Personal income tax laws differ greatly between Canada and the United States of America. One of the primary differences is that Canadian income tax laws are based on residency, while U.S. tax laws are based on citizenship.
This article is about the U.S. and Canadian tax consequences of U.S. citizens living in Canada. Readers are cautioned that information in this article is for general purposes only and does not purport to provide specific advice. It also not an exhaustive list of tax considerations. Individuals should consult with a tax professional. The author bears no responsibility for the use or dissemination of this information.
Personal income tax laws differ greatly between Canada and the United States of America. One of the primary differences is that Canadian income tax laws are based on residency, while U.S. tax laws are based on citizenship. For the sake of simplicity this means that if an individual is a full-time permanent resident of Canada, then the person will be taxed on their worldwide income in Canada. It doesn’t matter whether the person’s citizenship is U.S. or some other foreign nationality, they are taxable in Canada. If a Canadian citizen or resident at some point leaves Canada for a different country, and severs all ties with Canada, they are no longer a resident of Canada and not subject to Canadian income tax laws.
U.S. citizens on the other hand, have an ongoing obligation to declare and report their worldwide income to the U.S.A., regardless of where they reside. U.S. citizens who have permanently departed the U.S.A. and have become full-time permanent residents of Canada are still required to file U.S. income taxes on an annual basis with the Internal Revenue Service (IRS). The only way for U.S. citizens to avoid this would be to go through a process to renounce their U.S. citizenship, which is not practical or desirable for most people. Therefore, a U.S. citizen who resides in Canada is essentially subject to the same U.S. filing requirements as they would if they continued to reside in the U.S.A. This means filing U.S. Form 1040 every year, and reporting worldwide income.
The bottom line for U.S. citizen residents of Canada is that they must file two returns each year – a Canadian income tax return because they reside in Canada, and a U.S. return based on being a U.S. citizen. The Tax Treaty between Canada and U.S.A. has several mechanisms available know as foreign tax credits, to make sure the person does not have to pay duplicate taxes to both countries.
Forms to File
The 1040 form is the standard documentation for filing U.S. income tax returns to the Internal Revenue Service (IRS). Most likely there are many other forms required to be filed, including Form 2555 and Form 1116, to name a few. Some of the additional forms are discussed in this article, but this is by no means an exhaustive list. Readers are encouraged to contact the IRS, or their U.S. tax professional for guidance.
Besides filing an annual tax return (Form 1040), the U.S. citizen will most likely be required to submit documentation to the U.S. Treasury. Prior to 2013, form TD F 90-22.1 Foreign Bank Account Reporting (FBAR) was used, which essentially provides the U.S. Treasury with information on their Canadian bank accounts and other financial holdings (See note below). Form TD F 90-22.1 was a paper based submission to the IRS office in Detroit, Michigan. Effective for 2013, FBAR must now be electronically submitted to FinCEN (Financial Crimes Enforcement Network) via the BSA E-Filing system (Bank Secrecy Act). The BSA E-Filing system requires that taxpayers, or their tax professionals, have internet access. The new FBAR format, rules and information required is essentially unchanged from Form TD F 90-22.1
The FBAR form must be filed annually to report direct or indirect financial interests in all foreign accounts if the aggregate value exceeds US$10,000 at any time in the calendar year. Disclosure of this information is mandatory. U.S. citizens who are required to file FBAR and fail to properly file may be subject to a civil penalty not to exceed $10,000 per violation. If there is reasonable cause for the failure and the balance in the account is properly reported, no penalty will be imposed. A person who willfully fails to report an account or account identifying information may be subject to a civil monetary penalty equal to the greater of $100,000 or 50 percent of the balance in the account at the time of the violation.
Effective 2014, under the new Foreign Account Tax Compliance Act (FATCA), non-US financial institutions will be required to identify and report on accounts held for U.S. citizens. Although the reporting requirement for foreign financial institutions doesn’t begin until 2014, foreign financial institutions are required to begin their process of identifying U.S. citizens who have an interest in financial accounts.
As of the 2011 tax year, there are two additional FATCA disclosure requirements. First, U.S. citizens who have foreign accounts/assets with an aggregate value exceeding a specified amount are required to disclose certain information about these accounts on Form 8938, Statement of Specified Foreign Financial Assets. The IRS will use the information reported on this form to ensure that the income attributable to these foreign assets/accounts is properly reported on the individual’s U.S. income tax return. A single U.S. citizen/US resident living abroad would be required to complete Form 8938 if they have specified foreign assets with a value that exceeds US$200,000 at the end of the year or S$300,000 at any time during the year. Specified foreign assets can include (but are not limited to: bank accounts, RRSPs, stocks, pensions/annuities, partnerships, trusts, debt instruments, mutual funds and insurance contracts). Form 8938 must be attached to the individual’s U.S. income tax return. The disclosure requirement is in addition to the FBAR previously mentioned.
The second reporting requirement that was implemented as of the 2011 tax year requires U.S. citizens who have shares in a passive foreign investment company (PFIC) to disclose certain information regarding their investment in the PFIC on an annual basis. In general, a PFIC is a non-US corporation that derives most of its gross income as passive income or at least half of its assets produce passive income or are held for the production of passive income). In determining whether or not you have a reporting requirement for a PFIC, it is important to note that a Canadian mutual fund would be classified as a corporation regardless of the fact that it may be classified as a trust for Canadian income tax purposes. As such, if you hold units in a Canadian mutual fund, you may be subject to the new PFIC reporting requirements. In previous years, there was a reporting obligation with respect to PFICs (on Form 8621) only if there were transactions related to the investment (such as a distribution or a sale). However, the Form 8621 must now be filed even if there has been no activity related to the PFIC.
Additional reporting is required if the person owns investments such as Registered Retirement Savings Plans (RRSP), Registered Retirement Income Funds (RRIF), Tax Free Savings Account (TFSA), and Registered Education Savings Plan (RESP).
Income within an RRSP and RRIF grows tax-free for Canadian income tax purposes, but same annual income is considered to be taxable income for U.S. income tax purposes. However, there is an opportunity to mitigate double taxation, using the U.S. / Canada Treaty. The Treaty provides an election (on IRS Form 8891) that can be made to defer the U.S. income tax on that investment income for U.S. federal tax purposes until the funds are withdrawn. If the treaty election is made, the timing of the taxation becomes the same for both countries and foreign tax credits can be used to minimize any double taxation. Keep in mind that Form 8621 may also be required if the RRSP/RRIF holds a Canadian mutual fund, regardless of the fact that an election has been made to defer the income earned in the RRSP/RRIF. A further point to remember with regards to RRSPs, is that RRSP contributions are deductible for Canadian income tax purposes, but they are not deductible for U.S. income tax purposes.
Income earned in a TFSA is tax-free for Canadian tax purposes, however the same income earned is taxable for U.S. income tax purposes. Therefore the TFSA may not always be a recommended investment vehicle for a U.S. citizen. Keep in mind that the TFSA may be a beneficial savings vehicle for U.S. citizens residing in Canada if the individual has foreign (such as Canadian) taxes payable on other non-US investment income (held outside of a TFSA), as the foreign taxes payable on that other non-US investment income may be applied to offset some of the U.S. income tax attributable to the TFSA income.
Income earned in an RESP is taxable for U.S. income tax purposes. As such, if either the subscriber and/or the beneficiary of an RESP is a U.S. citizen, the U.S. tax filing and reporting obligations associated with a Canadian RESP should be considered to determine the feasibility of establishing (or maintaining) the RESP.
TFSAs and RESPs are considered foreign trusts for U.S. income tax purposes and would require additional annual reporting requirements such as a Form 3520 – Annual Return to Report Transactions with Foreign Trusts and Receipt of Certain Foreign Gifts, and Form 3520A – Annual Information Return of Foreign Trust with a U.S. owner. Completion of Form 8621 may also be required if the TFSA or RESP holds a Canadian mutual fund.
Transfer of a U.S. Retirement Plan to an RRSP
If you have lived or worked in the U.S., you may have an Individual Retirement Account (IRA) or 401k plan. Leaving these accounts in the U.S. can be administratively challenging and you may wish to consider moving them to Canada. In certain circumstances, a person with a 401k or IRA may be able to rollover their U.S. retirement account to a Canadian RRSP. The process can be tricky because the tax systems in Canada and the U.S. are different.
Transfer from 401k
The 401k is an employer sponsored defined contribution retirement plan that is similar, in many respects, to the Canadian Deferred Profit Sharing Plan (DPSP). The tax implications of moving your 401k to Canada depends on whether you were a resident of Canada at the time the contributions were made to the plan.
If you were a resident of Canada when your employer contributed to the plan, you will not be allowed to rollover the 401k to an RRSP. Although you can cash out your 401k, the lump-sum will be taxable in Canada. However, you can offset this by contributing to your RRSP, if you have RRSP contribution room available.
In contrast, a lump-sum payment from a 401k considered to be in the form of pension or superannuation attributed to services rendered while you were NOT a resident of Canada, may be transferred to an RRSP without affecting your RRSP contribution room. Transferring a 401k to an RRSP without affecting your RRSP contribution room is possible provided you meet the following conditions:
• Lump-Sum Payments Only – The amount received from the 401k must be a lump-sum payment and not be part of a series of periodic payments.
• Non-Resident Contributions – As outlined above, the payment must be the result of services rendered while you or your spouse or common law partner was not a resident of Canada.
• Included In taxable income – You are required to report the gross amount (i.e. before U.S. withholding tax or the penalty tax) in your taxable income on Line 115.
• Contribute by the deadline – You must make a contribution to your RRSP for an amount up to the gross amount received within 60 days after the end of the tax year you received the lump-sum payment. This is done under Section 60(j)(i) of the Canadian Income Tax Act and is reported on Line 240 of Schedule 7. You should advise your RRSP plan provider that the contribution is a section 60(j)(i) contribution.
Remember to consider the tax Implications – the lump-sum payment will be subject to a 30% U.S. withholding tax and if you are under age 59.5, a 10% penalty tax. For Canadian tax purposes, the gross amount is included in your income and you deduct the amount contributed to your RRSP under Section 60(j)(i). The 30% withholding tax may be claimed as a foreign tax credit but if you paid the 10% penalty tax, it cannot be claimed.
An Individual Retirement Account (IRA) is very similar to a Canadian RRSP. Contributions made to the account may be deducted from income in the year the contributions were made. Income accumulates in the account free of tax and is taxed as income when withdrawn. Withdrawals or collapse of the IRA before age 59-1/2 are also subject to the 10% penalty taxes.
From a Canadian point of view, a regular IRA can be rolled into an RRSP without affecting your RRSP contribution room. The lump-sum payment must be included in your taxable income and you can make a contribution to your RRSP under s.60 of the Income Tax. Like the 401k, the IRA will be subject to U.S. withholding tax and potentially the penalty tax. The withholding tax may be claimed as a foreign tax credit. Remember to consider the tax Implications above.
Foreign Earned Income Exclusion
U.S. citizens may be able to exclude up to $97,600 from 2013 earned income for U.S. tax purposes by completing Form 2555 or Form 2555 EZ and attaching it to the 1040 Form. (The exclusion dollar amount is adjusted by the IRS annually). Form 2555 and 2555 EZ are special forms which exclude foreign earned income from taxation in the United States. To claim this exclusion the person must meet 7 specific criteria which include 3 residency tests: Bona Fide resident of Canada, Physical Present in Canada for at least 330 days during the last 12 months, and whether Canada was the ‘Tax Home’ country. If a U.S. citizen has earned income less than $97,600 in 2013, then the person may be able to complete Form 2555 EZ. In either case, this would be attached to the 1040 form.
Tax Treaty Benefits
In most cases, treaty benefits are not available to U.S. citizens by virtue of Article XXIX, paragraph 2. This provision states that nothing in the treaty can prevent the U.S. from taxing its own citizens, except for those articles listed in paragraph 3. One of these exemptions is the article governing Social Security payments. This means that if a U.S. citizen receives Social Security benefits from the U.S.A., these benefits are not taxable in the U.S. They are taxable only in Canada. A 15% deduction can be claimed on Line 256 of the T1 Canadian tax return. The deduction may be 50% if certain conditions are met.
Foreign Tax Credit or Deduction
As mentioned previously, U.S. citizens can avoid duplicate taxation by claiming a foreign tax credit on the U.S. return for taxes required to pay to Canada. To claim the credit, Form 1116 must be completed and attached to the U.S. return. Alternatively, Canadian taxes paid can be claimed as an itemized deduction. Both the deduction and credit are limited to foreign income that is subject to U.S. tax, so neither can be claimed for income excluded on Form 2555.
U.S. citizens living in Canada have an automatic extension of two months to file their U.S. tax return. This means that the U.S. return is due on June 15 each year, rather than April 15. This provides time for U.S. citizens to complete their Canadian income tax return and determine their Canadian tax liability. This extension is needed in the event that the person needs to claim the foreign tax credit on their U.S. return. The IRS also provides the opportunity for additional extensions, using the prescribed Form 4868, to a maximum of 6 months. However, it is important to note that the IRS will begin assessing interest on any unpaid balances as of April 15th.
Getting caught up – IRS Streamlined Program
Many U.S. citizens permanently living in Canada were not aware of their requirements to file annual income tax returns and FBAR forms. For instance, a U.S. citizen might have moved to Canada as a child with their family and never returned to the U.S. The person is now an adult and permanently residing in Canada on a full-time basis.
The IRS realizes that U.S. citizens who permanently departed the US, or Canadians who acquired U.S. citizenship from their parents, may not have been aware of their U.S. income tax filing obligations. On June 26, 2012 the IRS introduced the “Streamlined” program to enable taxpayers, who meet the qualifications of the program, to become current with their U.S. filings. This program requires latest 3 years of U.S. income taxes, and 6 years of FBAR disclosures. Previously, U.S. citizens were required to go back as far as they had records, which was a very daunting task for most people, particularly with the complexity of interpreting U.S. and Canadian tax rules and regulations (not to mention locating paperwork).
The “Streamlined Program” (effective September 1, 2012) allows taxpayers who are low compliance risks to get current with their tax requirements without facing penalties or additional enforcement action. These people generally will have fairly routine income tax returns and owe $1,500 or less in tax for any of the covered years. Taxpayers using the Streamlined Program will be required to file delinquent tax returns (1040, 2555, 1116 etc) along with appropriate related information returns for the past three years, and to file delinquent FBARs for the past six years. Submissions from taxpayers that present higher compliance risk will be subject to a more thorough review and potentially subject to an audit, which could cover more than three tax years. All other forms should be completed separately for each year, using the forms applicable to each of those taxation years and submitted to the required IRS taxation centre.
The “Streamlined Program” which became effective September 1, 2012 was expanded and modified by the IRS on June 26, 2014 to accommodate a broader group of taxpayers. The revised 2014 streamlined program is similar to the 2012 streamlined program in that the latest 3 years of income tax returns and 6 years of FBAR disclosures are required. However, the 2014 revised program has the following key changes;
- IRS eliminated the “low compliance risk” assessment for taxpayers who owe less than $1,500 or less in taxes for each of the reporting years. Instead, tax returns filed under the IRS streamlined program, now face the same potential audit risk and penalties which are associated with all U.S. income tax returns filed.
- FBARs for the latest 6 years must be electronically filed using the BSA / FinCEN internet portal. Previously, under the 2012 streamlined program, FBARs were paper filed.
- The streamlined procedures are available to both U.S. individual taxpayers residing outside the United States (the “Streamlined Foreign Offshore Procedures”) and U.S. individual taxpayers residing in the United States (the “Streamlined Domestic Offshore Procedures”). U.S. citizens living in Canada would typically be included in the Streamlined Foreign Offshore program.
- Taxpayers using either the Streamlined Foreign Offshore Procedures or the Streamlined Domestic Offshore Procedures will be required to certify, in accordance with the specific instructions, that the failure to report all income, pay all tax, and submit all required information returns, including FBARs (FinCEN Form 114, previously Form TD F 90-22.1), was due to non-willful conduct.
Taxpayers who are concerned that their failure to report income, pay tax, and submit required information returns was due to willful conduct and who therefore seek assurances that they will not be subject to criminal liability and/or substantial monetary penalties, should consider participating in the Offshore Voluntary Disclosure Program (OVDP) and should consult with their professional tax or legal advisers.
After a taxpayer has completed the streamlined filing compliance procedures, he or she will be expected to comply with U.S. law for all future years and file returns according to regular filing procedures.
Taxpayers using the IRS streamlined programs will be required to file delinquent tax returns (1040, 2555, 1116, etc) along with appropriate related information returns for the past three years, and to electronically file delinquent FBARs for the past six years. The delinquent tax returns should be completed separately for each year, using the forms applicable to each of those taxation years and submitted to the required IRS taxation centre.
Keep in mind that the IRS has really ramped up their offshore compliance programs, and with FACTA, essentially forces Canadian banks to share information with the IRS regarding U.S. citizens. My office has helped many clients through the streamlined program – all qualified, and aside from a few follow up queries from the IRS, all were accepted, and are now current with their U.S. income filings.
If you require further assistance, please contact my office to schedule an appointment. I don’t mind talking to you for a minute or so as an introduction. If you prefer to have a tax consultation prior to engaging my services, there is a fee for this service. We offer a 1 hour consultation during which time we will provide an in-depth review your situation, and provide specific tax guidance. I would greatly appreciate the consultation fee being paid at the time the meeting via personal cheque, credit / debit card, or e-interact. Thank you very much – I look forward to hearing from you and supporting you with your income tax filings.
As mentioned at the beginning, this article is about the U.S. and Canadian tax consequences of U.S. citizens living in Canada. Readers are cautioned that information in this article is for general purposes only and does not purport to provide specific advice. It also not an exhaustive list of tax considerations which might include; Capital Gains, Dividends, Controlled Foreign Corporations (CFC), Passive Foreign Investment Company (PFIC), Dividends paid out of a “Capital Dividend Account”, Foreign (non-US) Trusts, U.S. Estate Tax, U.S. Gift Tax, Generation Skipping Tax (GST). Individuals should consult with a tax professional. The author bears no responsibility for the use or dissemination of this information.
About the author
Derek Edelkoort, CPA, CGA, of Edelkoort Smethurst CPAs LLP, is Fully Registered in Public Practice with the Certified General Accountants of Ontario to provide Corporate and Personal Taxation, and Financial Statement Compilation services to the public, is an authorized Canada Revenue Agency (CRA) e-filer, and is also an Internal Revenue Service (IRS) Registered U.S. Paid income Tax Preparer. Derek Edelkoort is also an IRS Certified Acceptance Agent.
Derek provides U.S. income tax preparation services to U.S. citizens living in Canada, including the IRS Streamlined Program. Derek also provides U.S. income tax preparation services to Canadians who are considered “non-resident aliens” for U.S. tax purposes – for instance; Canadian taxpayers requiring Form 1040 NR and related filings for U.S. residential rental properties.
Derek Edelkoort, CPA, CGA,
IRS Registered Paid Tax Preparer and IRS Certified Acceptance Agent
Edelkoort Smethurst CPA’s LLP
Chartered Professional Accountants
4903 Thomas Alton Boulevard, Suite 207
Burlington, Ontario, Canada L7M 0M9