Canadian residents may be wondering whether Joe Biden’s democratic tax policies will affect them once he becomes President. In many instances they will.
The big question is, how much power will Biden and the Democrats actually have? In order to consider this question, we must first examine how the U.S. electoral system is set up.
Although the media focuses on who will become the President based on votes, in reality it is the Electoral College that decides who will be the President. Each state has been assigned a certain number of electoral votes. All but two states normally vote all their electoral votes the same way based on a majority rule in that state. For example, Florida has 29 electoral votes. If the majority of the people in Florida vote Republican, then all 29 electorates for Florida will be Republican. Only Maine and Nebraska permit their electoral votes to be split proportionally between the parties. A presidential candidate must earn at least 270 of the 538 electoral votes to become President.
While one presidential candidate may have the majority of the nationwide popular vote in the November election, it is actually the Electoral College that votes for the President and the Vice President in December. This winning presidential ticket then forms the Executive Branch along with the Cabinet they choose.
There are two more branches of government in the United States: the Legislative Branch and the Judicial Branch. The Legislative Branch consists of the Senate and the House of Representatives, collectively known as Congress. The Judicial Branch consists of the Supreme Court and the lower federal courts. The Judicial Branch’s duty is to uphold the enacted laws and the Constitution.
As one part of the Legislative Branch, the Senate has 100 seats, with each state having two seats. Senators serve a term of six years and are elected by popular vote. Their terms are staggered such that approximately one third of the Senate is up for election every two years. Going into the November election, 47 Senate seats were held by Democrats and 53 were held by Republicans.
The second part of the Legislative Branch is the House of Representatives, which has 435 members. Members serve two-year terms. Their primary duties are to introduce, debate and vote on bills. They have the exclusive power to initiate all tax and spending bills as well as the power to impeach federal officials, such as the President. Going into the election, 232 House members were Democrat, 197 were Republican and one was Libertarian. There were five vacant seats.
Both the House and the Senate must approve all legislation by a simple majority vote before it is sent to the President for his or her signature and final enactment. The President has the power to veto a bill, sending it back to the House and Senate, which then have the opportunity to override the President’s veto with a supermajority (2/3) vote and pass the bill anyway.
Thus, if one party controls the Office of the President, the Senate and the House of Representatives, that party would have the power to introduce and pass legislation at will. In contrast, when the Senate and the House are controlled by different parties, it can be more difficult to pass legislation, as was the case with the Trump administration.
To determine what effect the change in power might have on taxes for Canadian residents, we will examine a few of the policies in Biden’s campaign platform.
First, Biden has indicated that he will raise the federal corporate tax rate from 21 per cent to 28 per cent (additional state taxes may also apply). Canadians doing business in the U.S. who are not treaty protected will face a tax increase on income earned in the U.S. Such a change will make it more important for Canadians to structure their U.S. operations properly.
Further, Biden has indicated that he will reduce the estate tax exemption from the current $11.7 million (current 2021 rate) to something much less, perhaps $3.5 million, and will impose a top tax rate of 45 per cent. For Canadians (non-U.S. citizens) owning U.S. real estate, or in some instances U.S. stocks in their portfolios, these changes mean that if the total worldwide asset value (not just U.S. assets) exceeds the new exemption level, the estate could potentially pay U.S. estate tax on those U.S. assets upon death. If a Canadian citizen’s U.S. assets are worth more than $60,000 (USD), the estate must file a U.S. estate tax return even if there is no U.S. estate tax owing.
For U.S. citizens living in Canada, if worldwide assets exceed the new threshold, the estate must pay U.S. estate tax upon death. Consequently, we expect to return to the U.S. estate planning strategies that were common before President Trump increased the exemption threshold significantly. Since the gift tax exemption is tied to the estate tax exemption, it would be prudent to do some planning in case tax legislation is changed, such as gifting some assets to other family members while the larger gift tax exemption still applies. Careful planning under the guidance of a tax advisor is critical, as there may be Canadian tax consequences as well.
In addition, the Biden administration could implement changes to the global intangible low-taxed income provisions. For U.S. citizens living in Canada and operating a Canadian business through a Canadian corporation, the U.S. has some complex rules that can result in U.S. tax on that income. The Biden administration proposes to increase the rate of tax on this income and to broaden the scope to eliminate the 10 per cent exclusion on qualified business asset investments.
On a positive note, the Biden administration proposes to temporarily increase the child tax credit from $2,000 to $3,000 for children under the age of 17, to add a $600 bonus for children under the age of six, and to make both benefits fully refundable. This change will affect some U.S. citizens living in Canada whose children meet the qualifications to be dependents for U.S. tax purposes.
Finally, high-income earners can expect significant tax increases, such as new Social Security taxes, a top federal tax rate of 39.6 per cent on income over $400,000, and qualified dividends and capital gains taxed as ordinary income at the highest federal tax rate for those who earn more than $1 million. Adding on the 3.8 per cent net investment income tax brings the top federal rate to 43.4 per cent before any applicable state tax.
While there are many more tax changes expected from a new administration, these are the most significant ones that will affect Canadian residents.
Although it is all but guaranteed that the Democrats will have Joe Biden in office for the next four years, the key to legislative power in the United States is not just who is the President but also which parties control the Senate and the House of Representatives.
At the time of this writing, most states have certified their votes with a predicted 306 electoral seats for the Democrats and 232 for the Republicans. The House of Representatives reports 222 seats for the Democrats and 206 for the Republicans. The Senate, however, reports 50 seats for the Republicans and 48 for the Democrats, with two seats still undecided. These last two seats will have run-off elections on January 5, 2021, with possible outcomes being Republicans retaining control of the Senate or a 50-50 split.
The results are crucial; when the Senate is split 50-50 and a vote is tied on an issue, the Vice President casts the deciding vote. Assuming the Electoral College appoints Joe Biden as President, deciding votes will be cast by the Democratic Vice President, Kamala Harris, giving the Democrats complete control to advance tax legislation.
Given that certain Democratic tax policies may impact Canadians with U.S. activities, and Americans living in Canada, it would be advisable to consider the impact these developments may have on your tax situation. Your Baker Tilly cross-border tax advisors are ready to help.
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