Top 10 Tax Considerations for
U.S. Citizens Living in Canada
Recent Canadian media reports have estimated that there are approximately one million U.S.
citizens living in Canada and that a relatively low proportion of this population is fully compliant
with their U.S. income tax and related filing obligations.
This problem is compounded by the fact that, by virtue of the definition of a U.S. citizen, there
may be individuals that are U.S. citizens without having a personal connection to the U.S., or
having even entered the country at all. In general, U.S. citizens include not only individuals who
were born in the U.S. and individuals who choose to become naturalized citizens of the U.S.,
but can also include children born in a foreign country with at least one U.S. citizen parent. If
you are a U.S. citizen living in Canada, it is important to be aware of the unique financial, tax
and estate planning issues that you may face.
The following article is for general information purposes only and does not provide tax or
legal advice. Please note that many of the topics discussed below are complex and a full
discussion of the all of the technical elements of these topics is beyond the scope of this
article. Taxpayers should seek advice from qualified cross-border tax advisors prior to
implementing any course of action.
1.
What are My U.S. Filing Obligations?
Unlike Canada, a U.S. citizen or permanent resident is taxed on his/her worldwide income on
the basis of citizenship and immigrant status rather than residence. Therefore, even if a U.S.
citizen has never lived or worked in the U.S., he/she is still generally obligated to file a U.S. tax
return, pay taxes and make certain financial disclosures
Even if a U.S. citizen has never lived or
to the Internal Revenue Service (IRS).
Some of the more common U.S. filing requirements for
U.S. citizens in Canada include:
•
worked in the U.S., he/she is still generally
obligated to file a U.S. tax return, pay taxes
and make certain financial disclosures to
the Internal Revenue Service (IRS).
Income Tax Return: U.S. persons (including U.S. citizens, U.S. residents and green card
holders) resident in Canada are required to file a U.S. federal income tax return (IRS Form
1040) for any year in which his/her gross worldwide income is equal to or exceeds the total
of the annual standard deduction and personal exemption amount. In 2013, for a single
person under the age of 65 who is not eligible to be claimed as a dependent by another
person, this amount is US$10,000. The thresholds vary for people with different filing
statuses.
For U.S. persons resident in Canada, the return is required to be filed by April 15. For U.S.
persons living abroad, the IRS allows an automatic two-month extension (June 15) to file
your return and pay any amount due. Where the foreign tax paid is equal to or exceeds
the amount of U.S. tax that would be paid on the same income, a foreign tax credit is
available and will generally be sufficient to offset any U.S. tax liability. For most Canadians,
the tax paid in Canada will be greater than the tax owing in the U.S. Therefore, there may
be no U.S. tax liability when filing a U.S. tax return.
•
FBAR: A U.S. person living in Canada will also likely have to file a Report of Foreign Bank
and Financial Accounts (FBAR). This form is filed separately from the U.S. federal income
tax return. In 2013, an individual is required to file a FBAR reporting each foreign account in
which he or she has a financial interest or over which he or she has signing authority, where
the total in all such accounts exceeds US$10,000 at any time during the year. Where an
individual owns over 50 percent of a foreign corporation by vote or value, the individual is
deemed to have a financial interest. Those who fail to file the FBAR may be exposed to
"ordinary" civil penalties of up to US $10,000 per account per year. Penalties for willful
failure to file can be much higher.
•
Form 8938: The Foreign Account Tax Compliance Act (FATCA) was enacted in 2010 as a
tool to address international tax evasion. For 2011 and subsequent years, FATCA requires
U.S. taxpayers to report their foreign financial assets with an aggregate value exceeding
certain thresholds on a new form, IRS Form 8938 (Statement of Specified Foreign Financial
Assets), with their annual tax return. Form 8938 requires certain U.S. taxpayers to provide
far more detailed information about their accounts along with other "foreign assets" that are
not reported on the FBAR. In 2013, the threshold for a U.S. couple filing jointly and living
abroad is US$600,000 at any time during the year, or US$400,000 at the end of the year.
Form 8938 is quite complicated, and reporting is expected to significantly increase many
individuals' accounting fees.
FATCA also requires Canadian financial institutions to register with the IRS and disclose
information about U.S. taxpayers who hold financial accounts at these institutions. FATCA
applies to all types of accounts such as insurance accounts, bank accounts and investment
accounts. Canadian financial institutions that fail to comply may be subject to a 30% U.S.
withholding tax on “withholdable payments” made to them.
•
Form 3520: IRS Form 3520 is the Annual Return to Report Transactions With Foreign
Trusts and Receipt of Certain Foreign Gifts. Taxpayers must use this form to report various
transactions involving foreign trusts, including the creation of a foreign trust by a U.S.
person, transfers of property from a U.S. person to a foreign trust and the receipt of
distributions by a U.S. person from foreign trusts. In addition, Form 3520 must be filed when
a U.S. person receives a gift of money or other property above certain thresholds from a
foreign person. The due date for filing Form 3520 is the same as the due date for filing an
annual income tax return, including extensions. U.S. persons may be penalized if they do
not file Form 3520 on time or if it is incomplete or inaccurate. Generally, the penalty is 5% of
the amount of the foreign gift for each month for which the failure to report continues (not to
exceed a total of 25%).
2. What Should I Do if I Have Not Complied With My U.S. Filing
Obligations?
Given the complexity of U.S. tax laws, it is easy for U.S. taxpayers living abroad to become noncompliant with their obligations under these laws. The IRS launched a series of amnesty
programs to offer relief to U.S. taxpayers who have not complied with their various obligations
under U.S. tax laws. These programs generally allow U.S. taxpayers to come forward and
voluntarily report undisclosed income and assets to the IRS without criminal penalties, and with
reduced monetary penalties.
The IRS has also indicated that they will not likely impose penalties on taxpayers who they
determine to be a low compliance risk. Among other criteria, the IRS has indicated that simple
income tax returns that show less than US$1,500 in tax due in each of the past three years will
generally be treated as low risk. Individuals with a higher risk level may be subject to a more
thorough review and possibly a full examination by the IRS.
3. Should I Hold My Funds in Registered Accounts or a TFSA?
For Canadian residents who are U.S. citizens, the Canadian benefits from retirement accounts,
RESPs and TFSAs may be more than offset by increased U.S. tax-compliance fees and
possibly U.S. tax liabilities.
Retirement Accounts
In Canada, the income earned by Canadian retirement accounts such as Registered Retirement
Savings Plans (RSPs) and Registered Retirement Income Funds (RIFs) is generally not subject
to Canadian income tax until its distribution from these plans. In contrast, RSPs and RIFs are
not tax-deferred under the U.S. Internal Revenue Code (IRC) and the income generated inside
these accounts technically is taxable income for U.S. tax purposes, even if the income is not
currently distributed. However, by virtue of an election in the Treaty, these accounts may
receive tax-deferred status in the U.S.
To make the election under the Treaty, U.S citizens must file IRS Form 8891, U.S. Information
Return for Beneficiaries of Certain Canadian Registered Retirement Plans, for each year the
account is held. A separate Form 8891 is required for each RSP or RIF account. Form 8891
requires certain information regarding the accounts, including the account number and the
balance held in the account at the end of the tax year. Form 8891 must be filed annually with
the individual’s U.S. income tax return. Failure to file the form will result in the accounts
becoming taxable in the U.S., and any income generated within the account must be reported
as income on the individual’s U.S. income tax return, even if no funds are withdrawn from the
account. This can lead to U.S. tax owing depending on the amount of income generated within
the account.
Under new IRS streamlined filing compliance procedures, U.S. citizens residing in Canada who
have failed to file these forms may use the procedures to become compliant, even if they have
previously filed their U.S. individual income tax returns.
Registered Education Savings Plan (RESP)
In Canada, an RESP allows money deposited for a child’s post-secondary education to grow on
a tax-deferred basis, with the income ultimately taxed in the child’s hands upon withdrawal.
There are also Government of Canada grants that match contributions to this plan, with certain
limitations.
For U.S. tax purposes, an RESP is not treated as a tax deferred plan, and is generally viewed
as a foreign grantor trust. Unfortunately, the RESPmay not be granted the same tax-deferral
election as RSPs/RIFs under the Treaty. Therefore, the income earned within the RESP is
generally taxable to the subscriber (i.e. the parent) on their U.S. income tax return in the year
the income is earned. This includes any interest, dividends, or realized capital gains or losses
on the contributions to the plan. Furthermore, any grants received from the Government of
Canada and income earned on such grants are taxable in the U.S. in the year they are received.
The parent/grantor must file Form 3520 (described above) with his/her U.S. tax return each
year. In addition, the trustee of the RESP must file IRS Form 3520-A, Annual Information
Return of Foreign Trust with a U.S. Owner each year. The minimum initial penalty for failure to
timely file Form 3520-A is US$10,000.
Tax Free Savings Account (TFSA)
A TFSA allows Canadian residents who are 18 or older to set money aside to earn investment
income free of Canadian tax throughout their lifetime. Up to CDN$5,000 (CDN$5,500 starting in
2013) can be contributed annually to the TFSA.
A TFSA is not a tax deferred account for U.S. tax purposes. In general, income received or
capital gains realized each year must be reported on the U.S. person's annual U.S. income tax
return. If a TFSA holds investments other than cash, or near cash items such as guaranteed
investment certificates, it is generally structured legally as a trust in Canada, though TFSAs
holding only cash could also be set up as trusts.
Where a TFSA is structured as a legal trust, a question arises as to whether it would be treated
as a "trust" by the IRS. If so, one must determine whether it should be treated as a US foreign
grantor trust and thus be subject to the Form 3520 and 3520-A information reporting described
above for the RESP, or treated as a bare nominee arrangement, in which case Form 3520 and
3520-A reporting is not required. In any case, income earned by the TFSA should be reported
on the U.S. account holder's annual U.S. income tax return.
4. What are the Tax Implications of Transferring My U.S.
Retirement Plan to an RSP/RIF?
Many individuals who have worked in the U.S. have invested funds in U.S. retirement plans,
such as Individual Retirement Accounts (IRAs) or 401(k)s. When these individuals move back
(repatriate) to Canada, they often ask their financial advisors whether they can also move the
savings in their U.S. retirement plans to Canada.
From a Canadian tax perspective, under certain conditions, the savings in U.S. retirement plans
may be withdrawn (subject however to U.S. withholding tax on withdrawal) and then transferred
and contributed to a RSP in Canada on a tax-deferred basis.
To transfer amounts from an IRA or 401(k) to a RSP in Canada, you would first have to collapse
your U.S. retirement plan and withdraw the funds as a lump sum. In general, only lump sum
amounts from an IRA or 401(k) can be contributed to and designated as a transfer to an RSP.
U.S. withholding taxes would apply on the withdrawal. In addition, if the holder of an IRA or
401(k) is under 59½ years of age at the time of withdrawal, the withdrawal may be subject to an
additional 10% “early distribution” tax in the U.S.
As a result of a designated transfer, assuming certain criteria are met, the savings in an IRA or
401(k) in the U.S. can continue to grow tax-deferred in your Canadian RSP. Furthermore,
designated transfers to an RSP will generally not affect your RSP contribution room.
U.S. citizens resident in Canada must report the transfer on their U.S. income tax return and
their Canadian income tax return. However, they will likely be able to claim a deduction for
Canadian tax purposes for some or all of the amount that is transferred into the RSP. In
addition, U.S. citizens in Canada may be able to reduce their Canadian income tax payable by
claiming a foreign tax credit for any U.S. taxes payable on the 401(k)/IRA transfer.
5. As a Home Owner, am I Entitled to the Principal Residence
Exemption?
Generally, Canadians living in Canada are not subject to tax on gains from the sale of their
principal residence. Under Canadian tax rules, the principal residence exemption reduces or
eliminates the capital gain that would otherwise arise on the sale of an individual’s principal
residence for each year during which the property was “ordinarily inhabited” by the taxpayer.
The U.S. has significantly different rules and definitions with respect to a principal residence,
which can result in unexpected U.S. taxes for those taking advantage of the Canadian rules.
The current U.S. rules allow for a maximum exclusion of US$500,000 from the gain on a sale to
be claimed on jointly filed returns (with a maximum of US$250,000 on single, head of
household, or married filing separate returns). Any capital gain exceeding the excluded amount
is taxed in the U.S. in the year realized.
Accordingly, U.S. citizens may be required to pay tax in the U.S. on the sale of their principal
residence in Canada to the extent that the gain on the sale of their principal residence exceeds
the U.S. exclusion amount.
6. As a Business Owner, am I Entitled to the $800,000 Lifetime
Capital Gains Exemption?
Upon the sale of shares of certain closely held corporations (Qualifying Small Business
Corporation Shares), Canadian residents are generally entitled to a lifetime capital gains
exemption of up to CDN$750,000 of the gain for Canadian tax purposes. In 2014, the
capital gains exemption is projected to increase to CDN$800,000. There is no parallel
exemption in the U.S. Accordingly, a U.S. citizen resident in Canada will generally be
subject to U.S. income tax on the entire gain upon the sale their Qualifying Small Business
Corporation Shares (generally at a rate of 20 percent).
7. What Are the PFIC Rules and How Do They Affect Me?
For U.S. tax purposes, Canadian mutual funds and Exchange Traded Funds (ETFs), even those
organized and treated as trusts for Canadian tax purposes, are generally considered to be
corporations and may be subject to the U.S. passive foreign investment company (PFIC)
regime. The PFIC rules are punitive and may involve significant reporting requirements and
costs. Therefore, for many U.S. persons living in Canada, it may not be economically feasible
or practical to hold Canadian mutual funds or ETFs.
In general, a PFIC is a foreign corporation that meets one of two tests:
•
•
Income Test - at least 75% of the corporation's gross income for the year is passive or
investment-type income; or
Asset Test - at least 50% of the average fair market value of its assets during the year
are assets that produce, or are held for the production of, passive income.
Since most Canadian-based mutual funds and ETFs primarily hold investments that are passive
in nature, they will generally be considered to be PFICs for U.S. tax purposes.
If a U.S. person receives income from a PFIC or recognizes a gain from the disposition of
shares of a PFIC, the negative U.S. income tax consequences of PFIC status generally include
the following:
• “Excess distributions" (a distribution in excess of 125% of the distributions received by
the U.S. shareholder over the last three years or their holding period, if shorter) are
subject to tax at the highest marginal rate, rather than at the taxpayer's marginal rate,
plus a non-deductible interest charge; and
• Any gain on the sale of the shares is treated entirely as an excess distribution (therefore
no capital gains tax rate applies).
A U.S. shareholder of a PFIC may, in certain circumstances, make elections to help mitigate the
adverse tax consequences of the PFIC rules.
U.S. persons who own shares of a PFIC must file IRS Form 8621, Information Return by a
Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund on an annual
basis.
The application of the PFIC rules to Canadian mutual funds held within certain retirement
accounts, such as RSPs or RIFs, was unclear for many years. However, the IRS has recently
released regulations that state that the PFIC rules do not apply to PFIC investments held in
RSPs and RIFs, as long as an election has been made by the U.S. person under the CanadaU.S. Tax Treaty.
In addition, the regulations provide an exemption from the PFIC reporting requirements:
1. for shareholders with PFIC assets that have an aggregate value of less than $25,000
($50,000 if couple filing jointly); and
2. for shareholders that hold PFIC shares through another PFIC, where the value of the
shareholder’s proportionate share of the upper-tier PFIC’s interest does not exceed
$5,000.
These exceptions apply only if the PFIC shareholder has not made a QEF or mark-to-market
election and has not received any excess distributions from the PFIC in the particular year.
Given the potentially punitive U.S. tax implications for U.S. persons living in Canada, careful
consideration of the PFIC rules should be factored into any analysis of whether a Canadian
mutual fund is a desirable investment.
8. Will I be Subject to U.S. Estate Taxes if I am Living in Canada?
As a U.S. citizen living in Canada, you may be subject to both the Canadian and U.S. tax
regimes at your death. As a Canadian resident, you are subject to Canadian income tax at
death. For Canadian income tax purposes, you will be deemed to dispose of your capital assets
upon your death for an amount equal to their fair market value at the date of death.
As a U.S. citizen, you are subject to U.S. estate tax on the fair market value of your worldwide
estate at the time of your death. Your worldwide estate includes all property owned at death,
regardless of where the property is located.
The U.S. estate tax rate starts at 18% and goes up to 40% when the value of your estate
reaches US$1,000,000. As a U.S. citizen, an individual is entitled to a lifetime estate tax
exemption of US$5.25 million (indexed annually), which is unified with the gift tax exemption.
This means that, as long as no portion of the exemption was used towards gift tax, no estate tax
is payable if your worldwide estate is valued at less than US$5.25 million (indexed annually).
You may also be entitled to a marital deduction or marital credit.
You may be entitled to some relief from double taxation under the Treaty. Under the Treaty,
Canada allows a federal credit for U.S. estate tax payable on your property situated in the U.S.
and the U.S. allows a credit for Canadian taxes payable at death on the deemed disposition of
your property located outside of the U.S. In the end, your estate generally pays the higher of the
two taxes. Because Canadian capital gains tax rates are lower than U.S. estate tax rates, your
estate will likely pay tax at the U.S. estate tax rate. Moreover, there is an element of double
taxation because the foreign tax credit is provided only at the federal level.
9. Am I Subject to the U.S. Gift Tax Regime?
The U.S. imposes a gift tax on transfers of property where the transfer is gratuitous, meaning
nothing of value is received in exchange for the gift, or where the transfer is partly gratuitous.
This gift tax is imposed on the donor.
It should be noted that gifts to a U.S.-citizen spouse are generally not subject to gift tax.
However, if your spouse is not a U.S. citizen, you will be subject to gift tax if your annual gift to
your spouse is more than US$143,000 (in 2013, indexed annually). A lifetime gifting limit of
US$5.25 million (indexed annually) is allowed before gift tax is incurred, however this exemption
must be shared with the estate tax exemption (see above).
In addition, U.S. persons are entitled to an annual exclusion of US$14,000 (indexed annually)
for gifts made to anyone other than a spouse. For example, if you have four children, you can
give up to US$56,000 to your children in 2013 and not be subject to U.S. gift tax. You will not be
required to file a gift tax return and the US$56,000 gift will not reduce your lifetime gift and
estate tax exemption amount.
10.
Should I Renounce My U.S. Citizenship?
Given the onerous U.S. income tax and information reporting requirements imposed on U.S.
citizens, some U.S. citizens have considered renouncing their U.S. citizenship, or “expatriating”.
The act of expatriation typically results in the individual being considered a non-resident of the
U.S. for income tax purposes and therefore only subject to U.S. income tax on U.S. source
income and subject to estate and gift tax on U.S. situs property only.
Prior to making this decision, you should be aware that as a result of significant changes to the
expatriation regime that were introduced on June 17, 2008, individuals renouncing their U.S.
citizenship may be subject to a more onerous expatriation regime.
There are generally three major adverse consequences upon expatriation:
1. an exit tax, modeled on Canada's deemed disposition rules;
2. increased withholding on certain U.S.-source income items; and
3. a gift tax on future gifts and bequests to U.S. persons.
The adverse consequences of expatriation generally apply only to a person who is a "covered
expatriate" (CE). In general, a CE is a person who meets one of the following three tests:
1. the taxpayer's net worth exceeds U.S.$2 million on the date of expatriation;
2. the taxpayer's average annual U.S. income tax for the five years preceding the year of
expatriation exceeds US$155,000 (for 2013); or
3. the taxpayer fails to certify full compliance with U.S. tax obligations for each of the five
years preceding expatriation.
Note that the first two tests generally are not applicable to:
1. certain dual citizens of the U.S. and another country; and
2. certain U.S. citizens who are under 18½ years of age.
If you are thinking about renouncing your U.S. citizenship, you should obtain professional advice
from a qualified U.S. tax advisor. In addition, you should seek the advice of a U.S. immigration
attorney to understand any issues that may arise should you decide to work or visit the U.S.
after renouncing your U.S. citizenship.
This memorandum was not intended or written to be used, and cannot be used, for the
purpose of avoiding tax-related penalties under U.S. federal, state, or local tax law. Each
taxpayer should seek advice based on its particular circumstances from an independent
tax advisor.
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