizens of living outside the United States as a tax residents of other countries! The description of how a change in Mexican tax law created an offense that triggered the US Mexico extradition treaty* is a visible and frightening example. But, there are many other examples which entrap even the most innocent of taxpayers.