I speak more about this in The Globe and Mail article ' U.S. expats face new Obamacare health care tax'
Are you a US citizen or green-card holder? While everyone's been focusing on the "fiscal cliff", something else has been going on that may actually raise your tax bill.
Effective January 1, 2013, to help fund "Obamacare", the United States has brought in a tax – the "Net Investment Income Tax". This tax is 3.8% of your investment income if your total earnings are above:
- For a married couple filing jointly, $250,000
- For a married person filing separately, $125,000, and
- For a single taxpayer, $200,000.
Investment income is, generally, interest, dividends, annuities, rents, royalties, and most net gains. It includes income from passive activities. It does not include distributions from qualified retirement plans.
"So what", you may say. I live in Canada. Canada effectively taxes me. "I don't pay US income tax".
Not so fast. This is described as a "Medicare Contribution", not an income tax.
"So what, if it's a Social Security tax, I'm exempt, because I live in Canada. Shouldn't it be covered by the Social Security Totalization Agreement?"
Well, it should, because it's the same kind of tax, but that agreement doesn't specifically cover this tax. This tax is not dedicated to the Medicare Trust Fund. It might not be covered.
"So what", you say again. "My income is subject to Canadian tax. I get a foreign tax credit on my US return, and it's just a paper filing exercise only.
Welcome to the new era, where the United States government is desperate for money.
First of all, the investment income could be generated from U.S. investments. One would think that if your Canadian tax rate is high enough, then you'll get a full Canadian foreign tax credit, and the problem goes away. But if you live in Alberta or a territory, your Canadian tax rate may be lower than your US rate, and your effective tax will now climb.
The problem can occur in other ways in the rest of Canada. Sometimes you can have income that is exempt from Canadian tax, but subject to US tax. For instance, the Canadian real estate market has been good over the past number of years, and the Canadian dollar has appreciated against the US dollar. When you sell your house, you may have a gain (measured in US dollars) of over $250,000 ($500,000 for a married couple). The excess is subject to regular US tax and to this new tax even though it's exempt from Canadian tax.
Finally, you could earn regular Canadian investment income. If you're in a province other than Alberta, the income is probably subject to Canadian tax at rates that are higher than the US rates, even including this new tax. Under the Internal Revenue Code, there is no foreign tax credit allowed against this new tax. It is arguable that the tax treaty provides for a credit, but at this point, this position is no sure thing.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.