Canadian individuals are well aware of the April 30 tax filing deadline for Canadian income tax returns. However, many Canadians may not be aware of the earlier April tax filing deadline of April 15 for United States tax purposes. A fundamental dichotomy exists between the basis for taxation in Canada and the U.S. While Canada’s taxation system is based on residency, meaning that residents of Canada are required to file and pay taxes in Canada on their worldwide income, the U.S. system for taxation is based on citizenship. This dichotomy translates into a dual filing obligation for certain Canadians with ties to the U.S (“U.S. persons”). Generally, U.S. tax issues for U.S. persons resident in Canada arise in the following areas:
- U.S. Citizens/ Green Card Holders
U.S. citizens or green card holders living abroad must file U.S. tax returns on an annual basis regardless of residency in respect of his or her worldwide income. Therefore, a Canadian resident who holds a U.S. citizenship must file both a Canadian T1 Income Tax Return and a U.S.1040 Income Tax Return. The U.S.1040 Income Tax Return is due April 15. However, U.S. citizens or U.S. green card holders living outside of the U.S. are granted an automatic extension to June 15 to file.
This dual filing obligation may not result in additional taxes owing for Canadians who file a U.S. tax return. The Canada-U.S. Tax treaty often shields a dual filer from double taxation as each respective country permits a foreign tax credit in respect of taxes paid in the other country. However, there are instances where the foreign tax credit is insufficient or unavailable to avoid additional tax in the other country. Examples of the most common transactions include the payment of a capital dividend by a Canadian corporation to a Canadian resident who is a U.S. person, or the disposition of shares by a Canadian resident (who is also a U.S. person) in a qualified small business corporation that may result in little or no Canadian taxes owing.
Even if a Canadian does not hold U.S. citizenship or a green card, he or she may still be subject to U.S. tax or filing obligations if the “substantial presence test” contained in the U.S. Internal Revenue Code is satisfied. Under the substantial presence test, U.S. residency is deemed to occur where the weighted total of the number of days spent in the U.S. over the last three years equals or exceeds 183 days, and the individual has been in the U.S. for more than 30 days in the current year. Generally, if an individual spends 183 days in the U.S. in any given year, he or she will meet the substantial presence test. However, if the Canadian instead regularly spends over four months a year in the U.S. (122 days), under the formula, he or she may still be considered to be a U.S. resident.
The substantial presence test is especially significant for employees working in the U.S. and for “snowbirds” who prefer the warmer climate provided in the U.S than Canada’s more taxing winter. If a Canadian satisfies the substantial presence test in any given year, the individual is automatically considered to be a U.S. resident for tax purposes and therefore subject to U.S. tax on U.S. source income. Notwithstanding that the substantial presence test is met, a Canadian may be entitled to an exemption from U.S. residency if he or she can claim the “closer connection exception” or a “treaty exemption”. Under either exception, the general principle is that the particular individual must have greater ties to Canada than the U.S. In cases where a Canadian has residential ties in both countries, the treaty provides tie-breaker rules to determine in which country the particular individual is resident for purposes of the Canada-US Tax Treaty. Note that the closer connection exception is not available if the particular individual spends more than 183 days in the U.S. in the current year, or the individual has applied for a green card. In order to claim either the closer connection exception or the treaty based exemption, a filing obligation exists in order to make the claim.
- U.S. Real Property
Another U.S. tax concern exists for Canadians who hold U.S. real property. In recent years, the number of Canadians buying real property into the depressed U.S. real estate market has increased exponentially. For those Canadians who hold U.S. real property and rent out the property, the income received is subject to U.S. tax. Furthermore, a disposition of the real property in the U.S. may also result in U.S. tax and could also result in Canadian taxes owing even though the Canadian taxpayer would be entitled to a foreign tax credit on the U.S. tax paid due to insufficient foreign tax credits or differing gains due to foreign currency fluctuations. Professional tax advice should be sought by a Canadian looking to acquire U.S. real property as it may be possible to mitigate tax exposure.
- U.S. Estate Tax and Gift Tax
Separate and apart from any Canadian tax issues on the death of a taxpayer, U.S. estate tax is also applicable in respect of U.S. citizens or green card holders. In order to prevent U.S. taxpayers from gifting his or her assets while living to avoid or reduce the impact of the U.S. estate tax, a U.S. gift tax also exists. While the particulars of the US estate and gift tax are beyond the scope of this article, these are other areas of note as the amount of tax can be significant.
- Report of Foreign Bank and Financial Accounts (“FBAR”)
Canadians holding U.S. citizenship or a green card are also subject to certain disclosure obligations. Foremost, is the requirement to submit a FBAR by June 30 each year if the individual has at any point in time in the year signing authority over a bank account with an aggregate value of USD $10,000.00 or more. The requirements for disclosure include popular accounts such as registered education savings plans (“RESP”) and tax-free savings accounts (“TFSA”). Note that while an RESP and TFSA can be a tax efficient vehicle from a Canadian tax perspective, from a U.S. tax perspective, the income derived may be subject to U.S. tax.
Considering the plethora of tax and filing obligations for Canadians with U.S. citizenship or a green card, Canadians should consider the benefit of U.S. citizenship against the increased compliance costs. For those Canadians, especially those who do not intend on living in the U.S., one option to consider is a renunciation of their U.S. citizenship. While a discussion of the renunciation process is beyond the scope of this article, the reader should be aware that such renunciation can result in a taxable event from a U.S. tax perspective if the individual’s net assets are significant enough. Anyone looking to renounce should also consider what impact, if any, such renunciation will have on the individual’s ability to travel to and from the U.S.
During the U.S. economic struggles, the U.S. debt load is increasing to historic levels and the U.S. government is looking for additional ways to increase its tax revenue. To do so, the U.S. is becoming more vigilant in collecting tax from foreigners and requiring foreigners to disclose more financial information. Given the close proximity of Canada to the U.S., it should come as no surprise that a majority of U.S. foreigners subject to tax under U.S. law reside in Canada. Canadians with U.S. ties must be cognizant of the issues discussed herein and seek professional advice to assist them with the various compliance obligations and planning to mitigate potential tax costs.
* The writers are not qualified to practice U.S. law and therefore the commentary herein should not be relied upon as tax or legal advice.