Why does the tax treaty between the US and Canada exist?
Published on May 20, 2024
by Aya Takriti
Aya Takriti, an IRS Enrolled Agent with 10 years of expat tax experience, specializes in US tax preparation, tax planning, and tax advice for US citizens and Green Card holders living and working in the Middle East. Aya speaks fluent Arabic and English and the odd word of German and Spanish if you catch her on a good day.
Table of Contents
Why was the tax treaty between the US and Canada established?
The US-Canada tax treaty was created to prevent double taxation for individuals and businesses that operate in both countries. This agreement ensures that income earned in one country by residents of the other is not taxed by both jurisdictions, lessening the tax burden for cross-border workers and enterprises.
You can explore the detailed provisions of this treaty on the official IRS website: Canada Tax Treaty Documents.
How can I claim benefits under the US/Canada income tax treaty?
- Understand Applicable Provisions: Start by understanding which treaty provisions apply to your specific situation, including rules related to dual residency, earned income, pensions, and investments.
- Filing the Correct Forms: To claim treaty benefits on your US tax return, file IRS Form 8833, Treaty-Based Return Position Disclosure, alongside your regular tax filing to detail the treaty benefits you are applying.
- Maintain Documentation: Keep thorough records and necessary documents from Canada, such as proof of tax residency or income statements.
- Seek Professional Advice: The complexities of the US-Canada Tax Treaty mean it is wise to consult with a tax professional who specializes in international tax laws to ensure accurate application of the treaty to your taxes.
Do US dual citizens living in Canada have to pay taxes to both countries?
As a dual citizen, your global income is taxable by the US, but the tax treaty allows you to mitigate double taxation. Both the US and Canada offer credits for taxes paid to the other country, which can be applied to reduce your tax obligations.
I want to know more about US taxes abroad
What are the mechanisms to prevent double taxation under the treaty?
The treaty provides several mechanisms to alleviate double taxation:
- Foreign Tax Credits (FTC): This allows taxes paid in one country to be credited against the tax liability in the other country, effectively reducing double taxation on the same income.
- Foreign-Earned Income Exclusion (FEIE): For 2023, US citizens and resident aliens can exclude up to $120,000 of foreign-earned income from their US taxable income, helping reduce the US tax burden for those earning income in Canada.
- Foreign Housing Exclusion (FHE): US expats can exclude or deduct certain foreign housing expenses from their taxable income, with the amount varying based on location and actual expenses.
What if there is a dispute over tax residency?
In cases where tax residency isn’t clear, “tie-breaker” rules outlined in the treaty are used to determine a taxpayer’s residency status for tax purposes. These rules help resolve scenarios where a person might otherwise be considered a resident of both countries, ensuring that taxation is fair and adheres to the established treaty framework.
How does the treaty address tax residency conflicts?
The US-Canada tax treaty provides a series of “tie-breaker” rules to determine tax residency when an individual qualifies as a resident in both countries:
- Permanent Home: Priority is given to where the individual has a permanent home.
- Center of Vital Interests: If a permanent home exists in both countries, the tie is broken based on where the person’s economic and personal ties are stronger.
- Habitual Abode: If it’s still unclear, the decision is based on where the individual spends more time.
- Nationality: If the above criteria do not resolve the issue, the person’s nationality is considered.
- Mutual Agreement Procedure: As a final step, tax authorities from both countries will collaborate to decide the residency status.
Why am I subject to US taxes while living in Canada?
The US employs a citizen-based taxation system, meaning that all US citizens and permanent residents must report and potentially pay taxes on their global income, regardless of where they live.
Does the treaty provide specific benefits for retirement savings?
Yes, the treaty offers several advantages for retirement planning:
- Tax-Deferred Growth: Investments within vehicles like Canadian RRSPs grow tax-deferred for US taxpayers until distributions begin.
- Deductions for Contributions: Contributions to recognized retirement plans can be deductible in the taxpayer’s resident country. This includes deductions for RRSP contributions on Canadian returns for US citizens residing in Canada.
What is the ‘Savings Clause’ in the US-Canada tax treaty?
The ‘Savings Clause’ is a provision that allows each country to tax its own citizens and residents as if the treaty did not exist, with some exceptions:
- General Rule: This clause primarily ensures that US citizens living in Canada remain subject to US tax on their global income, according to US laws.
- Exceptions: The treaty allows certain exceptions where specific income types, like pensions and social security benefits, can still enjoy treaty benefits despite this clause.
