A Canadian’s Guide To U.S. Tax Changes
Throughout 2017, the Trudeau government’s proposed changes to Canadian business taxation often dominated headlines. However, their gradual rollout and ponderous process resulted in something of a slow burn of coverage, which, however much Canadians discussed it, cannot hold a candle to the coverage of changes to the tax code south of the border. Rather then taking all year, changes to the American tax code were completed in about a month, and rather than being driven by the hopes of closing opportunities for tax planning to save sophisticated taxpayers money, they appear to be motivated by the opposite, creating particularly wide loopholes for business owners to squeeze through.
For Canadian taxpayers, it would be entirely understandable to want to avoid adding an additional layer of complexity overtop of the Canadian tax code. However, if you had heard changes to the American code mentioned on the news and have wondered how we do things differently, here is a basic discussion of one of the changes, what we do differently, and some ways the changes to the American system can be gamed.
SALT Deductions in the United States
Prior to the recent changes in the form of the Tax Cuts and Jobs Act, residents of American states could claim a deduction from their income at the federal level for state and local property taxes, as well as either state income taxes or state sales taxes. This reduced their income in calculating their federal taxes, and so residents of states with higher taxes tended to have lower federal tax rates.
Under the recently passed Republican tax plan, the SALT deduction is now capped at $10,000 USD wherever you are in the country. Through the SALT deduction, the American system offset federal revenue from states willing to increase their own taxes, essentially subsidizing taxes at lower levels. Because taxes are considered a business expense, this change to the code affects businesses less than individuals, as businesses do not require specific authority to deduct state and local taxes. Provided that property tax is for a business property, for example, businesses can expense it anyways. The change will primarily affect relatively well-off individuals in high-tax states such as New York or California.
State and Local taxes tend to be more regressive (affect people who make less money more for each dollar they earn) than federal income taxes in the US, as they are more likely to be based on consumption or property values.
However, only relatively well-off people tend to pay enough income tax, or more than $10,000 in state taxes, and so the move is less likely to affect them. Less wealthy Americans are also more likely to claim a “standard deduction”, reducing their income by a specific amount rather than individual deductions, which this change to the code will not affect.
There are, however, some possibilities for avoidance. On the individual end, wealthier individuals who would opt to itemize their state and local taxes may find yet another incentive to claim themselves to be “independent contractors” or to provide services (such as legal or medical services) through their own personal corporation. In this case, they may be able to claim deductions for some of their SALTs as a business expense.
In this case, many of the opportunities for tax avoidance come at the state level. If states still want to save their own residents taxes at the expense of the federal government, there are options available for them. Under one means of avoiding the change proposed by a group of American tax experts, a state could require businesses to collect income tax as a payroll tax, rather than have employees themselves file. In this way, the business can still deduct the tax, passing on the cost to their employees. In this way, the result can be very similar to that prior to the change in the tax code.
A Canadian Perspective
In eliminating the SALT deduction, the American tax system takes one step towards building a tax system like Canada’s. Canadian employees, who cannot claim deductions for most things unless specifically permitted to, cannot deduct provincial and local taxes. Provincial and local governments simply have to account for the full effect of their own taxes on their residents. As for American businesses, Canadian businesses can deduct taxes as expenses. This includes most local and provincial taxes, except for income/profit taxes.
Instead of generally deductible state and local taxes, we use “equalization”, which you have likely already heard of, and certainly will have if you live in the prairies. Through equalization, the Canadian federal government passes out money it earns at the federal level to provincial government depending on how much money they could raise. This depends on what the provincial budget would look like if the province had average revenues from five different sources (personal income taxes, business income taxes, GST/HST, natural resource revenue, and property taxes). While it is a common misconception, provinces do not pay equalization per se; people from provinces do, resulting in an outflow of cash from some provinces and an inflow to others, but it is not directly dependent on provincial taxes or budget balances.
Equalization, with the federal government taking in revenue to distribute to the provinces, is in part how Canadian provincial governments spend so much, allowing Canada to be the developed world country with the greatest share of revenue spent at the sub-federal level.
In contrast to the American approach, the Canadian system provides less of a subsidy to specific fiscal choices of lower-level governments, and instead allocates similar dollars on the basis of the recipients’ actual capacity. In the American contexts, the states that benefit from the SALT deductions tend to be relatively wealthy. Not only are individuals for whom it is worth claiming SALT relatively well-off, but the states that charge relatively high taxes (particularly, non-property taxes) tend to be better off as well.
If you are thinking about the implications of changes to the United States’ tax code and how it affects your Canadian business, or if you are thinking of disclosing funds held in the States, consider reaching out to one of our tax lawyers for a consultation!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.