1.02 U.S. Income Taxation of Citizens & Residents 2
(a) Taxation of Individuals 2
(b) Itemized Deductions and Standard Deduction 2
(c) When Returns are Due 3
(d) Medicare Taxes 3
(e) Taxes and Passports 3
(f) Americans Employed in Canada 3
(g) Self Employed U.S. Citizens Abroad 4
(h) Election to Treat Non Resident Alien Spouse as U.S. Resident 5
(i) Identification Numbers 5
1.03 Foreign Bank Account Reporting and FATCA 5
(a) Reports of Foreign Financial Assets 5
(b) Statement of Specified Foreign Financial Assets – Form 8938 5
(c) Passive Foreign Investment Companies – Form 8621 5
(d) Foreign Grantor Trusts 6
(e) Affordable Care Act 6
1.04 The Importance of Determining Residence 6
(a) Canadian Residence Rules: 6
(b) Residents of Both Canada and the U.S. 7
1.05 Elimination of Double Taxation 7
(a) Canada - U.S. Income Tax Convention, 1980 7
(b) Claiming Foreign Tax Credits 8
(c) Foreign Earned Income and Housing Exclusion 8
(d) Foreign Housing Exclusion 9
(e) Claiming Foreign Tax Credits vs the Earned Income Exclusion 9
(f) Alternative Minimum Tax 9
(g) Totalization Agreement - Social Security 9
(h) Canadian RRSP’s and U.S. Taxes 10
(i) Roth IRA’s in Canada 10
1.08 Ceasing to be Taxable in The U.S. or Canada 12
(a) Revoking U.S. Citizenship or Long Term U.S. Residence 12
(b) Leaving Canada - Canadian Taxation of Non Residents 13
1.09 U.S. Vs Canadian Estate Taxation 14
(a) U.S. Estate Taxation of Residents and Citizens 14
(b) Receipt of Gifts From Abroad 14
(c) Estates in Canada 14
(d) Canadian Marital Credit 14
(e) U.S. Estate Taxation of Non resident Aliens 15
(f) Foreign Tax Credits for Estates 15
* Copyright ©2021 by Mark T. Serbinski, LPA (Ont.) CA (Ont.), CPA (Ont.),CPA (Illinois & Florida) Mr. Serbinski is a Chartered Accountant/Chartered Professional Accountant practicing in Ontario and a partner in the firm of Serbinski Partners PC, Chartered Accountants, Toronto, Ontario as well as a Certified Public Accountant licensed in Illinois and Florida, and a practitioner in the firm of Serbinski Accounting Firms, PC, Certified Public Accountants in Chicago, Illinois. Admitted to practice before the Internal Revenue Service, Mr. Serbinski practices international tax and acts as a consultant to the profession. Further information is available at https://www.serbinski.com.
Taxation in the United States is based on either citizenship or residence, while Canada imposes income taxes only on residents of Canada. Therefore, U.S. citizens who live or work in Canada may find themselves subject to taxation on their world income in both Canada and the U.S. The income tax system in the U.S. is administered by the Internal Revenue Service, and is considered one of the most complex systems of taxation in the world. While some similar regulations exist, many legal reporting, compliance and filing requirements in Canada are considerably different from U.S. rules, and, in many cases, U.S. rules must be applied even to non U.S. entities controlled by U.S. citizens.
Even though a person may be exempt from income taxation in the U.S. as a result of provisions contained in the Canada-United States Income Tax Convention, 1980 and the subsequent Protocols or other exemptions, in many cases an income tax return or other forms may still have to be filed to establish the exemption being claimed. Failure to file U.S. income tax forms and elections in an accurate and prescribed manner and on a timely basis may result in a denial of the exemption being sought (therefore possibly resulting in double taxation if the person is also taxable in Canada), denial of otherwise deductible expenses, interest, and penalties for inaccurate, incomplete or non filed forms or returns. Therefore, in situations where a U.S. citizen intends to live or work in Canada, obtain any Canadian work permit, conduct a business in Canada, own Canadian investments or real estate, or even vacation in Canada for extended periods, experienced tax advisors should be consulted prior to
the commencement of Canadian activities.
The sections which follow are intended to provide a very brief summary only of some of the U.S. income tax topics relevant to Americans living or working in Canada and do not constitute a complete analysis of the tax law and planning opportunities available.
Accordingly, competent international tax advice should be sought prior to acting on any of the information contained herein.
Individuals who are citizens or residents of the U.S. are taxed on their income from all sources, both within and outside of the U.S. Form 1040 (U.S. Individual Income Tax Return) must be filed with the Internal Revenue Service, each year by April 15, for the prior calendar year. Unlike taxation in Canada, form 1040 may be filed either by an individual separately, or by a married couple on a joint basis. Income tax rates are graduated, and different rate schedules are used for returns with different filing status. In this way, income tax rates are adjusted to account for differences in circumstances for persons filing as single, married filing jointly, married filing separately, qualifying widow(er), or as head of household (HOH).
For tax years ending in 2021, the maximum tax rates for noncorporate taxpayers' net capital gains are as shown on the table below:
|0%||$ 40,400||$ 80,800||$ 54,100|
|10%||$ 9,950||$ 19,900||$ 14,200|
Generally, a U.S. citizen living anywhere in the world, must file a return if the minimum income indicated for the filing status below is met in 2021:
|Single (over 65)||$14,200|
|Head of Household||$18,800|
|Head of Household, over 65||$20,450|
|Married filing jointly||$24,000|
|Married filing jointly, one over 65||$26,750|
|Married filing jointly, both over 65||$28,400|
|Married filing separately||$ 0|
|Qualified widow(er), over 65||$13,600|
Individuals filing as U.S. residents must choose whether to claim the standard deduction, or whether to itemize deductions. Itemized deductions include such items as medical expenses, state and local taxes, charitable contributions and investment expenses.
For 2021 itemized deductions are severely restricted while the standard deduction has been increased (to the levels shown above under filing thresholds.) Most notably, real estate tax and state tax deductions are limited to $10,000 and home mortgage interest is restricted to the interest on the first $750,000 of debt for a married couple. Further, personal exemptions have been eliminated.
The phase out of itemized deductions at higher income levels has also been eliminated.
The result of these changes will likely reduce the number of taxpayers who itemize deductions.
If all taxes due are paid by April 15, an application may be made for an automatic extension of the filing deadline of form 1040 to October 15, and further extensions may be available in certain circumstances. U.S. citizens (or permanent residents) living outside the U.S. (and with no U.S. source employment income) have until June 15 each year to file their returns and pay taxes, without filing an extension.
Additional filings are required with the 1040 return for holdings of controlled foreign corporations (form 5471). Foreign grantor trusts such as Canadian Tax Free Savings Accounts (TFSA) and Registered Education Savings Plans (RESP’s) must file form 3520 with the 1040 return, and form 3520A by March 15 unless an available six month extension to September 15 is applied for before the initial due date.
U.S. citizens are also required to disclose foreign financial assets on U.S. Treasury form FINCEN 114, electronically by the (extended) due date of the 1040 return and form 8938, which is filed with the 1040 return.
(i) Net Investment Income Tax
Net Investment Income Tax (NIIT) of 3.8% is payable on investment income in excess of the following filing thresholds. This new tax will be reported on form 8960 and will affect U.S. residents only, where income exceeds 200,000 (single), $250,000 (married filing jointly) or $125,000 (married filing separately).
Net investment income will include gains from property held for investment, such as stocks, bonds, mutual funds, etc., including gains on the sale of a principal residence in excess of the exemption amount, less expenses related to investments. For NIIT
purposes, net losses from property dispositions cannot be less than zero (and therefore cannot offset other investment income), and are not available for carry forward to future periods.
(i) New Medicare Tax on Earned Income
Additional medicare tax of 0.9% of earned income in excess of the same income thresholds as for NIIT, and are reported on form 8959. Generally, employers are required to withhold the additional tax from pay exceeding $200,000 per year, but a problem may result from combining income from separate jobs, or spouse’s income on a joint return.
Failure to file and pay U.S. taxes when due may result in a denial of a U.S. passport renewal.
A resident of the U.S. who is employed by a U.S. company in Canada falls under the Canada U.S. Income Tax Convention (Treaty) - Article XV - “Dependent Personal Services”, which states:
“Subject to the provisions of Articles XVIII (Pensions and Annuities) and XIX (Government Service), salaries, wages and other similar remuneration derived by a resident of a Contracting State in respect of an employment shall be taxable only in that State unless the employment is exercised in the other Contracting State. If the employment is so exercised, such remuneration as is derived therefrom may be taxed in that other State.”
This has been defined to mean that employment income is exempt from Canadian taxation and withholding unless it is over $10,000 per year. If it is over $10,000 per year, it is exempt only if:
a) The individual was in Canada less than 183 days in any 12 month period, and
b) The cost is not borne by (deductible by) a Canadian. resident employer or an employer with a fixed base in Canada.
Therefore, to be exempt under the Treaty, an individual must be employed in Canada. by a U.S. corporation without a fixed base in Canada. Employment in Canada by Canadian. employers, and U.S. employers with a permanent establishment or fixed base in the Canada. is fully taxable in Canada.
A U.S. employer with a fixed base in Canada who hires or transfers U.S. residents to work in Canada should ensure that Canadian withholding taxes are deducted and remitted to Canada, and that withholdings to the IRS are eliminated, except for those required to fund social security and medicare taxes (under the Totalization Agreement). Failure to do so can create a cash flow problem for the employee, since they will be taxable in Canada and will be required to pay Canadian taxes before U.S. withholdings are recovered through the operation of the foreign tax credit.
Persons carrying on an unincorporated business as a sole proprietor or disregarded entity (such as a single member LLC, for example) in the U.S. are generally subject to income tax on their gross income less allowable deductions attributable to that income, and must file Schedule C with their form 1040 for each business, each year. Self employed persons are also subject to the Self Employment Tax, which amounts to 15.3% of self employment income up to $128,400 (for 2018), and is imposed in addition to any income taxes payable. The Self Employment Tax is used to fund social security taxes, and is the equivalent of the self employed Canada Pension Plan amount payable in Canada. One half of self employment tax is deductible from income prior to the calculation of tax liability.
Generally, under the terms of Binational Social Security Agreements (or Totalization Agreements), self employed persons who are subject to dual taxation are only required to pay social security taxes or their equivalent in the country in which they reside.
Accordingly, U.S. citizens resident in Canada are required to pay Canada Pension Plan (CPP) premiums and are therefore exempt from Self Employment Tax.
A U.S. citizen providing personal services in Canada. as a self-employed individual falls under Article VII(1) of the Treaty – Business Profits. Under this provision, taxation is limited to the profits earned within a “Permanent Establishment” and only to the extent earned in Canada.
Permanent Establishment Defined:
The definition of “permanent establishment” was subject to much interpretation in the former Treaty. Under the new rules, the application of benefits in many cases is tied to whether a person or company has a permanent establishment in a contracting state. A permanent establishment is now created where an individual spends more than 183 days in the other state in any 12 month period and during that time more than 50% of the gross revenue generated by the business is derived from services rendered in the other state by that individual. A permanent establishment may also be created where services are provided in the other state for more than 183 days in any 12 month period with respect to a project for a resident of the other state.
Consistent with changes in the definition of “permanent establishment” mentioned above, the blanket exemption from taxation available to individuals or businesses providing business services in the other state (but not through a permanent establishment) has been repealed. Now, “business profits” are taxable in each state on a basis proportional to the activity carried out through a permanent establishment in each state.
This now means that any self U.S. employed individual or corporate entity which meets the above definition of “permanent establishment” will not be exempt from taxation but will be proportionally taxable in Canada on the net income earned while conducting business in Canada.
(h) Election to Treat Non Resident Alien Spouse as a U.S. Resident
In general, a person who is a nonresident alien at the end of the tax year and who is married to a U.S. citizen or resident may elect to be treated as a U.S. resident for income tax purposes, if both spouses so elect.
As a result of the election:
- you and your nonresident alien spouse agree to be subject to tax on your worldwide income;
- you may claim a personal exemption for your spouse;
- you may claim deductions for items that were paid by your spouse which would not otherwise be deductible by you if you filed a
- separate income tax return;
- your income would be subject to tax at the rates for married taxpayers who file joint returns;
- any exempt income of your nonresident alien spouse from a public international organization remains tax exempt;
- your nonresident alien spouse may not, for U.S. income tax purposes, claim the benefits from any U.S. income tax treaty.
- An election may require the inclusion of investment income for taxation under the Net Investment Income tax.
The decision to make this election depends on your income, both U.S. and foreign, and normally requires that at least two alternative tax filing situations be prepared to determine whether the election should be made.
Every individual who files a U.S. income tax return must have a valid identification number issued by the Social Security Administration and acceptable to the IRS. For U.S. residents, citizens, and visa holders entitled to work in the U.S., a Social Security Number (SSN) is required, and is available by completing form SS-5 (Application for a Social Security Card). For
spouses, dependents and non-residents who file a U.S. tax return or are claimed as dependents on a U.S. tax return but are not permitted to work in the U.S., an Individual Taxpayer Identification Number (ITIN) is required, and is available by completing form W-7 (Application for IRS Individual Taxpayer Identification Number). Effective in 2012, the Certifying Acceptance Agent program has been eliminated, and all new applications must be accompanied by an original certified copy of a passport, issued by the home country passport office.
Tax forms which do not have the appropriate identification numbers will not be accepted by the IRS, and claims for dependents without appropriate numbers will be disallowed. ITINs issued before 2013 and not used in three years may need to be re-applied for starting in 2016.
Partnerships, corporations and self employed persons should apply for an Employer Identification Number (EIN) by filing form SS-4 (Application for Employer Identification Number).
The Foreign Account Tax Compliance Act (FATCA) was introduced in 2010, and is intended to increase reporting and compliance of foreign financial assets by U.S. citizens and residents.
Starting in 2016 U.S. persons who held an interest in any foreign bank account must file form FINCEN 114 with the Department of the Treasury, electronically, by the (extended) due date of the return. Serious penalties apply to late or incomplete returns. This form details the bank and securities accounts and discloses the maximum balance held in each account at any time in the year.
A U.S. person who holds an interest in many specified foreign financial assets over specified threshold amounts must also file form 8938 with the tax return. Specified foreign financial assets include bank and securities accounts, foreign company pensions, foreign grantor trusts, interests in RRSP accounts, interests in controlled foreign corporations and other financial assets.
U.S. persons who have an interest in a Passive Foreign Investment Company (PFIC) must also file form 8621. Many Canadian mutual funds and holding companies are considered PFIC holdings, and give rise to additional reporting requirements, and for the possible inclusion of unrealized changes in market value in current income. Provisions do exist for deducting unrealized losses. It is not recommended that U.S. citizens hold investments in PFIC assets without prior analysis of the possible negative tax effect.
Canadian TFSA (Tax Free Savings Accounts) among other types of foreign trusts, are considered foreign grantor trusts for U.S. purposes. Accordingly, any U.S. person who is a beneficiary of a foreign grantor
trust must file form 3520 in Ogden, UT at the due date of the 1040 return.
In addition, the foreign grantor trust itself must file a return each year on form 3520A by March 15 for the prior year. This date can be extended to September 15 if an extension is filed before March 15.
Serious civil penalties ($10,000 per return per year) apply for late or inadequate filing of either return.
Each individual resident within the United States must maintain minimum essential health care coverage for themselves and their dependents, or pay a shared responsibility penalty. For 2016 & 2017 the maximum penalty has increased to the lesser of 2.5% of household income and the national average for bronze level health coverage, which is $2,676 per individual.
Premium assistance is available for lower income Taxpayers.
The shared responsibility penalty has been eliminated for 2019 and subsequent years.
United States Citizens living outside of the United States are exempt from this requirement.
Since Canada imposes an income tax on residents based upon their world income earned within and outside Canada, and since Canada has income tax laws dealing with the taxation of the activities of non residents, it is important to understand the role that residence plays in determining the liability for income tax.
(i) Residents of Canada
Surprisingly, there is no specific definition of residence in the Canadian Income Tax Act, but residence is determined as a question of fact. Primarily, any person who spends more than 183 days in any year in Canada is considered a resident. In other cases the court system in Canada has held that the residence of an individual is the place where they customarily live. In determining residence, such factors as the following are taken into account:
- Permanence and purpose of being outside Canada. Generally, absences of less than two years are not considered sufficiently permanent to sever residential ties with Canada for tax purposes.
- Residential ties in Canada, including the maintenance of a home, location of dependents, investments, bank accounts, health coverage, drivers license, club memberships, professional memberships dependent on residence, personal property, vehicles, social ties, telephone listings, etc.
- Residential ties abroad, including visa status outside Canada, income, occupation and social ties. If a Canadian has not established a domicile in another country, he may be considered to have maintained Canadian residence. The type and duration of visas have a role in this factor.
- Regularity and length of visits to Canada, can establish continued residence in Canada.
Residents of Canada who give up residence in the year are deemed to have disposed of all of their capital properties at fair market value at the time of departure from Canada, giving rise to deemed capital gains or losses which are reportable in the year of departure. “Taxable Canadian Property” such as Canadian real estate are listed as assets but are not subject to the
deemed disposition rules on departure. For U.S. citizens who have migrated to Canada, a similar valuation of capital property was deemed to have occurred at the time of entry into Canada. Accordingly, only the difference between the fair market value of capital properties owned (anywhere in the world) when leaving Canada as compared to the fair market value of capital properties owned when entering Canada is used in the capital gains calculation upon departure, and only where a person has resided in Canada over 60 months.
(ii) Deemed Residents of Canada
Persons who have sojourned in Canada for 183 days or more in any year are deemed to be residents of Canada, and must report world income on their Canadian income tax return for the year. In the year of departure from Canada, both spouses are deemed to be resident in Canada until the date of the latter of the two to depart, unless both spouses immigrated to Canada. Care should therefore be taken to ensure that unplanned periods of tax residence in Canada are not encountered.
(iii) Deemed Non Residents of Canada
Under new interpretations of the tie breaker rule contained in the Treaty, certain persons, after February 25, 1998, are deemed to be non residents of Canada if they maintain closer connections to a country other than Canada. Persons in this category would pay tax to Canada only on Canadian source income regardless of the amount of time they spend in Canada.
Many individuals may find themselves residents of both Canada and the U.S. as a result of the application of the residence rules of Canada and the U.S. Under these circumstances, the individual is taxable on world income in each jurisdiction, and careful planning must be undertaken to apply the tax laws of both countries in the appropriate order and in a proper manner. Failure
to fully understand the special needs and obligations of dual residents can result in adverse income tax treatment in either or both jurisdictions, including the imposition of penalties and interest.
Under dual residence circumstances, double taxation can be eliminated if filings are made on a timely and accurate basis, as described in the following section.
Article XXIV of the Canada - U.S. Income Tax Convention, 1980 sets out the rules related to foreign tax credits which are available in circumstances where each country claims a right to tax the same income. The Treaty also deals with the treatment to be applied to specific types of income, specific occupations or business endeavors, the determination of residence, and withholding taxes.
By invoking protection under the Treaty, an individual or company claims special exception from taxation under the specific tax laws in either Canada or the U.S. as a result of a potential for double taxation.
Essentially, the Treaty provides that taxpayers, (with the exception of U.S. citizens in some cases), be taxed in their country of permanent residence, unless they have a “permanent establishment” or “fixed base” available to them in the other country. A “permanent establishment” or a “fixed base” has been defined to be an office, a permanent residence, or can be established through the use of an agent who has authority to bind the taxpayer. A resident of the United States, therefore will generally be taxable in the U.S. only, unless he has a permanent establishment available to him in Canada, and then will only be taxable in Canada on income associated with that permanent establishment. Under certain circumstances, such as where a part year resident of the U.S., or a spouse of a U.S. citizen elects to be taxed as a U.S. resident for the entire year, Treaty protection is not available.
Residents of both Canada and the U.S. may find that their overall income tax liability in any year is not affected by a requirement to file and pay U.S. income taxes, since the operation of the foreign tax credit allows a deduction from Canadian tax to the extent that the same income has been taxed in the U.S.
U.S. citizens and residents who work in Canada and are exempt by Treaty from Canadian taxation may apply for exemption from withholding of income and other taxes in Canada, but must have taxes withheld if their income, time present in Canada or other factors disqualify them from Treaty protection. Although the Treaty deals with a wide variety of topics, many issues have been left unresolved, and the courts have, in the fullness of time, made pronouncements and have further interpreted its provisions.
Income taxes paid by U.S. citizens to foreign countries may either be deducted from income taxable in the U.S., or claimed as a credit on form 1116. Although generally it is more advantageous for U.S. citizens living in Canada to claim the credit, an amended return may be filed within 10 years if you change your mind.
In order to claim a foreign tax credit, the tax paid on each separate class of income, and for each country, must be considered separately. Credits may not be claimed for income taxes paid on any other class to reduce taxes otherwise payable on a different class. Foreign tax credits are restricted to tax paid only on foreign source income.
The following are the classes of income considered for the purposes of filing form 1116:
- Passive income.
- General limitation income – all other income.
The purpose of the different income classes is to prevent the payment of tax on a highly taxed income class from offsetting other income earned in lower taxed classes.
U.S. citizens living and working in Canada may find that they have paid Canadian income taxes on employment or other income. Under these circumstances, the credit available is restricted to the actual amount of tax paid or accrued on each specific
category of income. Foreign income taxes which cannot be used in a given year can be carried forward to be used in respect of the same category of income in future periods for a limited time.
If you are a U.S. citizen or resident alien and if you meet the following tests, you can elect the "foreign earned income exclusion" provided for in Section 911 of the Internal Revenue Code. If you qualify, in 2019 you may exclude up to $105,900 of earned income from taxation in the U.S.
First, you must have a "tax home" in a foreign country. This means your main place of business or employment must be in a foreign country on either a permanent or indefinite basis. Your principal home can still be in the U.S., but if your foreign assignment is merely temporary, you will not qualify for the exclusion. Even if your foreign assignment is temporary and you do not qualify for the exclusion, lodging and meals expenses of a temporary assignment can be deductible travel expenses. Your assignment will not be considered temporary, however, if it's for more than a year. Secondly, while having the above tax home, you must either meet the bona fide foreign residence test or the foreign physical presence test.
(i) Bona Fide Residence Test
To meet the bona fide foreign residence test, you must be a bona fide resident of one or more foreign countries for an uninterrupted period fully covering at least one calendar tax year (i.e., Jan. through Dec.). Broadly speaking, you're a bona fide resident if you have the intent to live there for the time being. You can still intend to return to live in the U.S. eventually. Also, temporary brief trips back for vacation or business will not cause you to fail this test. If you make a statement to the taxation authorities in the foreign country that you are not a resident for tax purposes, you will fail the Bona Fide Residence test.
(ii) Physical Presence Test
For the physical presence test, you must be physically present in a foreign country for 330 full days during a period of 12 consecutive months. For this test, the months do not have to cover an entire calendar tax year but they can run, for example, from June through May of the next year. Interestingly enough, the same periods may be used to qualify for successive years, or the days may overlap from one year to the next. In this way you can use some of the same days as in the prior year to qualify for the current year.
If you qualify under the above tests, you can exclude the lesser of (1) $105,900 or (2) your foreign earned income for the year. (If your spouse qualifies as well, an exclusion is separately determined for him or her.) Remember that the exclusion applies to earned income only, and for example income paid by the U.S. government and income received as a pension or annuity is not included in foreign earned income. The $105,900 amount must be computed on a daily basis if you do not satisfy the tests for the entire year. If, for example, you qualify for the exclusion under the bona fide residence test for the last 40 days of 2018 (and then for all of 2019). For 2018, the maximum exclusion is 40/365 times $105,900, which equals $11,605. (For 2019, the entire $105,900 -indexed for inflation- exclusion is available.) A similar adjustment would be made if your qualifying days under the physical presence test were less than 365 for the year.
If your employer covers all or part of your foreign housing costs you may also qualify for a foreign housing cost exclusion. (In some cases, however, this may reduce your foreign earned income exclusion.)
Note that the foreign earned income exclusion is elective, not automatic. If you elect to take advantage of the exclusion, you cannot also claim a tax credit for taxes paid to a foreign country allocable to the excluded income. Thus, in some cases you will have to compare the tax savings of the exclusion with those of a credit. Since the foreign earned income exclusion is deducted from the “bottom” rate of tax, more intensive comparison may be necessary.
Here are some income tax planning considerations when determining which to claim:
- If you are an employee who expects to work in countries that have a lower tax rate than the U.S., the election should be made.
- If you are engaged in a profitable trade or business in a foreign country that has a lower tax rate than the U.S., the foreign earned income exclusion should be made.
- If your tax liability can be offset completely by a foreign tax credit, the election shouldn't be made. Due to the offset, there is no advantage to making the election, but by making it, you may restrict future flexibility.
- If you are engaged in a trade or business in a foreign country that produces a net loss, claiming the foreign earned income exclusion will result in a reduction of expenses attributed to the excluded income. This may reduce the loss available to offset other worldwide income to your disadvantage.
The operation of the Alternative Minimum Tax (AMT) rules may sometimes limit the benefit of items otherwise deductible. Based upon the principle that “preference items” should not completely eliminate taxes, all income items and deductions are recalculated using the AMT rules, and a separate tax rate is applied, subject to the AMT deduction. The tax actually payable in any year is the higher of the tax calculated under the regular rules, and that calculated under the AMT rules. Although the rules for AMT calculation differ in the U.S. and Canada, they operate in a similar manner, and can give rise to a tax liability where no tax would otherwise be payable. Care should be taken to take the AMT consequences into account in any international tax plan.
Currently, a full AMT foreign tax credit may be claimed, thus eliminating AMT for many expatriates.
An international agreement respecting social security between Canada and the U.S. sets out the rules for social security taxation for residents of one country working in the other. This agreement, also known as the Totalization Agreement, provides that a U.S. citizen working in Canada on a temporary assignment (of up to 5 years) for a U.S. company is exempt from Canada Pension Plan (CPP) if he remains covered by U.S. social security.
In order to prove coverage under U.S. social security, a certificate must by obtained from the Social Security Administration. This certified form then acts as the authority not to withhold and remit Canadian social security taxes at source from employment income. A similar exemption is available to self employed U.S. citizens who work temporarily in Canada. (Reciprocal rules are available for Canadian residents working for Canadian companies temporarily in the U.S.)
However, U.S. citizens employed by Canadian companies in Canada are not eligible for relief under the Totalization Agreement. Caution should therefore be used in the transfer of employees to Canada to ensure that the transferees remain residents of the U.S., and continue to be engaged by the U.S. company (or its subsidiary), since a person would not be covered under Social Security where he/she was considered to be "an employee engaged locally outside the United States".
Even though all Canadian social security taxes are available as a foreign tax credit to U.S. citizens working Canada (subject to limitation for income excluded under IRC 911) – resulting in no overall increase in tax to the employee, the benefits of the Totalization agreement are:
- If the employee were engaged in Canada for less than the 10 year minimum period for eligibility for CPP pension, all CPP contributions would be wasted.
- While the employee is working temporarily in Canada, social security taxes will continue to be paid, and will count toward eventual Social Security benefits;
U.S. residents who hold Canadian RRSP accounts are exempt from the taxation of any income earned within the RRSP plan unless it is withdrawn, since an RRSP is recognized under the Treaty. as a foreign pension arrangement. Form 8891, which was previously used to separately report RRSP holdings, has now been eliminated. RRSP holdings are reportable on forms 8938 (if applicable), and must be reported on form FINCEN 114.
Under provisions of the Fifth Protocol to the Convention, a Roth IRA is considered a “pension” for the purposes of Article XVIII(3)(b) as long as no contributions are made to the plan while a resident of Canada after December 31, 2008.
To ensure that income earned within a Roth IRA is deferred and considered a “pension” under Article XVIII of the Convention, an election must be made by April 30 after the year a person becomes or is considered a resident of Canada. Income earned after the date of a “Canadian Contribution”, based on the contributions made while a resident of Canada will be considered taxable in Canada in the year earned.
Any US person (including someone who becomes a US person during the year) must include in current taxable personal income on his 1040, his distributive share of Subpart F income earned by a foreign controlled corporation during the year (subject to some deductions for qualifying deficits).
Subpart F income includes income of the foreign corporation which relates to passive activities like rents, interest and dividends (unless part of active business) illegal payments, bribes, etc., services rendered outside the foreign country, foreign personal holding company income, sales commissions earned for sales outside of the foreign country, etc. as defined below. Subpart F income does not include active business income from operation of a business in the foreign country.
The thrust is to include in US personal taxable income passive income of US persons which has been channeled through a foreign country.
In order to disclose all relevant information related to a Canadian Corporation, form 5471 must be filed each year with the shareholders income tax return. Form 5471 requires a comprehensive reporting of all transactions which have occurred within the foreign corporation during its last fiscal year. This means that a detailed report about balance sheet items, income statement items, and transactions with shareholders must be reported on a multi-page form, both in United States dollars and foreign currency. There are serious penalties for failure to file form 5471.
Under U.S. corporate law, companies which exceed certain threshold amounts of retained earnings are required to pay a 20% penalty tax on accumulated earnings. This law is contrary to the usual method of Canadian corporate tax planning, under which active business income earned in Canada are taxed at a very low rate and left in small companies retained earnings to accumulate indefinitely.
Since U.S. citizens living in Canada are required to apply U.S. law to corporations which they control, this favored method of tax planning in Canada is not available, and dividends must be paid out regularly to ensure that the Canadian corporation does not exceed U.S. accumulated earnings tax thresholds of $150,000 for professional, scientific and similar companies and $250,000 for other companies. Failure to do so will result in possible double taxation.
1.07 Foreign Corporation Treatment in the U.S.
If a Canadian spends sufficient time in the U.S. and meets the substantial presence test, the result may be that he/she becomes liable to reporting the operations and retained earnings of Canadian corporations. Under the transition to the participation exemption system of taxation earnings retained while the corporation is a “controlled foreign corporation” is subject to tax in the U.S. This tax is applied to all earnings retained within the corporation since 1986.
In order to understand the implications of the new rules, it is important to define some terms used in the legislation:
A deferred foreign income corporation (DFIC) with respect to any U.S. shareholder is any "specified foreign corporation" of the U.S. shareholder that has accumulated post-1986 deferred foreign income as of November 2, 2017, or December 31, 2017, greater than zero (Code Sec. 965(d)(1), as amended by the 2017 Tax Cuts Act).
A specified foreign corporation is (1) a CFC, or (2) any foreign corporation in which a domestic corporation is a U.S. shareholder.
Therefore, insofar as an individual who becomes a U.S. person by residing in the U.S. and who has accumulated retained earnings in a controlled corporation (while a U.S. person), the transition tax appears to be applicable to the entire amount of earnings retained since 1986, even though these earnings were not considered subpart F income in all prior years because they were from active business income carried out in Canada.
The mechanism for the imposition of the transition tax is subpart F income. Therefore for the last tax year beginning before January 1, 2018 the subpart F income of a deferred foreign income corporation is increased by the accumulated post 1986 deferred foreign income (net of certain deficits) of the corporation as of either November 2, 2017, or December 31, 2017, without regard to the nature of the income accumulated.
A person who is a U.S. shareholder of any controlled foreign corporation (CFC) is required to include its global intangible low-taxed income (GILTI) in gross income for the tax year in a manner generally similar to that for Subpart F inclusions. The computation of GILTI is complex and requires the calculation of certain items of each CFC owned by U.S. shareholders, and then a single GILTI inclusion amount is determined by reference to all the U.S. shareholder’s CFCs. The provision applies to tax years of foreign corporations beginning after December 31, 2017, and to tax years of U.S. shareholders with which or within which such tax years of foreign corporations end.
The GILTI inclusion is treated similarly to a subpart F inclusion, for some purposes, but it is determined in a very different manner. In comparison to the computation of GILTI, subpart F income is determined at the level of the CFC and then included in the gross income of the U.S. shareholder according to the U.S. shareholder’s pro rata share of the income. The computation of the U.S. shareholder’s pro rata share of the CFC’s subpart F income is generally the last step in the process. The amounts are taken into account on a CFC-by-CFC basis. Because the GILTI inclusion amount is determined on the basis of all of the U.S. shareholder’s CFC, it ensures that the U.S. shareholder is taxed on GILTI, wherever it is derived.
Canadians who spend significant time in the U.S. and U.S. citizens resident in Canada must be aware of these new rules to prevent the imposition of these new taxes on Canadian corporation activities.
In order to cease to be taxable in Canada, an individual or corporation must give up Canadian residence, and in the case of non-U.S. citizens, U.S. residence. A U.S. citizen may cease to be taxable in the U.S. only under certain circumstances, and only by revoking U.S. citizenship before a consular officer.
(i) Mark to Market Tax:
Effective June 17, 2008, new Internal Revenue Code section 877A provides for an expatriation tax for “covered expatriates”. Effectively, this means that the expatriate is deemed to have disposed of all capital property at fair market value as of the date of expatriation, and must pay tax on the net gain if either net worth exceeds $2 million or if average US tax liability for the last 5 years exceeds $160,000.
(ii) U.S. Citizen Expatriates:
A U.S. citizen becomes an “expatriate” on the earliest of the following dates:
- The date U.S. nationality is renounced before a U.S. consular officer;
- The date the individual provides a written statement of voluntary relinquishment of U.S. nationality which is accepted by the State Department;
- The date the State Department issues a certificate of loss of nationality; or
- The date a U.S. court cancels a certificate of naturalization.
(iii) Long Term Resident Expatriates
An individual is considered a “long term resident” of the U.S. is a person who was a lawful permanent resident of the U.S. for at least eight of the past 15 tax years. Long term residential status is terminated by losing a green card status, either through revocation or by abandoning residential status. An individual also ceases to be treated as a long term permanent resident
of the U.S. if they are treated as a resident of another country with which the U.S. has a Treaty, and if they do not waive rights under that Treaty, and notifies the Secretary of State of that treatment.
Caution is therefore required by any long term green card holder who does not meet the residential requirements of that status, since they may inadvertently become expatriates under IRS code 877A.
A U.S. citizen who lives abroad and who does not revoke the application of any foreign tax treaty, is deemed for U.S. purposes to be taxable in the U.S. Accordingly, the 10 year period begins only after the revocation of citizenship and the cessation of the use of treaty provisions.
(iv) Covered Expatriates:
In order to be subject to the “mark to market” tax , an expatriate must be considered a “covered expatriate” by meeting one of the following tests:
- Average net income tax liability in the U.S. for the past five years must exceed $160,000 per year;
- The individual must have a net worth exceeding $2 million dollars; or
- The individual has not complied with U.S. tax filing obligations for the prior five years.
Note the importance for all persons who hold U.S. citizenship or residential status to file U.S. income tax returns each year.
The above tests do not apply to minors, or persons who were born both as a U.S. citizen, and the citizen of another country.
(v) Calculation of the Tax:
Any individual who expatriates on or after June 17, 2008 must complete and file form 8854 to satisfy whether they meet the “expatriate” and “covered expatriate” tests, and to provide net worth, income, and basis information required to calculate the tax, if it is applicable.
The tax is calculated under normal IRS code provisions as if all property was disposed of at fair market value as of the expatriation date, but only if the net gain exceeds $690,000. Wash sale rules, deferral benefits such as incomplete like-kind exchanges, and involuntary conversions are eliminated. The stepped up basis rule applies to property that was held on the
date an individual first became a U.S. resident as defined in IRC 7701(b), unless an irrevocable election is made not to have this rule apply.
(vi) Consequences of US Expatriation:
Persons who expatriate from the U.S. and who spend over 30 days in the U.S. in any of 10 years after expatriation will be considered taxable in the U.S. as if they were citizens. The allowable period of presence in the U.S. is extended to 60 days per year under certain circumstances.
Persons who are not residents of Canada are taxable in Canada on certain income from Canadian sources. Although this is a very large topic in taxation, this article will limit discussion to the taxation of former residents of Canada who derive income from Canada.
(i) Consequences of Leaving Canada
Where an individual ceases to be a resident of Canada there is deemed to be a disposition of all of the property of the individual at fair market value, and an immediate deemed re-acquisition of the property. The effect of this is to ensure that a person departing Canada will be subject to capital gains tax on accrued increases in property value while a resident of Canada. “Taxable Canadian Property”, including real estate, business property and some other assets are exempt from this treatment, but the taxpayer may to dispose of any or all of these items in any event.
No provision is made in the U.S. for revaluing the capital property at the time of entry into the U.S. (except in the case of non resident aliens moving for the first time to the U.S. and who are subject to deemed disposition in Canada, and for Canadian principal residences). Unlike the Canadian capital gains rules, which intend to tax capital gains only while a resident of Canada, dispositions of property by U.S. citizens will be subject to U.S. tax on the entire gain or loss from the date of acquisition.
(ii) Rental Real Estate in Canada
Where a non resident receives rental income from sources in Canada, the non resident may elect pursuant to Para. 216 of the Act to file a return of income respecting the rental property under Part I, rather than being taxed under Part XIII (withholding taxes - non residents). Non resident taxes are normally calculated on the gross rental income received, unless form NR6 is filed to anticipate the expenses associated with a particular rental property. Even though no personal exemptions may be claimed on a Para. 216 tax return, an RRSP deduction may be made to the extent a contribution is made within available room. The effect of Para 216 on net income is usually beneficial. Of course, all rental income must be disclosed on schedule E to form 1040 in the U.S., subject to foreign tax credits for taxes paid abroad.
(iii) Registered Retirement Savings Plans
No rollovers of Canadian RRSP’s are feasible to U.S. IRA’s or similar plans (or visa versa), since such a transfer would be considered a distribution under Canadian law, and would trigger taxation in both countries under the Convention. Accordingly, persons returning to the U.S. after a work period in Canada should consider leaving their RRSP intact, and drawing funds from the plan only upon retirement or as provided for under Canadian law.
Upon withdrawal, Canadian RRSP funds will be subject to a 25% (for lump sum withdrawals) or 15% (for annuities) non resident withholding tax (to non residents) and a non resident may elect to file a return under Para 217 of the Income Tax Act respecting RRSP income in any year, as long as such a return is filed by June 30 of the following year. Para 217 permits the filing of a return to include only the RRSP income of the non resident, but uses the non resident’s world income for calculation purposes. This elective return is normally beneficial to persons not earning any income while a non resident
For U.S. tax purposes, RRSP withdrawals are taxable as pension income, and eligible for a foreign tax credit for non resident withholding taxes imposed by Canada. Income earned within an RRSP is not subject to U.S. tax unless withdrawn. In the state of California, however, income earned within an RRSP is taxed for state purposes annually, and as a result RRSP withdrawals consisting of contributions prior to entry to California, and income reported in California are not taxable at the state level.
(iv) Other Income
Part XIII of the Income Tax (Canada) imposes a withholding tax on various forms of income from Canadian sources earned by non residents.
The U.S. and Canada have considerably different systems of taxation related to the estates of deceased persons. Accordingly, it may be appropriate for expatriates to have separate Canadian and U.S. wills and/or trusts to facilitate estate planning.
In the U.S., although estate tax is based on the value of the estate at the date of death (or the alternative valuation date which can be up to 6 months after the date of death), the estate tax in the period before elimination of the tax is subject to tax at rates ranging from 18 to 40%,
Gift tax is levied on persons who transfer portions of their otherwise taxable estate to beneficiaries, by way of gift. The tax may not be immediate, since taxable gifts over the lifetime of the grantor will reduce the estate tax exemption until it is depleted. For 2016, there is an annual exclusion of $15,000 per donee for gifts.
Each U.S. citizen or resident taxpayer is allowed an exemption against the gift and estate tax. The exemption amount shields a total transfer of $11.4 Million per person from tax in 2017.
The estate tax system is designed to defer the major tax cost until the second of a married couple die, since transfers to a U.S. spouse are exempt from estate taxation (by the application of the marital credit). Qualified trusts are also used to plan an orderly taxation of estates. Severe complications may result in cases where a U.S. citizen is married to a non resident alien, since the U.S. citizen’s estate may be increased by a bequest from a non resident alien spouse. Specialized planning including the use of trusts is recommended in such cases.
The exemption against estate tax is reduced by taxable lifetime gifts (since 1932) exceeding the annual gift limit, (which is $15,000 for 2019) thus reducing the opportunity for distributing an estate during the lifetime of the decedent.
A foreign gift is any amount you receive from a non-US person which you treat as a gift or bequest. A non-US person is any person other than a citizen or resident of the US or a domestic partnership or corporation. The term non-US person also includes a foreign estate or a trust treated as a foreign trust.
Foreign gifts do not include qualified tuition or medical payments made on behalf of the recipient or gifts which are otherwise properly disclosed on a return under the separate requirements applicable to amounts received from foreign trusts. Foreign gifts and bequests which are reportable, must be reported each year on form 3520.
For Canadian purposes, a Canadian resident, is deemed to have disposed of all property owned at the date of death at fair market value, thus triggering capital gains tax on any unrealized capital gains, with the tax payable by the estate. Tax deferred items, such as RRSP’s are deemed to be disposed of at the same time, giving rise to regular income for the estate in the year of death, subject to certain rollovers available to the spouse of the deceased. In order to alleviate some of the tax burden resulting from these dispositions, the estate is permitted to file up to four separate income tax returns for the same decedent for the year of death for four separate classifications of income. A personal exemption may be claimed on each of the returns, and income tax is calculated on each return at graduated rates, starting from zero. The beneficiaries of the estate receive the property with a tax value equal to the fair market value used by the estate on the deemed disposition, and there is no system of estate taxation.
Paragraph 3 of Article XXIX B of the Treaty allows a special marital credit for transfers of property to a surviving spouse who is not a U.S. citizen, but a citizen of or resident of Canada. To limit the provisions of this article to smaller estates, if certain conditions are met, this Treaty article allows for a marital deduction limited to the lesser of either the tax which would otherwise be payable on assets transferred to the spouse, or the amount of credits otherwise available. In order to invoke this special “Canadian Marital Credit”, the trustee must waive the benefits of any marital deduction which would normally be available under U.S. law.
The Death Tax Elimination Act signed on March 29, 2001 taxes only assets located in the U.S. and allows an exemption of the greater of $60,000 or the proportion of $175,000 that the U.S. situated assets represent of the entire estate. There is special relief from U.S. estate taxation for small Canadian estates with a total value under $1.2 million. In international estates, the marital credit is limited to spouses who are U.S. citizens. Many U.S. citizens married to a non citizen spouse use U.S. Qualified Domestic Trusts (QDOT) to allow a deferral of tax on transfers on death.
Since the basis of taxation of estates is different in Canada and the United States, no foreign tax credit is permitted. However, Canadian capital gains taxes resulting from deemed dispositions on death are deductible from the gross estate for U.S. purposes. Small estates (currently not in excess of 1.2 million dollars in worldwide assets) are exempt from estate taxation in the U.S., but may be subject to taxation in Canada if any unrealized capital gains exist.
This summary has been designed to provide a concise overview of the subjects addressed, and may not be complete. Reference should be made to original legislation prior to acting on any matter, and professional advice should also be obtained.
Please contact us for a confidential review of your individual situation. To ensure compliance with requirements imposed by the Internal Revenue Service, we inform you that any tax advice contained in the body of this document was not intended or written to be used, and cannot be used, by the recipient (a) for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions and (b) for the purpose of promoting, marketing, or recommending any tax related matters addressed within to another party.
Mark T. Serbinski CA, CPA