Regulations and monitoring of US citizens and Green Card holders living outside of the US has increased over the last few years. The penalties for not complying are severe, and effective tax planning is vital.
Do US citizens pay tax on Canadian income?
US citizens or Green Card holders living in Canada have to report their worldwide income to the Canada Revenue Agency (CRA) and the US Internal Revenue Service (IRS). Thanks to the Tax Treaty, taxpayers are not likely to pay tax to both countries (although there are exceptions).
In practice, if you’re living in Canada, you’ll pay tax to the CRA and pick up a tax credit for what you’ve paid, and that can be used to offset your US taxes.
Income tax rates in Canada are higher than they are in the United States, so typically you’ll always have enough “credit” to offset all of your US taxes, leaving you with nothing owing to the IRS.
US citizens have to pay taxes on foreign income if they meet the filing thresholds. Whether you owe taxes to the US is dependent on citizenship, not residency.
Taxable foreign-earned income includes:
- Rental income
While you aren’t exempt from your US tax obligations, there are exclusions and credits, such as the Foreign Earned Income Exclusion, Foreign Housing Exclusion and Foreign Tax Credit. These help to reduce the tax liability of US taxpayers living abroad.
Tax considerations for US citizens in Canada
As an investor, you may owe additional tax due to inadvertently investing in PFICs (Passive Foreign Investment Companies). If you’ve invested in a PFIC, you’ll need to file additional complicated tax reporting.
Additionally, retirement account holders will often find that their 401(k) has been frozen with no management of the assets.
Tax traps every US citizen living in Canada should be aware of
As a US person living in Canada, here are some common things to avoid:
- Retirement Education Savings Plans (RESP), as certain investments within the RESP can be considered as PFICs by the IRS and that can lead to double taxation. The grants are taxable to the US parent, meaning that the American parent could be taxed on its growth and grants, while the child is taxed by the CRA when they take the money out.
- Some types of TFSAs may contain PFICs as categorized by the IRS too. This means you’ll face additional tax filing requirements and won’t benefit from tax free growth or income.
- Canadian Mutual Funds and Canadian ETFs can also house PFICs. You can still use US ETFs and mutual funds without PFIC issues.
- Investing in a Canadian Holding Company that produces passive income, as this creates costly and complicated tax filings, and can be considered a PFIC or Canadian Foreign Corporation (CFC). US GILTI (Global Intangible Low-Taxed Income) tax may apply, if profits from the CFC exceed 10% on the CFC’s depreciable tangible assets.
- US citizens living abroad can legally create tax free savings accounts, also known as a TFSA in Canada. A big question for many American expats living in Canada is whether they need to file for the IRS forms 3520 and 3520-A as a result of owning their TFSA.
Revenue Procedure 2020-17 came out at the beginning of the year and specifically covers foreign trusts that are allowed to forgo the forms 3520 and 3520-A. These are funds that are set up for a specific reason, such as a college or a disability fund. Unfortunately, TFSAs do not meet the requirements laid out in revenue procedure 2020-17, meaning that if your TFSA meets the below conditions then you will have to file the forms 3520 and 3520-A
Luckily, most expats with a TFSA, forms 3520 and 3520-A only need to be filed if your savings account meets the definition of a trust. However, this leaves many people unsure of their taxation requirements as the IRS has never actually stated whether a TFSA is a trust or not. This means that a TFSA’s status as a trust is dependent on the specific clauses laid out when you opened your savings account.
How is the US tax system different from the Canadian tax system?
Single Filer or Married Filing Jointly
In Canada, you only have the option to file your income tax return as an individual. You’re not able to file jointly as a married couple.
Income Tax Rates
In the US, some states don’t have income tax. In Canada, all provinces have provincial tax.
In terms of federal tax, rates in the US range from 10% to 37% and in Canada range from 15% to 33% of taxable income.
Tax based on Citizenship or Residency
In the US, you’re taxed based on your citizenship rather than residency. This means that if you are living in a foreign country but are a US citizen, you’ll have to pay taxes on your worldwide income. In comparison, in Canada you’re taxed based on your residency. This means that if you live in Canada, you must file a tax return to the Canada Revenue Agency (CRA).
A person’s principal residence in the US has a capital gains exclusion of USD $250,000 if single, or $500,000 if married and filing jointly. You’re eligible for this exclusion if you’ve lived in the home for 2 of the past 5 years immediately preceding the sale of the home, and you can’t have used this exclusion on another home in the last 2 years. For any capital gains above this amount, you’ll pay tax.
In comparison, in Canada there is a principal residence exemption and any capital gain on your residence is tax free.
In the US, there is a one-off tax at death called the Estate Tax.
Capital Gains Tax
In Canada, 50% of your capital gain is taxed at your marginal income tax rate regardless of how long an asset is owned. Investors pay long-term rates if the asset was held over one year, or short-term rates if held for less than a year. The short-term capital gains are taxed as ordinary income at an investor’s current tax rate. Long-term capital gains are taxed more favorably. The rate ranges from either 0%, 15%, to at most 20%.
Social Security and CPP Rates
In the US:
- Employees pay 7.65% of their taxable income into Social Security and Medicare.
- US healthcare is primarily paid out of pocket.
- Employees pay 4.95% of their taxable income into CPP and medical benefits are included.
- The income taxes Canadians pay fund socialized health care.
Because U.S resident employees pay a higher percentage of their income into social security, they receive higher monthly benefits in retirement than a person who earned the same income and paid into CPP in Canada.
Step-up Basis vs. Cost Basis
In the US, when someone dies, the person who is inheriting an asset applies the current fair market value as their cost basis – meaning that the gains from when the initial person owned the asset to when they passed away is not taxed.
In Canada, when someone dies, the estate has to pay the taxes before transferring the proceeds to the beneficiaries, unless there is a surviving spouse. Assets are assumed to have been sold the day before the death at fair market value.
The main aspects of the US-Canada tax treaty
The US and Canada have a tax treaty to help their taxpayers and avoid double taxation. This is achieved through foreign tax credits. A resident of Canada will have paid tax in Canada and therefore will not be taxed again on this income on their U.S. taxes. Usually the combined Canadian federal and provincial personal income tax rates are higher than the combined U.S. Federal and State personal income tax rates.
The main provisions to be aware of are:
- Article X provides for a reduced rate of taxation on qualifying dividends
- Article XI provides for a reduced rate of taxation on qualifying interest income
- Article XV provides for an exclusion of qualifying income (provided it does not exceed $10,000) from dependent personal services
- Article XVIII provides for a reduced rate of taxation on qualifying pensions
US-Canada double taxation
The US-Canada Income Tax Treaty prevents double taxation by exempting US citizens from taxation on their income earned and taxed in Canada. However, when US people invest in products or structures that fall outside of the treaty, this won’t apply. A common example is holding an RESP, in which case the US subscriber and beneficiary may end up paying double tax.
Canadian Social Security
As the US and Canada have entered into a Totalization Agreement, you won’t have to pay social security taxes to both countries on the same earnings. If you pay Canadian Social Security, you most likely won’t have to pay US Social Security. Whether you pay to the US or Canada is dependent on the circumstances of your employment.
When am I a resident of Canada for tax purposes?
You’re considered a resident of Canada for tax purposes when:
- You spend more than 183 days in a calendar year in Canada
- Your primary residence is in Canada (significant residential ties to Canada are a home in Canada, dependents in Canada, or a spouse/common-law partner in Canada. You can be a daily commuter crossing the border to work in Canada and still be considered a U.S. resident while living in Canada if you don’t have the above significant residential ties to Canada).
I want to know more about US taxes abroad
Canadian tax rates
For the 2022 tax year, the income tax rates are:
|2022 Taxable Income||Tax Rates|
|over $46,226 up to $92,454||9.15%|
|over $92,454 up to $150,000||11.16%|
|over $150,000 up to $220,000||12.16%|
For the 2021 tax year:
|2021 Taxable Income||Tax Rates|
|$0 to $42,184||5.06%|
|$0 to $42,184||5.06%|
|$42,184.01 to $84,369||7.70%|
|$84,369.01 to $96,866||10.50%|
|$96,866.01 to $117,623||12.29%|
|$117,623.01 to $159,483||14.70%|
|$159,483.01 to $222,420||16.80%|
Can you collect CPP?
U.S. citizens may be eligible for the Canada Pension Plan (CPP) if they worked in Canada after the age of 18 and paid into CPP through payroll deductions. They also may receive credits from a former spouse or former common law relationship.
All US citizens must report all foreign financial assets to the Treasury department every year, if the total value of their funds (across all accounts) reaches $10,000 at any point. The penalties for failing to file an FBAR are harsh. If you wilfully didn’t file, penalties can be as much as $100,000 USD or 50% of the amount in the account.
Transferring a 401k/IRA to Canada
It is possible to move a 401(k) into a rollover IRA, and then into a RRSP/RRIF, this isn’t a great option. There are complications when transferring an IRA to a RRSP/RRIF.