Let’s discuss US expat taxes in Canada
There are more than one million U.S. expats living in Canada and paying tax to the Canadian government. All of them are still required to file a U.S. tax return every year, report their worldwide income and pay any tax imposed by U.S. laws.
It is usually unnecessary to invoke the treaty to prevent double taxation. This is because both jurisdictions recognise foreign tax credits. Read more about foreign tax credits here – https://htj.tax/2021/04/lets-talk-about-foreign-tax-credits-form-1116/
Regardless, the tax laws differ greatly between the two countries.
As previously mentioned, all US exposed persons must comply with US tax rules regardless of where they reside. A return is due even though no taxes may be payable.
Under the treaty with the U.S., Canada shares taxpayer information with the IRS. For example, Canadian banks must report information to the IRS on their U.S. account holders.
If a U.S. expat has financial accounts in Canada and elsewhere? An (Foreign Bank Account Report) FBAR and/or Form 8938 may also be due – https://htj.tax/2020/10/fbars-and-form-8938-2/
Assets in this category include registered retirement savings plans, stock, pensions, annuities, partnership trusts, mutual funds, and insurance contracts. This form is required to ensure that the income attributable to these assets is properly reported on the individual’s U.S. 1040 income tax return.
Canadian Tax Status
Who is a Canadian resident for tax purposes, and what does it mean? Generally speaking, someone is a Canadian resident for tax purposes if:
- They have significant residential ties to Canada i.e. their home is in Canada,
- Their spouse lives in Canada,
- and/or their dependents live in Canada.
That means that they are subject to income tax in Canada on their worldwide income. It can also include various potential reporting obligations. We did a comprehensive livestream here – https://htj.tax/2023/01/taxes-in-canada-for-entrepreneurs-investors-expats-and-nomads-18th-january-2023/
Other Reporting Requirements
The IRS also requires expats to report shares they may have in a Passive Foreign Investment Company on form 8621. This includes owning non-U.S. mutual funds. It also includes dividends, interest, rent, royalties, capital gains from the sale of securities- https://htj.tax/2015/08/what-is-pfic/
Persons who have an investment in a foreign corporation may need to file a 5471 form. They may also have to file form 5471 in the year in which they obtain 10% or go from owning more than 10% to less than 10% –https://htj.tax/2014/03/the-scariest-us-tax-form-ever/
Avoid Double Taxation
The vast majority of expats living in Canada rarely pay any taxes to the U.S. government, because their tax bill in Canada is higher than it would be in the U.S. As explained above, foreign tax credits allow them to offset taxes paid to the CRA against liabilities to the IRS.
- There are a number of tax free financial instruments available under Canadian law, which are taxable under U.S. law. These include Registered Retirement Savings Plans, Tax Free Savings Accounts and Registered Educational Savings Plans, Canadian-based mutual funds, and capital gains on selling one’s primary residence.
- Under the treaty, US social security benefits paid to a resident of Canada are taxed in Canada as if they were benefits under the Canada Pension Plan. However, 15% of the benefit amount is exempt from Canadian tax. That means, if you receive US Social Security benefits and are a resident of Canada, Canada will tax 85% of the benefits you receive. Of course, you can take a Foreign Tax Credit on your US tax return.
- The US tax treatment of the Canadian pension plan will depend on the type of retirement plan. Previously, a typical Canadian retirement plan was at risk of being a PFIC (Passive Foreign Investment Corporation). A PFIC incurs unfavorable tax treatment in the US as explained in the link above. However, in 2020, the IRS just announced that these pension plans are no longer considered as PFIC.
- You can take a charitable deduction on your US return for contributions made to Canadian charities. If you have both US and Canadian income, the amount you can deduct will depend on your adjusted gross income and how much of it you earned in each country.
Registered Retirement Savings Plans (RRSPs) for U.S. Persons in Canada? RRSPs qualify as a “do”.
Why? A U.S. Person living in Canada should strongly consider RRSP contributions if they do in fact generate RRSP contribution room. While the RRSP is subject to FBAR and FATCA reporting, significant relief is provided by the Canada-United States Tax Convention5 (“the Treaty”) from a tax standpoint.
What is the key benefit of Treaty coverage? Normally, when a U.S. Person makes contributions to what is considered a “foreign grantor trust”, they are subject to tax on the income earned in the trust. However a RRSP is treated as a pension plan under the Treaty. Then, an automatic tax deferral is granted in the U.S. on income or capital gains earned in these plans.
Any other benefits? In the case of a RRSP, also exempt from extra filing requirements under the foreign trust rules. i.e. Forms 3520 and 3520-A. A RRSP as a savings vehicle is also preferred as it avoids the complex Passive Foreign Investment Company (PFIC) filing requirements in the U.S. per Form 86216. Did you know that PFIC forms are not required for mutual funds held within a RRSP?
What happens when you start a RRSP/RRIF withdrawal? Upon withdrawal from a RRSP/RRIF, the entire amount is taxable in Canada, but in the U.S. the original contributions are non-taxable. This calculation can be complex, but ultimately double taxation is typically eliminated via the foreign tax credit. Due to all these factors, RRSPs are a preferred retirement savings vehicle for U.S. Persons living in Canada. The benefits as noted also apply in the case of RPPs, group RRSPs, PRPPs and equivalent pension accounts such as LIRAs/LIFs.
A word of caution: In the case of spousal RRSP contributions, U.S. gift tax rules may result in double taxation. That will depend on the level of the contribution and whether the spouse is a U.S. citizen as well.
Non-Registered Investments for U.S. Persons in Canada? “Do” …. but keep it simple.
If you want to invest in mutual funds or exchange-traded funds (ETFs) in a non-registered environment, there are several considerations. Especially as it relates to U.S. reporting requirements. Canadian mutual funds trusts, corporate class mutual funds and ETFs are considered PFICs. Without diving into the specifics of the underlying definition7, we will focus on the key considerations when investing in a PFIC.
Why is a PFIC a big deal? If you invest in a PFIC, you will be required to submit Form 8621 with their U.S. tax return. This form is highly complex and must be submitted for each individual PFIC held. The reconciliation process can take several hours to complete. Read more here – https://htj.tax/2015/08/what-is-pfic/
Tax Free Savings Account (TFSA) for U.S. Persons in Canada? “Don’t” … for the most part
While income earned in a TFSA is tax-free for Canadian tax purposes, for a U.S. Person it is fully taxable in the U.S. Unlike the RRSP, it is not covered by the Treaty. It does not receive the same favourable treatment. Depending on what you invest in, another 8621 Form may be required.
Are foreign reporting requirements relaxed to any extent? Revenue Procedure 2020-17 issued March 2, 2020, provided guidance and relief for U.S. Persons with tax-favoured Canadian foreign trusts. It includes specifically Registered Education Savings Plans (RESPs) and Registered Disability Savings Plans (RDSPs)9. This was welcome news as Form 3520, Annual Return to Report Transactions with Foreign Trusts, and Form 3520-A, Annual Information Return of Foreign Trusts with a U.S. Owner, were previously required for RESPs and RDPSs. They are also costly and time consuming.
Why is the 2020-17 Revenue Procedure relevant for TFSAs? There has been a healthy debate as to whether or not a TFSA would qualify as a tax-favoured trust for the purposes of the exemption, as the IRS doesn’t explicitly mention the TFSA within the Revenue Procedure.
What about RDSPs and RESPs? “Don’t” … unless you can avoid common pitfalls
Just like a TFSA, RDSPs and RESPs are taxable for U.S. Persons, and subject to U.S. filing and reporting obligations – aside from forms 3520 and 3520-A as noted above. If a U.S. Person is a subscriber, they are subject to U.S. tax on earned income within the RESP, government grants (and bonds) received within the RESP, and income earned on those grants and bonds. The amounts are fully distributed to the RESP beneficiary. Even if a non-U.S. Person contributes to a RESP with a U.S. subscriber, those amounts, plus the proportionate grants and bonds, would be taxable to the U.S. subscriber. There are additional tax considerations at death as well.
When can RESPs be more appealing? Ideally one of the parents of a child is not a U.S. Person, in which case the cross-border tax headaches may be avoided. If the subscriber is a non-U.S. Person and there is no U.S. contributor, the RESP will generally qualify as a foreign non-grantor trust which can yield a better tax result
Consider the tax status of the beneficiary given the fact that one or both of their parents may be a U.S. Person. In the case where the RESP beneficiary is a U.S. Person, the U.S. tax impact can be undesirable given the harsh “look-back” provisions. Once withdrawals begin, the U.S. beneficiary may be taxed punitively on the distribution that represents income that has accumulated in the plan but not paid out in the year it was earned. There is also a resulting interest charge on the income that is considered accumulated income. Foreign tax credits can help to an extent given that a portion of the withdrawals will also be taxable in Canada. A U.S. beneficiary may also be subject to annual filing requirements given the status of the RESP as a foreign non-grantor trust. Gift taxes may also apply in certain circumstances.
Did you know? If the U.S. Person simply contributes to a RESP, the RESP may still be considered a foreign grantor trust. This would result in the same tax treatment as if they were a U.S. subscriber.
Overall, the best way to avoid these potential traps, is to have a non-U.S. parent be the contributor and subscriber of the RESP, if possible. It may still be worthwhile if it’s not possible given the available grants and bonds. In that case, the RESP won’t be tax-sheltered in the U.S. and the complexity factor would ramp up considerably. The U.S. beneficiary trap may be something that is unavoidable, however.
What if you are a non-U.S. subscriber, but the successor spouse is a U.S. Person? If the non-U.S spouse is the contributor/subscriber, they may be able to minimize U.S. reporting from the parents’ perspective during the non-U.S. spouse’s lifetime. If the subscriber spouse passes away, and the U.S. spouse is named as the successor subscriber, the plan may be reclassified as a foreign grantor trust thereafter and subject to U.S. tax. This may be the only reasonable course of action if there is no other appropriate successor subscriber in the family. If a non-U.S. grandparent, or aunt or uncle etc., could otherwise be named as successor subscriber that may yield a better tax result. However, considerations pertaining to the parameters of the plan and the level of trust placed upon the potential successor subscriber should be reviewed.
Are there any other unique considerations for RDSPs?
Many of the same considerations apply as with RESPs, as a U.S. holder in the case of an RDSP would also typically imply a foreign grantor trust for U.S. tax purposes. i.e. the U.S. holder would be subject to U.S. tax on contributions, grants and bonds, not to mention multiple filing obligations. As with the RESP, it may be better to structure a RDSP with the holder being a non-U.S. Person, if possible. Consider whether the beneficiary is a U.S. Person as that could create additional filings and income tax exposure.
Self-Employed Taxpayers in Canada
The Canada Revenue Agency (CRA) taxes self-employed Americans conducting business in Canada on their net profits (income minus expenses) if they have a permanent establishment there. A permanent establishment is a fixed place of business through which you are conducting business. This can be
- A brick and mortar office or building such as a warehouse or factory, or
- An agent (person) who is a Canadian resident performing actions on behalf of the business.
Even if you don’t have a brick-and-mortar building and don’t reside in Canada continuously, the CRA may still treat you as if you had a permanent establishment. This applies to you if you meet one of the two criteria:
- If you are present in Canada for more than 183 days during a 12-month period and during that time you earned more than 50% of your gross income from services you performed in Canada; or
- Your business provided services for 183 days or more to residents of Canada or to other businesses that have a permanent establishment in Canada.
Since the US and Canada have a Social Security Totalization agreement, it generally means you will only be paying self-employment tax to the country you are residing in while self employed. It is important to obtain a certificate of coverage from the local Canadian office to be able to show the IRS you are paying into their system.
US LLC Taxed as a Corporation in Canada
Canada does not treat a US Limited Liability Company (LLC) as a pass-through entity like the US does. Instead, Canada does not recognize and tax this entity structure as anything other than a corporation.
Corporate and provincial taxes are due. Furthermore, an additional 25% branch profits tax may be due on any amounts earned above CAD $500,000.
Depending on the structure of your LLC, certain tax treaty benefits may apply that will help reduce your Canadian tax liability.
Consult with an experienced international tax accountant. You should speak with a US / Canada tax team.